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WHAT'S WRONG WITH IOWA'S TAX CLIMATE

October 11, 2006

I asked Chris Atkins of the Tax Foundation to comment specifically on Iowa's tax climate, which the Foundation ranks as one of the ten worst in the nation. His reply:

Iowa ranks 43rd overall in our 2007 state business tax climate index. This is a three spot improvement from their 2003 rank of 46th.

The overall ranking is based on scores in five component areas: corporate taxes, individual income taxes, sales taxes, unemployment insurance taxes, and property taxes. A state that has a relatively low, single rate and a relatively broad base will score better in these component areas than a state with a relatively high rate (or multiple rates) and a relatively narrow base.

Iowa’s corporate and individual income tax systems drag down its overall ranking. On these two component areas, Iowa respectively ranks 46th and 45th.

Iowa’s corporate tax system scores poorly because it features a top rate of 12 percent on income earned in excess of $250,000—the highest top corporate income tax rate of any state. Iowa also scores poorly because it narrows its tax base by offering tax credits for investment, job creation, and research and development. Iowa also gets a low score because it is one of only 8 states with a corporate alternative minimum tax (AMT) and it fails to index its tax brackets for inflation.

For individuals, Iowa scores poorly because it has 9 different tax brackets, ranging from .36 percent to 8.98 percent on income earned in excess of $57,106. Only one other state (Missouri) has more individual income tax brackets, and only two other states (Hawaii and Ohio) have 9 brackets. Not helping matters is the fact that Iowa allows the double taxation of interest, dividends, and capital gains, fails to index its standard deductions, exemptions, and its tax brackets for inflation, and levies an AMT on individual filers.

I know that Iowa gives deductibility for federal taxes paid. While this undoubtedly helps to keep Iowa’s tax burden low (Iowa ranks just below average—26th—in our annual calculation of the state tax burden) it unnecessarily complicates Iowa’s tax structure. The state would be better off if it eliminated this deduction and used the revenue generated to move toward a lower and simpler rate structure for corporate and individual income taxpayers. It is good for states to reduce the tax burden on their citizens, but they shouldn’t complicate their tax systems in the process. When you reduce taxes by offering unwarranted credits and deductions, you just substitute a whole new set of problems for your taxpayers. Lowering the rate is the most economically efficient way to reduce taxes and improve your overall business tax climate.

It's hard to find anything to argue with here. I can only add that the tax credits tend to go to well-connected constituencies, making things even worse for those of us without lobbyists.

Correction: Mr. Atkins points out an error in his response - Iowa does index brackets. He says Iowa's ranking does take the indexing into account.

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