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ARE IOWA VALUES FUND TAX CREDITS UNCONSTITUTIONAL?

May 03, 2005

The new Grow Iowa Values Fund legislation (H.F. 868) headed to the Governor's desk relies heavily on new and improved targeted tax credits to launch the Iowa economy into the 21st century. Yes, we know, it's a little late, but better late than never.

The reliance on these credits isn't surprising; targeted tax credits have been at the core of Iowa's economic development efforts for years. While they haven't made Iowa an economic juggernaut, the 19 existing credits have their grateful and vocal constituencies.

But what if they are illegal?

A COMMERCE CLAUSE VIOLATION?

The U.S. Court of Appeals for the Sixth Circuit has ruled that Ohio's investment tax credit scheme is unconstitutional as a violation of the commerce clause (Cuno v. Daimler-Chrysler, Inc):

Specifically, any corporation currently doing business in Ohio, and therefore paying the state's corporate franchise tax in Ohio, can reduce its existing tax liability by locating significant new machinery and equipment within the state, but it will receive no such reduction in tax liability if it locates a comparable plant and equipment elsewhere. Moreover, as between two businesses, otherwise similarly situated and each subject to Ohio taxation, the business that chooses to expand its local presence will enjoy a reduced tax burden, based directly on its new in-state investment, while a competitor that invests out-of-state will face a comparatively higher tax burden because it will be ineligible for any credit against its Ohio tax.

(emphasis added)

This ruling, if its application expands to our Eighth Circuit, would likely invalidate the tax credits in H.F. 868; indeed, it would undo almost all of Iowa's 19 existing credits. An excellent writeup in yesterday's State Tax Notes (available to all today thanks to the invaluable efforts of the TaxProf) outlines how the ruling's logic threatens similar credits in other states:

If Cuno is expanded nationally or its rationale is accepted by a Minnesota court, it is very likely the Minnesota statutes at issue in Olson would be struck down, as they are very similar to the Ohio statutes. The most obvious similarity is that both programs provide credits against corporate franchise tax for investments and purchases made within Ohio or within specific designated areas in Minnesota. In both states, the investments must represent increased economic activity. In Minnesota, businesses qualifying for the credits must increase their employment or capital investment by a set percentage. Under the invalidated Ohio statutes, businesses receive credits depending on how much their individual investment compares with overall new investments within a county.

The paragraph would be just as accurate if you substitute "Iowa" for "Minnesota." In fact, cases challenging targeted credits have been filed in Minnesota and Nebraska, both of which are in the same circuit as Iowa.

The authors of the Tax Analysts article expect the Supreme Court to decide the issue. Unless they reverse the Sixth Circuit, all of the legislature's economic development efforts may be worthless. <insert your own smart-alec comment here>

IS THERE ANOTHER WAY?

Sometimes it's said that politicians will do the right thing, after all alternatives have been exhausted. The courts might get Iowa to consider whether a low-rate, simple tax system with a broad base might be more attractive to businesses than our byzantine system with all of its credits and incentives.

The current system taxes Iowa's existing businesses to lure and subsidize their competitors. It's sort of like trying to attract girls by beating your wife. And anyone you attract that way probably isn't much of a catch.

UPDATE: Chad makes a good point down in the comments:

I've been thinking about this and wonder whether these tax credits/corporate welfare subsidies violate the Iowa Constitution's equal protection clause in the same way differential tax rates on land based and water based casinos do. Certainly the Newton racetrack sales tax giveaway seems spot on for violation.

We've had similar thoughts.

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