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Big costs, few real breaks

Posted April 17th, 2018 to Blog

The latest tax bill to emerge from the Iowa House would take $90 million from the state budget, robbing the ability of the state to adequately fund education, mental health, and public safety. And yet Iowans will see so little in return that most will not even be able to tell they got a tax cut.

By the time the House bill’s provisions  are fully phased in (fiscal year 2021), the income tax cuts and sales tax modernization measures will result in about $90 million a year less revenue flowing to the state’s general fund than was projected before the federal tax bill was passed.[1] After years of revenue shortfalls and budget cuts, the House bill would guarantee that those problems will continue.

Iowa is one of only three states where you can deduct your federal income tax before computing your income subject to Iowa tax. As a result, the federal tax cut bill will reduce that deduction and increase your Iowa taxable income and your Iowa income tax. But that effect is tiny. If the state were to do nothing at all, taxpayers would still keep 94 to 98 percent of the federal tax cut (see table below).

House plan offers little break for individuals, at great cost to services
Combined effects of Iowa House tax plan and federal tax changes

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Source: Institute on Taxation and Economic Policy, Washington, D.C.

The House bill goes beyond what would have been needed to restore the small tax increases due to federal deductibility. It makes a number of changes in the income tax, including an increase in the state standard deduction. Overall, it reduces income taxes for those in the middle three-fifths of Iowa taxpayers by about $100 to $155 a year. The bill also modernizes the state sales tax, and those measures would bring in about $73 million a year from Iowa residents, and cost the middle income taxpayer $37 to $60 a year.

The net effect of all of this is an average tax cut of just $29 to $53 a year for those in the middle three-fifths of Iowa taxpayers, and smaller amounts for others. In other words, despite all the hoopla, the average taxpayer is going to hardly notice the effects of this bill — another three or four dollars a month.

Let’s just walk that through for a household with income of $53,000, which would put them right in the middle of all Iowa households. They can expect to pay $860 less in federal taxes, with federal deductibility taking back just $26 of that in state income taxes — they get to keep 97 percent. Then they get a $122 income tax cut and a $47 sales tax increase from the House tax bill. Net effect: $860 less in federal taxes, $49 less in state taxes.

While the tax savings are insignificant — three or four dollars a month — the House bill will take all that back and much more for many Iowa families. Tuition at public universities and community colleges will continue to rise because public funding will not be able to keep up with costs. School districts will be forced to enact more cuts as state funding fails to keep pace with inflation. Mental health initiatives will remain underfunded.

[1] Iowa Department of Revenue memo to Jeff Robinson, April 17, 2018. This is the net revenue loss compared to projected revenues before the federal tax bill was passed. The revenue loss compared to Iowa tax revenue including the windfall gain from federal deductibility ($178 million) would be $269 million in FY2021.

2010-PFw5464Peter Fisher is research director of the nonpartisan Iowa Policy Project. pfisher@iowapolicyproject.org

Governor’s budget: More details needed

IFP Statement — IPP’s Peter Fisher: Eliminating federal deductibility and adding sales tax for online transactions are good starts. Still, many reasons to question Governor Reynolds’ plan.

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IOWA CITY, Iowa (Feb. 13, 2018) — The Iowa Fiscal Partnership today released the following statement from Peter Fisher, research director of the nonpartisan Iowa Policy Project, about Governor Kim Reynolds’ tax proposals.

Governor Reynolds today reinforced her commitment to eliminate federal deductibility, which has long distorted a clear picture of what Iowans pay in income taxes. Iowa is one of only six states that permit a state tax deduction for federal taxes paid, and one of only three that allow a 100 percent deduction. Ending that archaic provision is a good start.

So is her proposal to collect sales tax from online retailers, to level the playing field between national retail giants and brick-and-mortar Main Street businesses. But there is much to question.

Our initial review indicates her plan misses the mark of what is needed for true, responsible reform of Iowa individual income taxes, let alone the overall system that taxes lower-income Iowans more heavily than the wealthy.

State taxes need to be more fair to low-income Iowans and need to better assure adequate revenue for critical services, such as education. There is no assurance of the latter in the Governor’s plan, which promises cuts in income taxes by $1.7 billion by 2023 with no impact on expected revenue growth; this claim demands more information and scrutiny.

Past analysis has shown Iowa could eliminate federal deductibility and reduce its top rate of income tax below 7 percent while remaining revenue-neutral and — with the right combination of other changes — retain or enhance the fairness of the income tax. Missing from the plan is a crackdown on Iowa’s rampant spending on business tax credits and any effort to plug corporate tax loopholes, which could gain the state as much as $100 million.

The proposal acknowledges that Iowa’s tax system does far less than the federal to acknowledge the cost of raising a family. But nothing is proposed to remedy that problem beyond eliminating federal deductibility; the meager $40 per child “exemption credit” remains.

In addition, the proposal opens a potentially costly — the numbers were not provided — back door to the controversial issue of taxpayer subsidies of private schools, offering a deduction for private K-12 tuition through the 529 plan. Families who already can afford to send their children to a private school would receive a benefit they do not need, at a time public schools are being held back.

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More Millions for Millionaires

IFP POLICY BRIEF /

Flat-Tax Option Showers Benefits at High Incomes — Services Face New Cuts

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By Peter S. Fisher

Tax legislation pending in the Iowa House would shower most benefits on higher income Iowans, while reducing revenues by over half a billion dollars.

Already for the coming fiscal year, $277 million — two-thirds of the increased revenue to the general fund — is going to be funneled to commercial and industrial property tax relief. This will leave the state short of funds to adequately finance education and other services, before the new legislation would strip the general fund of another $482 million.

House File 604 would give taxpayers a choice each year: File income taxes using current law, or a new flat rate option. Under the flat rate option, the tax is 5 percent of all “base income,” where that is defined more broadly than current taxable income (no deduction for federal taxes), but allows the deduction of all federal interest, all retirement income, and a larger standard deduction.

Higher income Iowans would benefit most — Iowa tax filers with adjusted gross income of $40,000 or less (representing over half of all taxpayers) get just 6 percent of the $373 million in tax cuts for tax year 2015 under this bill, for an average of just $30 savings per tax filer (see Table 1).[i] Nearly two-thirds of the $373 million goes to those with income of $100,000 or more, representing just 1 in 6 taxpayers. Of that group, Iowa’s millionaires — representing just four-tenths of 1 percent of taxpayers — get 10 percent of the total benefit, or $5,463 each.

Table 1. Tax Savings from HF604 Flow Mostly to High Income Iowans

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Source: Letter from the Iowa Department of Revenue to Jeff Robinson, Legislative Services Agency, March 26, 2015. Note: This table omits $11.5 million in tax benefits for 2,542 composite returns with unknown AGI. This amount is part of the $373 million total tax reduction.

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Iowa’s millionaires get 183 times the average benefit of those under $40,000 in income (Figure 1). Those with $1 million or more income get on average a 15 percent tax cut; other taxpayers average 11 percent.

None of this should be surprising given provisions in the bill. Key points:

  • The flat tax option cuts the top rate — which applies to income over $69,225 — by 44 percent.
  • The tax rate on taxable incomes below $13,851, now between 0.36 percent and 4.5 percent, would actually be higher under the flat tax.
  • While the flat tax option does eliminate the deductions for federal taxes, itemized deductions, and Iowa capital gains (features of the current tax that benefit primarily higher income taxpayers), it also eliminates all taxes on pension income.

Since current law already exempts all of Social Security benefits and the first $6,000 per person of pension income, eliminating the rest of the tax on pensions primarily benefits higher income seniors. The flat tax option also eliminates all tax credits, some of which (such as the Child and Dependent Care Credit and the Earned Income Tax Credit) are worth more to lower income taxpayers.

Moving to a flat tax does nothing for tax simplification. Claims to the contrary are entirely disingenuous. The bill does not substitute a simpler tax for the current calculation; it offers taxpayers the option of filing under the current system or the alternative flat tax. Thus taxpayers will have to figure their tax both ways to determine which one works to their advantage. This additional complication also increases the cost of tax administration by an estimated $796,000.[ii]

The bill will almost certainly cost the state’s general fund more than the estimates provided in the Department of Revenue tables. As the DOR points out, giving taxpayers an option provides an opportunity for taxpayers to game the system by filing under the current law one year and the flat option the next. For example, a taxpayer could have extra federal tax withheld during 2015 and then file Iowa income tax for 2015 under current law, deducting all those extra federal taxes and reducing Iowa tax. In April 2016 the taxpayer receives a large federal refund because of overpaying for 2015. But the taxpayer files Iowa tax for 2016 using the flat rate option and so does not have to add the refund to Iowa taxable income as would be required under current law. The entire amount of the federal refund, deliberately inflated by the taxpayer, thus represents Iowa income that should be taxable but escapes Iowa income tax entirely. The DOR had no way of knowing the extent of such gaming and so could not include its effects in its revenue estimates.

In sum, the flat tax bill is a very expensive effort to sharply cut taxes, mostly for upper income Iowans, and especially for millionaires. It would put a large hole in state finances for years to come, undermining the state’s ability to maintain a quality education system.


[i] The $373 million is the amount for tax year 2015 — that is, the reduction in taxes owed for income received during calendar 2015 on tax returns filed by April 2016. The Department of Revenue has translated tax year losses into fiscal year losses. The reduction for FY2015 is estimated at $482 million, then settles down to around $400 million for each of the next three fiscal years.

[ii] Letter from the Iowa Department of Revenue to Jeff Robinson, Legislative Services Agency, March 26, 2015.

Note: This Policy Brief, originally circulated March 25, 2015, was revised March 26 with new estimates from the Department of Revenue, which previously had estimated a larger benefit than shown here to filers with adjusted gross income greater than $1 million.

2010-PFw5464Peter S. Fisher is research director of the Iowa Policy Project, which together with the Child & Family Policy Center formed the Iowa Fiscal Partnership, a nonpartisan initiative focused on helping Iowans to understand the impacts of budget choices and other public policy issues on Iowa families and services. IFP reports are at www.iowafiscal.org.