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A TAX THAT'S ONLY TOLERABLE IF IT APPLIES TO NOBODY

January 21, 2008

So Iowa has the highest corporation income tax rate in the nation, 12%. We stand head and shoulders above Number 2, Pennsylvania, and its 9.99% rate. Why aren't Iowa's big corporations kicking and screaming about this?

Because they pay very little tax. Iowa corporations with multi-state operations can apportion their taxable income out of Iowa based on their sales. If a company that makes $100 million only has 1% of its sales to Iowa customers, it only pays the 12% tax on 1% of its taxable income. That's true even it it doesn't actually pay income tax in any other state. Other tax breaks, such as the refundable research credit, enable companies to pay little Iowa tax, or even to be net subsidy recipients.

Source: 11/19/2007 Memo to members of Iowa Legislature. Click to enlarge.

Hungry for more revenue, Governor Culver has called for "combined reporting" to collect more revenue from multi-state corporations. Similar proposals have died in the last two legislative sessions, and this one probably faces the same doom. Why does a proposal to tax big bad corporations from out-of-state fail to move in a legislature controlled by Democrats?

IT ONLY WORKS IF IT DOESN'T WORK

Iowa's highest-in-the-nation corporation tax is tolerated only as long as it applies to nobody. In this way it is like the federal estate tax, which for many years was tolerated and relatively non-controversial, even with a crushing 60% top rate. This was because it applied to almost nobody because of the then-generous lifetime exemption, and because is was riddled enough with loopholes that it was almost optional. As inflation pushed the upper middle class couples into net worths over $1.2 million, the estate tax began to apply to actual voters, became very unpopular with the political donor class, and barely avoided repeal.

In much the same way, effectiveness could be very dangerous for the Iowa corporation tax. Our overall tax structure is already generally regarded as hostile to business. A 12% rate that actually applied would keep all but the most easily-bribed businesses from locating here.

IS IT WORTH IT?

Only 5% of Iowa's tax revenue comes from the corporation tax - $320 million in the most recent fiscal year.

The Des Moines Register reports that the state has agreed to provide economic development tax credits of $444.8 million since 2003. This only counts specific credits that are run through the Depearment of Economic Development. It doesn't include the refundable research credit. It also, I believe, omits historic rehabilitation credits. Of course the state has to maintain an examination function to collect the corporation tax. Given this, maybe Iowa could repeal its corporation tax without much revenue loss if it got rid of all of the corporate welfare tax credits at the same time.. If we still need to make up some revenue, get rid of the stupid $25 million "Iowa Power Fund" and the $50 million "Grow Iowa Values" fund giveaways.

There are logistical problems with a corporation tax repeal - principally the problem of S corporations, whose earnings are taxed directly to shareholders returns. Perhaps these companies could elect to be taxed as C corporations for Iowa, with shareholders paying Iowa tax only on their distributions.

If our lawmakers were smart, the debate this session would be over the continued existence of the corporate tax, and whether a 0% corporate tax would be better for economic growth than the dozens of economic development tax credits that function as a great corporate welfare scheme. But they aren't , so they will instead be talking about "closing loopholes" in a tax that shouldn't exist in the first place.

Tags: iowa tax policy.

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