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Repealing the Iowa corporate income tax: just a good start

March 01, 2010

Kristan, who writes a tax blog for Roth & Co., has a rationale for eliminating the tax. It goes like this: The corporate income tax is not a big income producer. It is expensive to administer. Also, Iowa's high tax rate discourages new businesses from locating in the state.

So, why not get rid of it?

One reason, he admitted, is that too many businesses with highly paid lobbyists benefit from the complicated network of tax credits that has grown over the years to mitigate the cost of the tax.

Dave Elbert provided a nice overview of the problems with Iowa's coporation income tax. Yet while it's important to fix the corporation income tax (and by "fix" I mean "get rid of"), that's only a start. Iowa's income tax system has become a goofy means of half-backed industrial and social policy via tax returns. With dozens of tax credits and special breaks for everything from ethanol and soy-based transformer fluids to tuition funds and film credits, the tax law has ventured far from it's real job, funding state government. It is now a lobbyist's playground, with the influential getting funds at the expense of the rest of us.

That's why we need something like the Quick and Dirty Iowa Tax Plan. We'll reproduce the whole thing below. And consider: is it better to have low rates for everyone, or high rates and special deals for those favored by our 150 legislative supergeniuses?

The Tax Update's Quick and Dirty Iowa Tax Reform Plan

1. Eliminate the Corporation income tax. The Iowa corporation income tax has the highest stated rate in the country, and one of the highest effective rates. The only reason it doesn't destroy Iowa's economy altogether is that it is so riddled with loopholes that collections are very low - well under 5% of the state budget. Yet it is a very expensive tax to administer and to comply with. Eliminating the tax would send a powerful message to companies looking for a place to invest for the long term.

2. Reduce the Iowa individual income tax to 4% or less. 3.99% would be much more attractive to entrepreneurs and executives considering Iowa locations. It would bring our rate decisively below all of the border states except for Illinois and South Dakota. Only a low rate will enable Iowans to give up the large number of special breaks that make compliance and tax administration expensive.

3. Strip down the Iowa tax law. To get the rate down to this level, Iowa will need to strip its tax law of a host of politically-motivated tax breaks. These include, among others,

- All economic development tax credits - ethanol, films, R&D, "targeted" jobs and the like, they all should go. Low rates are more important than any of these, all of which serve primarily to fund the well-connected.

- The deduction for Federal income taxes. If the rates are low enough, the deduction doesn't matter nearly as much. If its built into the rates, you protect poorly advised taxpayers who have a big once-in-a-lifetime income item - say, from selling a business - and losing the value of the deduction by paying the tax when it is due, rather than prepaying in the year of sale.

- The exclusion for ten-year capital gains.

- The credits for tuition funds, community foundations, and the like.

- The special pension and tuition breaks for old folks. Any breaks for poor folks should be in the form of a generous low-income exemption. Old folks with low income aren't necessarily more worthy than younger folks. In fact they often are much more wealthy than their younger counterparts.

Just because a break isn't mentioned here doesn't mean I want to keep it.

4. Make federal taxable income the starting point for Iowa taxable income. If you use federal AGI as the starting point, you can achieve even greater simplification and lower the rates further. (Unmodified AGI as a tax base can create grossly unfair results, but it if you allow a deduction for gambling losses and Schedule A investment interest, you get a decent base). Federal changes in income computation would automatically be incorporated in Iowa's tax code, absent a vote of the legislature otherwise. It also makes Iowa's tax forms potentially postcard-sized.

5. Make Iowa's tax forms into a reconciliation format, starting with Federal taxable income. Have lines to back out federal Treasury income, which the state can’t tax. If Iowa chooses to tax muni bond income, have a line for that. Have one last line for all (any) other addbacks and subtractions, which would feed from separate detail schedules.

6. The most difficult issue is taxation of S corporations. I would allow S corporations to elect to be Iowa C corporations and make Iowans taxable on distributions from the corporation as if they were C corporations. Electing corporations would have to report distributions to Iowa shareholders to the state, and the shareholders would be taxed as if the distributions were taxable dividends; otherwise electing corporations would pay no tax on Iowa-source income. Iowans owning Non-electing S corporations would be taxed in Iowa on all their S corporation income. This would achieve near-parity between Iowa C and S corporations.

These proposals do not have revenue projections. The idea is to not reduce Iowa’s tax receipts. This is an attempt to provide a target, an ideal for improving the system. I would love to see what the revenue projections would be. Unfortunately, unlike IRS, Iowa doesn't release any statistical information that would enable us to make those kinds of estimates.

Whatever the projections would be, I have no doubt that "no corporate taxes and low individual rates" would be better for Iowa's economy than "high taxes with lots of loopholes for those with connections and lobbyists."

Tags: Dave Elbert.iowa tax policy.Quick and Dirty tax plan.