For years, Iowa has been known for having low business taxes. However, politicians often use this reputation to justify further tax cuts. In March 2014, a report by the Iowa Fiscal Partnership showed that the claim that Iowa’s business taxes are competitive is false. Several factors influence businesses’ decisions to locate or expand within a state, including infrastructure, proximity to materials and customers, workforce skills, good schools, roads, hospitals, and public safety. State taxes, however, play a minor role in such decisions.
In Iowa, the argument that business taxes are not competitive is common. It has been used to enact significant tax cuts for commercial and industrial property, and it is an excuse for giving away large tax credits to businesses throughout the state. However, the entire range of taxes that fall on businesses in Iowa is lower than the national average, and the corporate income tax rate is lower than all but 14 states.
Iowa’s low tax rate is due to a 12 percent tax rate applied to only a small portion of a company’s profits. Iowa is one of only five states that allow a portion of federal income taxes to be deducted from income. Unlike most states, Iowa uses single sales factor apportionment, which means that the state ignores a corporation’s payroll and property in the state and only takes into account its sales within the state. This results in many large corporations earning substantial profits on Iowa operations but paying taxes on only a small fraction of those sales and their profits.
Iowa does not have combined reporting to plug tax loopholes, making it easy for a multistate firm to shift its profits out of state and avoid Iowa taxes. Additionally, Iowa offers a range of generous tax credits that further reduce corporate tax liability.
The best measure of the level of corporate income taxation from one state to another, a measure that takes into account all features of the tax code, is the amount of tax collected as a percent of the private economic activity generated in the state, as measured by state private-sector GDP. In Iowa, this average from fiscal years 2010-2012 was less than two-tenths of 1 percent (0.17 percent), placing Iowa’s rank at 36th among the 50 states for those three years.
Besides the corporate income tax, businesses in Iowa also pay local property taxes on their buildings (but not on machinery and equipment, including computers), and they pay some sales taxes. Many businesses, such as proprietorships, partnerships, or “S-corporations,” do not pay corporate income taxes. Instead, the net profits from the business are reported on the owner’s personal tax returns and are assessed at their individual income tax rates. If the business has more deductions than sales, the losses are used to reduce taxable income.
A recent report by accounting firm Ernst and Young sheds light on the overall level of taxation of businesses of all kinds in the 50 states during FY2012. The report shows all business taxes imposed by local as well as state governments, as a percent of state private-sector GDP. On that measure, Iowa was tied with one other state for 27th; 22 states taxed businesses at a lower rate, and 26 states at a higher rate.
In conclusion, despite politicians’ claims that Iowa’s business taxes are not competitive, the fact remains that the entire range of taxes that fall on businesses in Iowa is lower than the national average. The corporate income tax rate is lower than all but 14 states, and businesses also benefit from generous tax credits. Additionally, Iowa does not have combined reporting to plug tax loopholes, making it easy for multistate firms to shift their profits out of state and avoid Iowa taxes. Therefore, there is no case that businesses in Iowa are taxed too high relative to other states.