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Tax relief in Iowa -- what will that mean?

Joe Kristan is a founding member of Roth & Company P.C.
Big changes in Iowa tax are suddenly likely next year as a result of the election of a Republican Iowa Senate. Now that tax changes can pass without bipartisan agreement, the incoming Senate majority leader, Bill Dix of Shell Rock, promises "tax relief" legislation in the coming Iowa General Assembly session.

One approach to tax relief is a tax cut. While the new Legislature might like to cut taxes all around, they probably need to cut spending to do so. Under current revenue projections, the state isn't expected to be collecting much revenue that it won't be spending right away. Spending cuts are hard (though if I were king, I'm sure I'd find some), so straight-up tax cuts are hard.

Fortunately, reducing tax revenue isn't the only way to relieve burdens caused by the tax law. A simple tax system with low rates and a broad base is less burdensome than one with high rates and complex special breaks for the well-advised and well-lobbied. The Legislature could provide tax relief by improving the tax system itself.

Iowa taxes need fixing. Iowa's business tax system consistently rates poorly in the Tax Foundation's State Business Tax Climate Index. We have the highest corporation tax rate in the nation, and our individual income tax rate is no bargain, either. Meanwhile, the tax base is hollowed out by special-interest tax breaks and economic development incentives. That makes the system inefficient and costly to comply with. It also means similar taxpayers can end up with wildly different tax burdens.

The Legislature has a road map pointing the way to a better system. Earlier this year the Tax Foundation released "Iowa Tax Reform Options: Building a Tax System for the 21st Century." It is the result of extensive research into the Iowa tax system and dozens of interviews with Iowa taxpayers and tax policy figures. It provides a menu of tax policy options that would give Iowa a better tax system without reducing state revenues. 

My favorite set of proposals from the "Iowa Tax Reform Options" study is its "Option A":

· A 5.15 percent flat individual income tax made possible by the repeal of federal deductibility and business tax credits, which also has the effect of eliminating the marriage penalty. 

· The retention of the current standard deduction of $1,970 and the $40 personal exemption credit.

· The repeal of both individual and corporate alternative minimum taxes. These add much complexity to Iowa's tax law while collecting little revenue.

· A 6.5 percent flat corporate income tax with the repeal of federal deductibility and all business tax credits. 

· The restoration of a three-year net operating loss carryback.

· The exclusion of business inputs from the sales tax base.

· The repeal of the inheritance tax.

This would be a tremendous improvement over the current system. We now have an 8.98 percent federal top individual rate and a highest-in-the-nation 12 percent corporate tax rate. Option A would reduce rates, lower compliance costs and retain popular breaks such as the Section 179 deduction and the earned income credit. It would also raise as much revenue as the current system.

What about Kansas? Some commentators fear tax relief efforts because Kansas botched its tax reforms a few years ago. That state still is struggling to balance its budget because of an ill-considered tax cut package.

Fortunately, there are better examples. North Carolina recently enacted tax reforms largely informed by Tax Foundation analysis. The reforms improved the state's ranking in the Business Tax Climate Index by 28 places, to 16th place. The state's financial health has also improved, with cash reserves higher now than before the reforms were enacted.

Tax relief is hard when you can't get by with less revenue. Fortunately, the Legislature can reduce tax burdens and make Iowa a better place in which to do business while keeping the state financially sound.


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