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Iowans for Tax Relief: making the perfect the enemy of the good

April 07, 2010

Yesterday's post on tax issues in the Iowa Governor's race lamented the candidates' timid approaches to income tax reform:

Far better to adopt the key planks of the Quick and Dirty Iowa Tax Reform:

- Eliminate the corporation income tax
- Lower the to individual rate to 4 percent or less.
- Eliminate all corporate welfare and special interest tax breaks
- Allow Iowa S corporations to elect to be C corporations, taxable only on distributions to Iowa residents, for Iowa filing purposes.

This would require ending federal deductibility, the sacred cow of the powerful lobby Iowans for Tax Relief, and it would take away annual taxpayer checks to influential corporations via the refundable Research credit. That probably explains why candidates are reluctant to do the right tax policy thing.

That prompted a phone call from an unhappy Ed Failor, Jr., President of Iowans for Tax Relief, who felt this was unfair to his organization. I explained that I thought IFTR's hardline position in favor of deducting federal taxes on the Iowa return was an obstacle to improving Iowa's tax system. He said that IFTR was willing to give up deductibility if there were adequate protections against subsequent tax rate increases. I invited him to send an e-mail response. This arrived shortly afterwards:

In 2003, House File 692, Division IV would have lowered the state income tax and eliminated federal deductibility. The bill included a contingent effective date for the elimination of federal deductibility. If a constitutional amendment requiring either a 60% majority of the Legislature to increase tax rates or a vote of the people to increase tax rates had been ratified, the rates in Division IV would have been applicable. If a constitutional amendment were not ratified, then the rates in a previous section of the bill would have been the applicable individual income tax rates, and federal deductibility would remain.

The legislation is available online at: http://coolice.legis.state.ia.us/Cool-ICE/default.asp?Category=billinfo&Service=Billbook&menu=false&ga=80&hbill=HF692

The lobbyist declarations for HF 692 (the Iowans for Tax Relief Lobbyists in 2003 were Boeyink/Failor (2)/Robinson, registered as “Undecided”) are also online at: http://coolice.legis.state.ia.us/Cool-ICE/default.asp?category=Lobbyist&Service=DspReport&ga=80&type=b&hbill=HF692.

After further review, the call on the field stands. IFTR's position is an obstacle for improving Iowa's tax system, in my humble opinion. Why? Because they are willing to give up federal deductibility as part of tax reform only on conditions that can probably never be met, given the difficult process of amending Iowa's constitution.

A straight-up swap of federal deductibility for lower tax rates would bring the top individual tax rate down from 8.98% to about 6.03% under current rates, or 5.29% under the Obamacare rates scheduled to take effect in 2013.

Getting the individual rate below 4% should be a goal for Iowa. Once the rate is that low, state taxes become a much smaller issue in business and personal decision-making. While repealing federal deductibility by itself doesn't get you there, it goes a long way, and getting rid of Iowa's rats nest of special interest exemptions and corporate welfare tax breaks should get you across the line. Getting there without repealing federal deductibility would be almost impossible.

In our phone call Mr. Failor argued that once the rates were lowered in exchange for exemptions, the political class would start to creep the rates back up again, so there should be no compromise until the constitutional guarantees sought by IFTR are enacted. He cited the way federal rates have come up after the base-broadening, rate-lowering 1986 federal tax reforms as proof.

I look at it another way. The Reagan-era reforms shifted the terms of the debate way down the rate scale. Prior to the 1986 reforms, the top individual rate was 50% and the top corporate rate was 46%. Immediately afterwards the top individual rate was 28% and the top corporate rate was 35%. Yes, rates have crept up since then (but not corporate rates). But would anybody argue that we should have left the top rates at 50% and 46% just because the 1986 tax reforms didn't include constitutional guarantees against gutless and feckless politicians? We have had a whole generation with far lower tax rates than we would have ever had absent tax reform. We had a long good economic run with the lower rates that only now, almost 25 years later, is petering out as a result of enduring and accelerating political irresponsibility.

So if we get the Iowa rate down to 3.99% without a constitutional guarantee against tax increases, or a constitutional limit on spending, politicians can ratchet up taxes again later. But then the baseline for debate is 3.99%, not 6.02% or 8.98%. Meanwhile, Iowans will benefit from the lower rate and the simple system for some years. Better one generation benefit from lower rates than none.

The IFTR position also assumes that it can protect federal deductibility forever. That's not necessarily so. Last year the legislature came within a whisker of repealing federal deductibility in a way that would have done nothing to improve the overall tax system.

The current Iowa income tax system is awful. With the exception of the Branstad-era cuts in the individual rate from an unbelievable 13% to 8.98%, Iowa's basic tax system is almost unchanged from the 1970s. If Rip Van Winkle, CPA woke up and started to do Iowa returns today, he would have almost no learning curve. And the results of this system?

- Iowa has the 5th-worst business tax climate in the country, according to the Tax Foundation, and is perennially in the bottom 10.

- Iowa is consistently in the bottom 10 in entrepreneurship by about every measure -- and dead last by some measures. Business startups are the key to a dynamic and growing economy.

While the tax system isn't the only thing that makes Iowa a bad place for entrepreneurs, it's a big thing. If we have to trade in federal deductibility to get a low-rate, low-loophole tax system and a dynamic economy, it's a good trade -- even if it doesn't prevent future legislative foolishness. Insisting on constitutional guarantees in exchange for tax reform doesn't protect a good system in pursuit of something even better; it protects a rotten system in a hopeless pursuit of a perfect one.

Tags: Ed Failor Jr..iowa tax policy.Iowans for Tax Relief.Quick and Dirty tax plan.

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