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High Cost of Conformity

Coupling with Federal Tax Changes Would Dent Iowa’s General Fund

Instead of incentives to invest, the proposals reward decisions made with no subsidy needed

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By Peter S. Fisher

Introduction

Late last year Congress passed a law extending various federal income tax deductions and credits that were set to expire and preserving more generous versions of those deductions and credits. If the State of Iowa chooses to “couple” with these changes in federal law, the more generous provisions would be available on Iowa income tax returns wherever Iowa has a corresponding deduction or credit that is specifically tied to the federal credit. If the state does not couple, then those deductions and credits would be available on Iowa state tax returns either at the old rates or levels, or not at all.

The Iowa House passed a bill (HF2092) that would couple Iowa with all of the federal tax changes (with the exception of something called bonus depreciation) for the 2015 tax year. The changes would be retroactive to January 1, 2015, and so would affect the tax returns that are due this April 30 based on last year’s income. (For farmers, taxes are due March 1 if they want to avoid a penalty for underpayment.) The bill does not couple Iowa law with the federal changes for 2016 or beyond, though of course that could be done later this session or early in 2017.

The Department of Revenue has estimated that HF2092 would reduce current year revenues by nearly $100 million. Because it increases deductions Iowans can take on returns filed this spring, it increases refunds that must be paid this fiscal year and reduces collections. This current-year reduction cuts funds available for the Fiscal Year 2017 budget by nearly $100 million, and thus has an impact on funding for education and other priorities.

By far the most costly provision of the tax change is the so-called “Section 179 expensing” of business assets, where coupling will cost the state $79.8 million, nearly 80 percent of the total cost of the coupling legislation. Six other provisions together produce about $17 million in revenue losses.  We discuss each of these provisions in turn. 

Expensing Business Assets

Normally, when a business purchases assets such as buildings or machinery, the cost of those assets must be spread over a number of years (in theory, over the useful life of the building or machine). A share of the cost is deducted each year as depreciation. Section 179 of the Internal Revenue Code, however, allows businesses to “expense” some assets — that is, to deduct the entire cost in the first year — instead of deducting annual depreciation.  It is usually to a business’s advantage to deduct a cost now rather than later.[1]

Without the federal “extender” legislation, businesses would have been allowed to expense up to $25,000 of assets in 2015. This cap is phased down for businesses with more than $200,000 in total purchases of assets that qualify for 179 expensing. The cap is reduced by $1,000 for every $1,000 in asset purchases above $200,000, so that a business with $225,000 in asset purchases can no longer expense any assets. Though any business can use Section 179 expensing, the cap and phaseout effectively target expensing at smaller businesses, since large businesses will tend to purchase more than $225,000 in assets each year.

The federal legislation extended and made permanent a temporary increase in Section 179 limits to $500,000 in asset purchases in any given year. Furthermore, this limit begins to phase out only when total asset purchases exceed $2 million. By coupling with the federal law, Iowa businesses would be able to expense up to $500,000 in purchases of machinery and equipment, buildings and software for the 2015 tax year, instead of $25,000. Businesses with asset purchases of under $2.5 million would be able to use expensing.

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In the absence of coupling for 2015, Iowa businesses filing taxes this spring can still take full advantage of the federal changes on their Federal returns. The ability to expense a larger share of asset purchases is worth far more in terms of federal tax savings than Iowa tax savings. In the absence of coupling the typical small business[2] still gets over three-fourths of the combined federal-state tax benefit.

coupling-boxIt is also worth emphasizing that this increase in the Iowa expensing provisions has nothing to do with incentives to invest. Taxpayers who would take advantage of it when they file their taxes this spring can do so only for assets purchased last year. Those assets were bought presumably because they were needed at the time and made economic sense for the farm or business, and the purchase decision was made when an enhanced Iowa tax benefit did not exist.

Canceled Home Mortgage

Some homeowners who were unable to make payments on their home during the recent financial crisis had all or a portion of their mortgage debt canceled. If the home was a principal residence and the cancellation occurred after 2006, the amount of principal canceled (up to $2 million) does not have to be added to income for tax purposes. (Normally, a canceled debt is considered a form of taxable income.) The federal bill extended this provision to cancellations that occur through 2016. In the absence of coupling, debt cancellations occurring during 2015 will not qualify for the exclusion in Iowa and the amount of debt canceled will be added to Iowa gross income.

Deductibility of Home Mortgage Insurance Premiums

This provision of the tax law allows the premiums that homeowners pay for mortgage insurance to be counted and deducted as home mortgage interest. The deduction phases out as a taxpayer’s adjusted gross income reaches $110,000. This is of benefit only to taxpayers who itemize deductions. The 2015 federal law extended the deduction through 2016. In the absence of coupling, Iowa taxpayers who itemize would not be able to include mortgage insurance premiums paid in 2015 as deductible interest.

Tuition Deduction

Under this provision, taxpayers can deduct up to $4,000 in higher education tuition and related expenses. The deduction is an adjustment to gross income, so it can be taken regardless of whether the taxpayer uses the standard deduction or itemizes. The federal legislation extended this deduction through 2016.

Deduction for State and Local Sales Taxes

Federal taxpayers have in recent years had the option of claiming an itemized deduction for state and local income taxes, or for state and local sales taxes, but not both. The taxpayer can deduct actual sales taxes paid or use a schedule of deductible taxes specified by the IRS. The sales tax option was set to expire but was made permanent by the 2015 federal law. The Iowa law allowing Iowa itemizers to choose the sales tax deduction instead of an income tax deduction, if they chose the sales tax deduction on their federal return, has expired. HF2092 would extend the provision to 2015. In the absence of this bill, Iowa taxpayers who itemize and who take the federal sales tax deduction instead of the income tax deduction, will not be able to deduct state and local sales taxes on their Iowa return.

IRA Charitable Distributions

Individuals who are at least 70½ years of age and who have a distribution from an IRA go directly to a charitable organization can avoid paying any income taxes on that distribution. The distribution, up to $100,000 per taxpayer, is excluded from income. The 2015 federal legislation extended this provision permanently. Coupling would allow Iowa taxpayers to exclude the distribution from Iowa taxable income. It should be noted that the advantage of this provision is not as large as it may appear; a taxpayer may still take the IRA distribution personally, and then use the proceeds to contribute to a charitable organization and deduct that when itemizing Iowa deductions.

Deduction for Classroom Expenses

Elementary and secondary school teachers may deduct up to $250 in classroom and professional development expenses. This is an adjustment to gross income, so it is of benefit whether or not the teacher itemizes deductions.  This deduction was set to expire, but the 2015 federal legislation made it permanent. In the absence of coupling, Iowa teachers would not be able to take this deduction on their 2015 Iowa return.  Note that the maximum effect, for a teacher in the 8.98 percent tax bracket with $250 in deductible expenses, is $22.45.

Bonus Depreciation

Federal bonus depreciation has allowed business with larger asset purchases that are unable to take full advantage of Section 179 expensing because of the phaseout, to take additional first year depreciation on qualified asset purchases. Iowa has not coupled with bonus depreciation in the past, and this bill excludes it from coupling. In the absence of the bill, Iowa taxpayers would still not be able to use bonus depreciation on their Iowa returns. For that reason, there is no fiscal impact associated with the bonus deprecation provision of HF2092.

Fiscal Impacts Beyond FY2016

Should Iowa couple with all of the federal changes (except bonus depreciation) in future years, we can expect the fiscal impact to be similar. However, HF2092 couples only for tax year 2015. As a result, the fiscal effect of the bill for 2016 and beyond is positive rather than negative. This is because the additional Section 179 expensing that will occur for 2015 as a result of coupling will automatically increase state revenue over the next several years. A business can deduct the cost of a business asset only once; any asset expensed in 2015 does therefore not generate a depreciation deduction in 2016 or later. In the absence of coupling, the business would be depreciating that asset over several years, spreading the reduction in its tax liability (and the state revenue loss) over those years.

An Alternative Approach to Coupling

The Department of Revenue has drafted a bill that would couple with most of the tax credits extended by the 2015 federal legislation.  A major difference with HF2092 is that this bill (SSB3107) would not couple with those changes retroactively, but would start in 2016. The changes would be permanent. Most importantly, this bill does not couple with either bonus depreciation or the enhanced version of section 179 expensing.

The Department of Revenue has not produced a fiscal impact estimate for this bill. However, the overall cost in FY2017 would be just a fraction of the FY2016 estimate for HF2092 because the most costly component of the House bill — section 179 expensing — is not included in SSB3107.

Conclusion

Federal coupling legislation has been portrayed as little more than an accounting change designed to make it easier to file taxes this spring, and to encourage new investment, but that is not really the impact of the federal coupling legislation that has been proposed in the House. The bulk of the benefits are essentially bonuses to specific taxpayers for decisions they already made, with a significant cost that affects revenues available for the coming fiscal year.

Legislators must decide if the boon to specific Iowans is more important than improving the lives of Iowans in general by doing such things as funding schools and other General Fund items with the revenue otherwise lost.


[1] To see why this is so, imagine that expensing a $1,000 machine reduces taxes by $300 this year. (By taking the deduction the business saves the taxes on $1,000 worth of income, so if the marginal tax rate were 30 percent, it saves $300). In future years, the firm will not have depreciation deductions because they were in effect all used up by expensing this year. So future taxes will be higher by the same amount: $300. However, the $300 taken now could be invested and earn interest, with the principal used up gradually to pay the higher taxes in the future. This still leaves the firm ahead by the amount of interest earned.

[2] An Iowa small business or farm with taxable income (after all deductions and exemptions) of $50,000-$65,000, for example, would be in the 7.92 percent Iowa tax bracket but the 25 percent federal bracket. The new federal expensing provision is thus worth over three times the Iowa provision.

 

 

2010-PFw5464Peter S. Fisher is Research Director for the Iowa Policy Project. He holds a Ph.D. in economics from the University of Wisconsin-Madison and is professor emeritus of Urban and Regional Planning at the University of Iowa. A national expert on public finance, Fisher is frequently quoted in the Iowa and national media on issues involving tax policy and economic development strategies. His two published critiques of various state business climate rankings have resulted in a new website, Grading the States, at www.gradingstates.org.

 

Big Money, Big Companies — But Whose Benefit?

IFP BACKGROUNDER

Official Report Exposes Continuing Issues with Iowa Research Activities Credit  

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160224-RAC-boxIowa’s most lucrative business tax credit program is the Research Activities Credit (RAC). Through the RAC, some big companies receive big dollars from the state of Iowa, some as credits — effectively, discounts — on their taxes. But some as well (186 in 2015) either owe no income tax or reduce it to zero with the RAC, and have tax credits left over. In those cases they can receive state checks as a “refund” — $42.1 million in state spending last year.

As the Iowa Fiscal Partnership has noted, Iowa’s RAC is far different from what was envisioned when it originally passed, in 1985. Designed to support start-up companies to do research, this program primarily benefits very large companies, with little scrutiny. More information has been available about the RAC since 2009, when state legislators ordered the Iowa Department of Revenue to provide an annual report by February 15 on both individual and corporate claims against income tax for the previous calendar year.[1]

As illustrated in Table 1 below, little of this tax credit is used to reduce taxes for its recipients. Rather, the credit is used mostly to provide subsidies, in state checks worth sometimes millions of dollars, to corporations that pay little or no income tax.

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The amount of the corporate claims under the RAC has ranged from about $45.2 million to $53.3 million over the six years covered by the full-year annual reports, from 2010 through 2015. The 2015 report showed 246 corporations claimed a total of $50.1 million from the RAC — covering both the regular RAC and the supplemental credit.

160224-RAC-Fig1The share of those claims provided as “refund” checks to corporations — meaning they had no corporate income tax in Iowa — has ranged from about two-thirds of the benefit to as much as 95 percent. After dipping below 70 percent in the previous two years, the share of research credits paid out as checks rose to 84 percent in 2015, with a cost to the treasury of $42.1 million. (Table 1.)

The number of companies claiming the credit has risen sharply — by 55 percent to 248 claims in each of the last two years compared to the 160 corporate claims in 2010. (Figure 1) Likewise, the share of claimants receiving checks has risen over that time from 133 to 186 — a 40 percent increase.

Another trend that has remained strong is that large claimants have taken $8 or $9 out of every $10 from the corporate credit. This is illustrated in Table 2 below. These are companies that have over $500,000 in corporate claims. Recalling that the credit represents 6.5 percent of the increase in Iowa research spending above an established base level (box, page 1) this effectively means a company with $500,000 in claims has Iowa research expenses of at least $7.7 million —not a small company. It is reasonable to ask whether the subsidy is necessary for a company already devoting such sizable resources to research.

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The annual reports by law must identify the largest corporate claimants, those with claims of more than $500,000. The largest claimants have looked similar at the top year to year, but the number of large corporate claimants has grown, from nine in 2010 to more than twice that — 20 — last year. Table 3 provides information from the six full-year annual reports disclosing big claimants and amounts claimed. A stronger law would disclose how much of each of those large claims was paid as a “refund,” or check, illustrating which companies received state assistance but did not pay Iowa income tax. It also would require corporations to report on their economic activities and investments in the state.

A Special Tax Credit Review Panel appointed by Governor Chet Culver in 2009 examined all Iowa tax credits in the wake of a scandal in the Film Tax Credit Program. That committee came back in January 2010 with a report making several recommendations, including a five-year sunset for all tax credits so that lawmakers would have to review them and affirmatively vote to continue them, and specific recommendations on the Research Activities Credit. Among those recommendations: eliminate refundability of the RAC for companies with gross receipts in excess of $20 million yearly, but permit a five-year carry-forward. “It seems unreasonable for the State to be providing successful, larger corporations refund checks for amounts of the Research Activities Tax Credit over its tax due to the State.”[2]

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These large claimants are highly profitable companies. The biggest recipient of the Iowa credit in 2015, Rockwell Collins, reported $686 million in profits in fiscal 2015.[3] Deere & Co., had $7.5 million in research costs offset —yet reported over $1.9 billion in 2015 profits.[4] DuPont reported almost $2 billion in profits in 2015, but claimed $7.5 million from Iowa taxpayers for research.[5] As Table 3 indicates, Rockwell Collins and Deere have both benefited from more than $67 million in RAC claims over the last six years, and Dupont from more than $45 million. These figures raise serious questions about the need for state help to cover what may be considered normal expenses. After all, what keeps these companies competitive in their fields is their research and development work. Where there might be a benefit to company stockholders, there is no demonstration to Iowa taxpayers about a return on their investment in these companies’ operations.

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State fiscal experts predict will be a growing subsidy outside the budget process (Figure 2). The Department of Revenue projects the cost of this program to rise from about $54.9 million for individual and corporate claims in FY2013 to $64.4 million this year and more than $75 million by FY2020.[6]


[1] All annual reports filed as a result of the 2009 law are on the Department of  website, at https://tax.iowa.gov/report/Reports?combine=Research Activities. Reports for calendar year 2010 and after offer full-year information; the 2009 report was for a partial year. Our tables summarize the corporate claims in those full-year reports.
[2] State of Iowa Tax Credit Review Report, Jan. 8, 2010, p. 8, http://iowapolicyproject.org/2010docs/1001-TaxCreditReview.pdf
[3] Rockwell Collins Annual Report 2015, http://s1.q4cdn.com/532426485/files/doc_financials/annual/2015/COL-ANNUAL-REPORT-FINAL.pdf
[4] Deere & Co. news release, https://s2.q4cdn.com/329009547/files/doc_financials/quarterly_earnings/2015/Q4-2015/Q4_2015_Media-Release-and-Financials.pdf
[5] DuPont news release http://investors.dupont.com/investor-relations/investor-news/investor-news-details/2016/DuPont-Reports-4Q-and-Full-Year-Operating-EPS-of-027-and-277/default.aspx
[6] Iowa Department of Revenue,Tax Credits Contingent Liabilities Report, December 2015, https://tax.iowa.gov/sites/files/idr/Contingent Liabilities Report 1215.pdf; Table 9. Note: These figures are fiscal-year costs and projections in reports provided by the Department for use by the Revenue Estimating Conference, as opposed to the calendar year reports provided by the Department as required by the Research Activities Credit disclosure law passed in 2009. They also include individual claims as well as corporate claims, while the Tables 1-3 in this report only show corporate claims. (Corporate claims have represented 90 percent of the amount of all claims in the six years covered by the full-year RAC reports under the 2009 disclosure law.)

News Release (Feb. 15, 2016)
Special Tax Credit Review Panel Report (Jan. 8, 2010)

Iowa Fiscal Partnership

The Iowa Fiscal Partnership (IFP) is a joint budget and tax policy initiative of two nonpartisan, Iowa-based organizations, the Iowa Policy Project in Iowa City and the Child & Family Policy Center in Des Moines. IFP is part of the State Priorities Partnership, a network of nonpartisan organizations in 41 states and the District of Columbia that share a commitment to rigorous policy analysis, responsible budget and tax policies, and a particular focus on the needs of low- and moderate-income families. IFP research is supported by the Stoneman Family Foundation and by the Annie E. Casey Foundation. Policy conclusions are the responsibility of the Iowa Policy Project and the Child & Family Policy Center and not necessarily the view of either the Stoneman Family Foundation or the Annie E. Casey Foundation. Iowa Fiscal Partnership reports are available to the public at http://www.iowafiscal.org.

A good deal if you can get it

Posted February 19th, 2016 to Blog

But research credit refund checks are poor fiscal stewardship

The millions Iowa gives to companies that do not pay state income tax is about the same amount of 1 percent in state school aid.

That’s one takeaway from the latest annual report from the state on Iowa’s Research Activities Credit (RAC). That tax credit is used far less to ease taxes than to shovel subsidies to big corporations outside the budget process, whether they pay taxes or not.

The report shows that in 2015, 248 companies had $50.1 in claims from this tax credit. Because the credit is refundable, companies get the full benefit no matter how much they owe (or don’t owe) in taxes. And the report shows that of those claims, 75 percent, or $42.1 million, were paid as checks to 186 companies that paid no corporate income tax to the state.

As we note in a summary by the Iowa Fiscal Partnership, each percentage-point increase in Supplemental State Aid for schools costs about $41 million to $43 million (Iowa Association of School Boards estimate).

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What’s more, the largest claimants — 20 corporations receiving over $500,000 from this credit — took the lion’s share of the benefit with $43.9 million overall (about 88 percent).

Many millions are spent this way every year, outside the budget process. These companies don’t have to compete for what are supposedly scarce public dollars needed for critical public services such as education, health care, environmental protection and public safety. The latter types of spending must compete in the budget process.

The Research Activities Credit is only an entitlement. And except for the occasional lawmaker willing to stand up to restore some accountability, there is silence from the General Assembly.

This is perfectly legal. In fiscal policy terms, however, it’s a scandal, because it is legal. Lawmakers refuse to even consider whether to take this spending off autopilot.

When they claim the state is too strapped for money to provide more for school aid or human services, lawmakers should admit they let corporations take what they want first.

Owen-2013-57Posted by Mike Owen, Executive Director of the Iowa Policy Project
Contact: mikeowen@iowapolicyproject.org
For more information about the Research Activities Credit, visit www.iowafiscal.org

No taxes, big checks

Iowa has choices: Keep giving millions to companies that don’t pay Iowa state income tax — OR add 1 percent in school aid.

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FOR IMMEDIATE RELEASE MONDAY, FEB. 15, 2016

Big companies erase taxes — take millions in state checks

Research Credit annual report shows big companies keep gaining

IOWA CITY, Iowa (Feb. 15, 2016) — A lucrative tax subsidy is providing as much in checks to companies that don’t pay income tax as the state could use to pay for 1 percent in state aid to schools.

A new annual report from the Department of Revenue outlines the use of the Research Activities Credit (RAC), which in 2015 provided $42.1 million — about the cost of an additional percentage point in school aid — to companies that paid no state income tax. Most of that went to very large companies.

The state report, released Monday, shows that in 2015:

  • Claims by 248 companies totaled $50.1 million for the RAC and the related supplemental RAC for which some claimants are eligible.
  • Of those, 186 (75 percent) are companies that not only owed no state corporate income tax after applying the credit, but received state checks in return.
  • Eighty-four percent of the tax credits were paid as checks to the companies.
  • Very large claimants — companies with over $500,000 in RAC claims — had at least 85 percent of those checks ($35.8 million) while paying no income tax.
  • Rockwell Collins, Dupont, Deere & Co., John Deere Construction and Monsanto were the largest corporate claimants, as they have been for the past six years. Together, those five companies have claimed nearly $218 million from the RAC program from 2010-15. (See table below.)

“This spending outside the budget process is distorting the choices now on the table as state lawmakers consider what is available for schools, clean water, human services and public safety,” said Mike Owen, executive director of the nonpartisan Iowa Policy Project.

“Is it a better use of taxpayers’ money to send millions in checks to profitable companies to do research they would do anyway, or to make sure schools can hire enough teachers next fall? That is the question that should be raised by this automatic spending on business tax breaks. To ignore it is a fiscal scandal.”

Overall, the credit program cost $57.1 million in calendar year 2015, with $50.1 million of that in claims by corporations and the rest by individuals. The credit is refundable, which means that if a company has more tax credits available than it owes in taxes, the state makes a payment for the difference. These so-called “refunds” — not of taxes owed but of credits in excess of taxes owed — accounted for 84 percent of all of the corporate research credits in 2015, according to the new report from the Department of Revenue.

The report is available on the Department of Revenue website at https://tax.iowa.gov/sites/files/idr/RAC Annual Report 2015.pdf

The Iowa Fiscal Partnership (IFP), a joint initiative of the Iowa Policy Project and another nonpartisan organization, the Child & Family Policy Center in Des Moines, has reported on the RAC for many years.

Owen noted that Iowans have access to more information about this credit than they did years ago because of the annual report, which was ordered by the Legislature in 2009.

All of the state annual reports on the RAC are available on the Iowa Department of Revenue website at https://tax.iowa.gov/report/Reports?combine=Research%20Activities.

Those reports show that the number of corporate claimants has grown from 160 in 2010, the first full year covered by the annual reports, to 248 in both 2014 and 2015. The number of claimants receiving the credit as checks, rather than to only erase tax liability, rose from 133 in 2010 to 181 in 2014 and 186 in 2015.

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Basic RGBAn IFP report last month showed that Department of Revenue forecasts indicate business tax breaks will grow by 13 percent from this budget year to the next, even though the debate over school aid focuses on numbers between 2 percent and 4 percent.

According to the Iowa Association of School Boards, each percentage point increase in Supplemental State Aid (SSA), costs about $41 million to $43 million.

“There is at least a legitimate question, one that lawmakers are refusing to consider, of why large, profitable corporations do not have to defend these millions of dollars in tax breaks and subsidies, when teachers and children’s advocates are going hat in hand to the Capitol for enough to keep up with basic costs,” Owen said.

A special tax credit review panel recommended in 2010 that the state curtail some spending on business tax credits. Among its proposals were to scale back “refunds” of the research credit, and to impose a five-year sunset on all tax credits to assure that the Legislature would have to vote to continue them.

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For more information about the Research Activities Credit and other Iowa tax credit issues, see the Iowa Fiscal Partnership website at www.iowafiscal.org.

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The Iowa Fiscal Partnership is a joint public policy analysis initiative of two nonpartisan, nonprofit Iowa-based organizations, the Iowa Policy Project and the Child & Family Policy Center. Reports are at www.iowafiscal.org.

Building blocks of inequity

Posted February 10th, 2016 to Blog

Iowa’s school funding process is broken.

Consider:

  • The Legislature repeatedly violates the law by failing to set state aid in time for districts to adequately plan their budgets.
  • The levels of funding lawmakers set — averaging less than 2 percent growth over the last six years — are routinely below the growth in costs that schools face.

As if those two things are not bad enough, inequities grandfathered into the school funding formula have not been corrected. While the four-decades-old formula was designed to reduce inequities between districts of higher and lower property values by augmenting property tax revenues with state aid, a gap persists.

Long and short: There is a $175 range in the “cost per pupil” that school districts must use as the building block of their annual budgets. While the minimum cost for this year is set at $6,446 per student, six districts are as high as $6,621.

The inequities have been known for some time. When combined with chronic underfunding, these inequities are magnified. In one case, Davenport school officials are defying state limits on use of their own resources to make sure their students have the same opportunity as students in other districts.

For example, as school budgets are based on enrollment, a district with 1,000 students and operating at the minimum — the state cost per pupil — is losing out on $175,000 per year in comparison with a district at the maximum. In a district the size of Davenport, that’s about $2.8 million a year.

What many Iowans might not realize is that their own school district may be in a similar situation to that of Davenport.

Few districts (only six) are at the maximum per pupil cost; most districts (84 percent) are $100 or more below the maximum per pupil cost. Nearly half of all districts (164 of 336) are at the minimum.*

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The more you look at this, you can see it is not a Davenport issue, but an Iowa issue, and a failure of public policy.

Owen-2013-57Posted by Mike Owen, Executive Director of the Iowa Policy Project

 

*Iowa Department of Management, www.dom.state.ia.us/local/schools/files/FY16/DistrictCostPerPupilAmountsAllFY2016.xls

State aid up 13 percent — for business breaks

Posted January 28th, 2016 to Blog

What do you expect would be the outcry if Iowa’s public schools asked for 13 percent growth in state aid?

Yet few bat an eye when this happens with business tax breaks, as we can expect for FY2017.*

The early scorecard gives business tax breaks the big edge, a 13 percent increase, vs. between 2 and 4 percent for schools.

The Senate approved 4 percent for FY2017 (covering next school year), but the Iowa House on Monday approved 2 percent — even though schools have averaged less than 2 percent for six years, from FY2011-16.

In fact, the Iowa Association of School Boards this year did not even ask for a specific growth number, but rather, that it be set in a timely manner (it’s almost a year late already), and “at a rate that adequately supports local districts’ efforts to plan, create and sustain world-class schools.”

That hasn’t happened for some time. Over the last six budgets, per-pupil growth has been held to 2 percent or below in all but one year. Depending on enrollment trends, some districts even see less.

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Business tax breaks do not face the same budget constraints — ironic, since the cost of those breaks limits what lawmakers permit themselves to spend on services that their constituents demand, not the least of which is education. Other areas — environmental quality, child care, health care and public safety — also are constrained.

A much greater percentage increase in business tax breaks is set in place, as shown below. The total increase of $71 million from this budget year to the one lawmakers are working on now actually may be understated. The $35 million for a new sales-tax exemption for manufacturers is considered a conservative estimate. Even at $71 million overall, however, it represents a 13 percent increase.

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Spending on business tax breaks is rarely burdened by the public scrutiny and debate that comes with spending on schools and water programs, which must be approved annually.

Most business tax breaks, once passed, are never touched again unless they are expanded. And as shown by the sales-tax break for manufacturers scheduled to begin this summer, a break may never receive legislative approval but still become law. The Governor is implementing this one on his own, with a split legislature unable to stop him.

Budget choices? Instead of that $35 million in FY2017 for the new sales-tax break, the Legislature could provide about 1 percent growth in per-pupil school funding. We can expect to find another 1 percent in what we’ll spend in checks to companies that do not pay any state income tax, but have more research tax credits than they owe in taxes.

Perhaps one day we will treat all spending the same, whether the spending comes before or after revenues reach the state treasury. Then the wealthy corporations can compete directly for their tax breaks against education for the skilled people they want to work for them.

Owen-2013-57Posted by Mike Owen, Executive Director of the Iowa Policy Project
Mike Owen is a member of the school board in the West Branch Community School District, first elected in 2006.
* For more about Iowa tax breaks for business, see Peter Fisher’s report for the Iowa Fiscal Partnership, “Here a tax break, there a tax break, everywhere a tax break.” http://www.iowafiscal.org/here-a-tax-break-there-a-tax-break-everywhere-a-tax-break/

Here a tax break, there a tax break, everywhere a tax break

Iowa’s revenue shortfall largely self-inflicted — education, other priorities suffer

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By Peter Fisher

Iowa legislators facing projections of scant revenue growth for next fiscal year will have a difficult time adequately funding education and other priorities, but their dilemma is largely self-inflicted. A penchant for tax cuts over the past 20 years has left the state with a long-term revenue shortfall.

As lawmakers anticipate meager revenue growth for a budget exceeding $7 billion, they face built-in and anticipated spending increases for existing programs, projected to total $269.5 million.[i] Furthermore, these increases assume no boost in per pupil state school aid because the 2015 Legislature failed to set that figure for FY2017 as required by law. The governor has proposed 2.45 percent growth in school aid, which would add another $100 million to the budget. Clearly that cannot be funded without large cuts elsewhere in the budget — or addressing the elephant in the room: rampant spending on business subsidies. 

Business tax credits create part of the problem

Why is revenue growth a problem in a state that has done better than most in recovering from the Great Recession? The answers can be found in the growth in business tax breaks. Business tax credits already on the books drained $178 million from the state treasury in fiscal year 2015, then grew by $94 million to $272 million in FY16, and are expected to remain at about that level next year. The six largest credits (or groups of credits) account for 84 percent of the total (Table 1).

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Spending on business tax credits has grown 263 percent since 2007. Caps on individual credits and groups of credits have done little to slow growth. The cost of credits has far outstripped growth in general fund spending overall.

New tax breaks have worsened the problem

Recent measures have added greatly to the problem. The massive commercial and industrial property tax bill passed in 2013 is responsible for a $268 million cut in funds that otherwise would have been available to adequately fund education, natural resource programs, and other priorities in the current fiscal year, FY16. Next year that figure is expected to grow to $304 million.[ii] The property tax breaks are larger than the sum of all business tax credits.

160108-IFP-Budget-Fig2

To make matters worse, the administration has enacted a rule, without legislative approval, that greatly expands a sales tax exemption for manufacturing. That will cost the general fund another $35 million next year, while depriving schools and local governments of another $13 million.[iii]

Altogether business tax breaks will drain $611 million in revenue from the state general fund next fiscal year. At a time when the state is struggling to fund education at all levels, those business tax breaks take on added importance. And they tell us something about the state’s priorities.

Iowa business taxes are already quite competitive

Iowa did not need these tax breaks, and certainly does not need to add to the damage to state services by enacting more. Iowa has been right in the middle of the pack in how it taxes business for a long time. The most recent study of state and local taxes on business as a percent of state GDP by Ernst and Young and the Council on State Taxation shows that Iowa taxes business at 4.5 percent of GDP, just below the national average.[iv]  A study by Anderson Economic Group in 2015 found Iowa’s effective tax rate on businesses to be 8.7 percent of profits, which placed it 32nd among the states, and again below the national average.[v]

State and local taxes have little effect on business location decisions

State and local taxes are less than 2 percent of total costs for the average corporation.  As a result, even large cuts in state taxes are unlikely to have an effect on the investment and location decisions of businesses, which are driven by more significant factors such as labor, transportation, and energy costs, and access to markets and suppliers.

Tax breaks erode support for public investments in our future

The proliferation of tax incentives and business tax cuts over the past two decades has resulted in several hundred million dollars each year cut from the state budget. This has undermined the state’s ability to support quality education, from preschool through public colleges and universities, which in the long run will have serious consequences for state economic growth and prosperity.

Fixing Iowa’s problem with unsustainable revenues

Long-term sustainability for Iowa revenues should begin with a recognition that business tax breaks have grown to unsustainable proportions. At the very least, the Legislature should reject any proposals for new tax breaks. Any bill to couple with the recently enacted federal tax changes should exclude coupling with the new depreciation rules. There is no justification for piling on additional business tax breaks at a time when basic state services cannot be adequately funded, breaks that will continue to erode revenues on into the future.

In the 10 years from FY2005 to FY2015 state tax revenue actually declined as a share of the Iowa economy. State taxes represented 5.8 percent of state personal income in 2005, 5.6 percent in 2015.[vi] If taxes had grown along with the economy over this period we would have had an additional $279 million in revenue in FY2015. A real long-term solution to sustain Iowa’s critical public services, including education, will require that the state rejuvenate state tax revenues by reducing or eliminating unnecessary and ineffective tax breaks and seeking new sources of revenue. To do otherwise is to shortchange our future.




[i] Figures are based on Legislative Services Agency, Fiscal Services Division. Summary of FY2017 Budget and Department Requests. December 2015, pp. 12-13, with some adjustments for the Revenue Estimating Council report of December 10, 2015 which was released after the LSA report.

[ii] Legislative Services Agency, Fiscal Services Division. Summary of FY2017 Budget and Department Requests. December 2015, pp. 17 and 55. Includes the effect of SF 295 on state school aid as originally estimated.

[iii] Legislative Services Agency, Fiscal Services Division. Summary of FY2017 Budget and Department Requests. December 2015, p. 59.

[iv] Ernst and Young and the Council on State Taxation, Total state and local business taxes: State-by-state estimates for fiscal year 2014. http://www.cost.org/Page.aspx?id=69654

[v] Anderson Economic Group, 2015 State Business Tax Burden Rankingshttp://www.andersoneconomicgroup.com/Portals/0/AEG%20Tax%20Burden%20Study_2015.pdf

[vi] Legislative Services Agency, Fiscal Services Division, Issue Review January 6, 2015.

 

 

 

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.

 

Big ‘Oops’ for tax-cutters in school vetoes

Posted July 15th, 2015 to Blog

Governor Branstad’s vetoes of “one-time” funding pose “ongoing” and “recurring” problems for a major and ill-advised proposal by his allies to restructure personal income taxes in Iowa.

And they should.

During the last session, while lawmakers and the Governor were telling schools the state could not afford more than a 1.25 percent increase in per-pupil school aid, a group in the House was pushing a plan to let individuals choose a “flat” income tax rate option. In other words, figure your taxes under the current rate structure, then compare it to the flat rate, and choose which one costs you less.

It benefits primarily the wealthy, and it costs big money. There is no upside.

We have seen such a proposal in the past, and we are virtually guaranteed to see it again in some form in 2016. Not only does it compound fairness issues in Iowa’s tax structure, but it loses hundreds of millions of dollars in revenue, year after year, that Iowa legislators and the Governor have been telling us we cannot afford to lose.

Its supporters cannot avoid that contradiction, given their obsession this year about not letting a surplus — and a sustained one at that — be used for “ongoing” or “recurring” expenses on grounds they were not “sustainable.” Those are the grounds for the Governor’s vetoes of one-time funds for local schools, community colleges and state universities.

For good analysis of the 2015 alternative flat-tax proposal, which was not presented on the House floor as some of these messaging contradictions quickly became clear, see this Iowa Fiscal Partnership backgrounder by Peter Fisher. As Fisher noted, the projected revenue loss was projected at nearly half a billion dollars — $482 million — for the new fiscal year and around $400 million for each of the next three.

In short, the flat-tax idea is not “sustainable.” No need to discuss in the 2016 session.

Owen-2013-57Posted by Mike Owen, Executive Director of the Iowa Policy Project

Ongoing mistake in ‘one-time’ rhetoric

Posted July 8th, 2015 to Blog

The Governor appears to be missing his own point.

Vetoing one-time funding for one-time uses — as Governor Branstad did last week — goes against what the Governor himself has been saying. And Iowa students will suffer for it.

Set aside for a moment that it can be quite sensible to use one-time funds for ongoing expenses. It depends on the circumstances. Set aside the fact that Iowa revenues and projections are strong and that state money seems to be available on an ongoing basis for corporate subsidies if not for restoring repeated shortfalls in education funding.

In the case at hand, the Governor vetoed one-time funds — for public schools, community colleges and the three regents universities — that ironically would have been spent in line with his own stated concern. The $55.7 million in one-time funds for local schools and area education agencies would have supplemented regular funding, set at 1.25 percent growth per pupil, all part of a package negotiated by the split-control Legislature.

Here’s the oft-stated concern about one-time funds, in a nutshell: You don’t spend one-time money on things that commit you to the same or greater spending in the future, because you don’t know whether the funds will be there later on.

The compromise on school funding negotiated and passed by legislators (part of HF666) reflected that concern:

  • For K-12 schools, the legislation specifies that funds “are intended to supplement, not supplant, existing school district funding for instructional expenditures.” It goes on to define “instructional expenditures” in such a way that assures the funds are for one-time uses that carry no additional commitment beyond the FY2016 budget year.

So, you can add to one-time expenses that you would have had to leave out, for purposes such as textbooks, library books, other instructional materials, transportation costs or educational initiatives to increase academic achievement. You can’t plan on having the same funds available in the following budget year.

  • For community colleges and the regents, each section of the bill included this stipulation: “Moneys appropriated in this section shall be used for purposes of nonrecurring expenses and not for operational purposes or ongoing expenses. For purposes of this section, ‘operational purposes’ means salary, support, administrative expenses, or other personnel-related costs.”

In his veto message, the Governor stated, “Funding ongoing expenses with one-time money is unsustainable.” In neither case did the Legislature propose doing so.

The larger problem with one-time funding is that such a cautious approach was unnecessary, because funds are available for more ongoing spending on education than what either the Governor or the House leadership permitted. The latest estimates are for 6 percent revenue growth in the coming year.

With or without the one-time funds that would have helped school districts, the legislative compromise ensures the continued erosion of the basic building block for school budgets, the per-pupil cost.

150602-AG-history
Supplemental State Aid (formerly termed “allowable growth) defines the percentage growth in the cost per pupil used to determine local school district budgets, which are based on enrollment. For FY2016, the Legislature and Governor have set the growth figure at 1.25 percent. Though state law requires this figure to be set about 16 months before the start of the fiscal year, the issue was not resolved until last week, when the Governor signed the legislation, and the fiscal year had already begun. The Senate passed 4 percent growth for FY2017 and the House 2 percent, but no compromise emerged and that remains unsettled. The education funding vetoed last week by the Governor affects separate one-time spending that would not have affected future budgets.

For the last six budget years, per-pupil budget growth has been above 2 percent only once. Once it was zero, and schools for the coming year are at 1.25 percent. This does not come close to meeting the costs of education at the same level year after year.

Ultimately, that is the test of what is, or is not, sustainable.

Owen-2013-57Posted by Mike Owen, Executive Director of the Iowa Policy Project

 

See the Iowa Fiscal Partnership statement from July 2

Veto words ‘ring hollow’

‘Governor Branstad’s words ring hollow in his decisions to cut education funding and to prevent greater access to child care assistance.’

IOWA CITY, Iowa (July 2, 2015) — The Iowa Fiscal Partnership released this statement from Mike Owen, executive director of the nonpartisan Iowa Policy Project, about actions taken late today by Governor Branstad on school funding and legislation that would have expanded eligibility for child care assistance:

 
Governor Branstad’s words ring hollow in his decisions to cut education funding and to prevent greater access to child care assistance.
 
First, the Governor is whacking $55.7 million in one-time funding for local schools and area education agencies from a budget compromise reached over many months by legislators. To defend this and other vetoes, the Governor speaks of concern about across-the-board cuts, when there is no threat of that possibility. These one-time funds for education were designated for one-time uses — in deference to the Governor’s previously stated concerns. The veto leaves schools with only 1.25 percent growth in the cost per pupil for the new fiscal year, well below schools’ actual costs — a legislative decision that will drive up property taxes for many districts. Neither the Governor nor the Legislature can claim accurately that they have provided sufficient funds for Iowa’s public schools, and the conclusion to this question comes 16 months past the legal deadline.
 
Second, low- and moderate-income Iowans face severe “cliff effects” — a sharp loss of resources — when their income rises enough to end their eligibility for child care assistance. A vetoed provision of SF505 would have lessened this effect for an estimated 200 families and nearly 600 children each month. These families, whose incomes are just below 150 percent of the federal poverty level (about $36,400 for a family of four), would have become eligible for child care assistance. This would have been a small but significant first step toward reducing the cliff effect. The Governor talks about increased incomes, but his veto means families will not be able to accept or seek small pay increases if it means they could no longer afford child care. The Governor’s claim that an improvement would “perpetuate” the cliff effect is to totally misunderstand the impact of this important benefit for low-income working families. Child care costs are not going down, and incomes are not rising fast enough for families to recover.
 
These issues are only two pieces of the package of decisions announced at the end of the day by the Governor’s Office. There will be more for Iowans to consider as the Governor’s decisions are reviewed more fully.

 

The Iowa Fiscal Partnership is a joint public policy analysis initiative of two nonpartisan, nonprofit Iowa-based organizations, the Iowa Policy Project in Iowa City, and the Child & Family Policy Center in Des Moines. For more on the issues raised in this statement, see the IFP website at www.iowafiscal.org.