Reining in business tax breaks

Real reform of Iowa business tax subsidies is needed now more than ever.

It has become a familiar story: Tax breaks and tax expenditures growing at a pace that spending on traditional state priorities cannot match. This growth continues on autopilot, year after year, with little scrutiny and often with weak justification.

The cost of business tax credits under the income tax grew from $214 million in Fiscal Year 2015 to $244 million in FY19, and is projected to be $287 million for FY20.[1] The commercial and industrial property tax cuts enacted in 2013 have added significantly more to that estimate. The business property tax credit enacted in that legislation, which will remain at $125 million every year, will bring the overall state cost of business tax credits to more than $400 million by FY20. In other words, business tax credits in total will have about doubled in six years. (See graph.)

Related business breaks would drive total spending on subsidies to business much higher.

      • Iowa in recent years has spent $152 million annually to backfill local public revenues lost when commercial and industrial property assessments were rolled back to 90 percent of actual value, a tax break to business.[2]
      • Revenue losses from the state’s failure to enact combined reporting to plug loopholes in the corporate income tax amount to an estimated $200 million.[3]
      • The state also spends nearly $60 million annually backfilling the loss of tax base to school districts as a result of city and county use of tax increment financing, much of which reduces the costs of business development.[4]

The total cost of business subsidies, in other words, approaches $800 million, even without other so-called tax expenditures, such as the state’s use of single-factor apportionment.

Tax credits have the same impact on the state’s bottom line as any other spending. Such spending comes outside the normal budget process where agencies, advocates and constituents make proposals that lawmakers vote up or down, on the record. Tax credits, with few exceptions, cause spending outside that competition.

State spending on business subsidies necessarily comes at the expense of other budgetary priorities, including education, health, and public safety. Investments in education and infrastructure, the building blocks of a strong economy, suffer when the annual budget debates start out with a billion dollars already committed to business incentives.

Real reform is needed now more than ever.

See our Roadmap for Opportunity two-pager on this topic.

 

 

 

[1] The following tax credits listed in the Iowa Department of Revenue Contingent Liabilities Reports are included in our analysis as business tax credits: Enterprise Zone Programs, High Quality Jobs Program, Historic Preservation, Industrial New Job Training Program (260E), Research Activities, Targeted Jobs, Venture Capital, Accelerated Career Education, Redevelopment, Renewable Chemical Production, Renewable Energy, Wind Energy Production, Biodiesel Blended Fuel, E15 Gasoline Promotion, E85 Gasoline Promotion, Ethanol Blended Gasoline, Ethanol Promotion. With the exception of Historic Preservation, this list is in line with credits classified as “business incentives” by the Iowa Department of Revenue in their most recent tax expenditure study. https://tax.iowa.gov/reports/2010-iowa-general-fund-tax-expenditures-excel.

[2] Legislative Services Agency, Summary of the Governor’s Budget Recommendations FY2021. Jan. 16, 2020, page 212.

[3] Iowa Department of Revenue, 2017.

[4] Legislative Services Agency, FY 2018 Annual Urban Renewal Report, February 15, 2019, p. 24. About 15 percent of TIF erxpenditure in FY18 went directly for business projects; it is not known how much of the 63 percent that went to property acquisition, roads, bridges, utilities, and water or wastewater treatment plants was associated with business development.

Peter Fisher is research director of the nonpartisan Iowa Policy Project.

pfisher@iowapolicyproject.org

Anti-taxers don’t get ‘competitiveness’

Iowa is a low-tax state for business, and has been for some time. Two leading business consulting firms have demonstrated this.

slide_taxfoundation-cropHere we go again. Whenever Iowa legislators or lobbyists want to cut taxes for business, or for high-income individuals, they trot out the same myth about competitiveness.

The reality is pretty simple: Iowa is a low-tax state for business, and has been for some time. Late last year, the Council on State Taxation released its latest report on how much businesses pay in state and local taxes, prepared by the accounting firm Ernst and Young. Iowa was 18th lowest — only 17 states had a lower overall tax rate on business.[1] (See graph.) Another accounting firm, Anderson Economic Group, ranks Iowa’s business taxes even lower, at 14th — only 13 states have lower taxes.[2]

But why use real data when you can just cite some anti-tax, anti-government think tank that has cobbled together a “competitiveness index” that makes Iowa look bad?

So it is again in 2020. The governor cited the need to be competitive in her condition of the state address, and the Senate president repeated the theme. To support the claim, Senator Charles Schneider pointed to a bogus study by the Tax Foundation that ranked Iowa 42nd among the states in “business tax climate.” Only eight states were worse.

The Tax Foundation, it turns out, mashes together 124 components of state tax systems to produce an overall “index number” to rank the states. Their index is meaningless; it gives weight to components that cannot plausibly affect tax competitiveness, while ignoring features that have a large impact on business taxes.[3]

The last problem is particularly salient for Iowa. Iowa offers single-factor apportionment, which can drastically reduce a corporation’s Iowa tax if they export much of their production. And Iowa is one of the few states that allow corporations to deduct part of their federal income taxes on their state return. Both of these factors are completely ignored by the Tax Foundation. Instead, they focus on things like the number of tax brackets. Meanwhile, the sales taxation of food is a good thing, in their book; Iowa’s failure to tax food somehow makes us less competitive. This is nonsense.

Iowa is a slow growing state, but more tax cuts for those at the top will not help. They will further erode the state’s ability to invest in our roads and bridges, in our children and our workforce, the building blocks of a strong economy. Education, from early childhood through college, not only produces the skilled workforce businesses need, but makes it easier to attract workers from elsewhere, knowing their children will get a good education.

[1] Business taxes as a percent of GSP. Ernst & Young LLP, Total state and local business taxes, October 2019. Table 4, page 12. https://www.cost.org/globalassets/cost/state-tax-resources-pdf-pages/cost-studies-articles-reports/1909-3269660_50-state-tax-2019-final.pdf

[2] Business taxes as a share of business pre-tax operating surplus. Anderson Economic Group LLC, June 2018. 2018 State Business Tax Burden Rankings, Exhibit I, page 17. https://www.andersoneconomicgroup.com/wp-content/uploads/AEGBusinessTaxBurdenStudy_2018_FINAL.pdf

[3] For a more detailed critique of the Tax Foundation’s ranking, and others, see “Grading the States: Business Climate Rankings and the Real Path to Prosperity.” http://www.gradingstates.org/

2010-PFw5464Peter Fisher, research director of the nonpartisan Iowa Policy Project in Iowa City, is professor emeritus in the University of Iowa School of Urban and Regional Planning. His widely cited Grading the States analysis is at gradingstates.org. pfisher@iowapolicyproject.org

New rule! Governor wants to make laws himself

We have entered a new world of executive authority in Iowa.

We all know the drill: The Legislature passes bills and the Governor signs or vetoes them, whereupon they become either laws, or nothing.

Not anymore, apparently.

The move by the Branstad administration to implement a new sales tax break worth an estimated $40 million a year — possibly more — is taking place outside the legislative session. If it succeeds, we have entered a new world of executive authority in Iowa.

Business lobbyists wanted the change, it could not pass the Legislature, and the administration thinks it has found a short cut: Change the longstanding interpretation of the existing law. Presto, tens of millions of dollars will be available for manufacturers. And those same tens of millions of dollars will not be available for schools.*

Consider a Des Moines Register guest opinion by Mike Ralston of the Iowa Association of Business and Industry, a lobbying group representing manufacturers who would benefit from the change:

Part of the change affects Iowa’s existing sales and use tax exemption for machinery and equipment used in the manufacturing process.  The change is sound policy.

If that’s the case Mr. Ralston wants to make, let him make it during the legislative session. This rules change skirts the legislative process, and Iowans are noticing. Jon Muller writes in an insightful piece on the Bleeding Heartland blog:

It’s easy to look at political discourse today and conclude everything is a battle between Democrats and Republicans, the left and the right, liberals and conservatives. But far more is going on with this issue. … A Democrat will surely be Governor again someday, and it would be a mistake to set a precedent that allows the Executive Branch to so drastically change the tax climate. If Republicans in the Legislature do not stand up against this unprecedented over-reach of power, they will almost certainly live to regret it.

James Larew, an Iowa City attorney who was general counsel to former Governor Chet Culver, served for four years as Culver’s appointee on the Administrative Rules Review Committee, a panel of legislators who have the authority to delay the rule change from taking effect. He advised the panel: “This is new territory. What is sauce for the goose eventually becomes sauce for the gander, too.” Larew went on:

The balance of political power changes from one election to the next.

The balance of constitutional power — the relationship between the Iowa General Assembly and executive departments of government — is more serious and more lasting.

Broad interpretive powers given up by the Legislature, in one moment of time, concerning one issue, are not easily, later recovered.

As the Cedar Rapids Gazette opined in an editorial, the change “breaks the rules of good government.” The Gazette wrote:

The Branstad administration should drop its rule change bid and make its case to the General Assembly, which is elected to craft a budget and write tax policy. If it’s truly a great idea that will create jobs, as the department contends, surely the sales job won’t be that difficult.

Many businesses, we often note at IPP and the Iowa Fiscal Partnership, already pay no income tax in Iowa, and they just had their property taxes slashed. The corporate appetite for tax cuts is insatiable. Guess who pays?

*  Note: The Department of Revenue estimate of the cost of this tax break to both the state and local governments is over $40 million for each of the first four full years of implementation, according to a document provided the Administrative Rules Review Committee. The Legislative Services Agency has told ARRC that it does not have enough information to determine the accuracy of that estimate. We have revised the initial version of this blog post to reflect this uncertainty, until state officials agree on an estimate.
Owen-2013-57Posted by Mike Owen, Executive Director of the Iowa Policy Project

 

Iowa Cannot Afford Another Wasteful Business Tax Break

Enacting a subsidy through administrative rules guarantees complete absence of evaluation and accountability

2010-PFw5464Statement by Peter Fisher, Research Director, The Iowa Policy Project, before the Administrative Rules Review Committee

October 13, 2015

The administration’s proposal to create new sales tax exemptions for Iowa businesses is unnecessary, expensive and counterproductive. The state can ill afford another tax break that will harm essential state services while producing little or no economic benefit.

Iowa business taxes are already quite competitive

  • The most recent study of state and local taxes on business as a percent of state GDP by Ernst and Young and the Council on State Taxation shows that Iowa taxes business at 4.7 percent of GDP, exactly the same as the national average. Iowa ranks right in the middle of the pack.
  • A study by Anderson Economic Group in 2015 calculated state and local taxes on business as a percent of pre-tax profits and found Iowa’s effective tax rate to be 8.7 percent, which placed it 32nd among the states, below the national average.

State and local taxes have little effect on business location decisions

  • State and local taxes are less than two percent of total costs for the average corporation. As a result, even large cuts in state taxes are unlikely to have an effect on the investment and location decisions of businesses, which are driven by more significant factors such as labor, transportation, and energy costs, and access to markets and suppliers.

Enacting a subsidy through administrative rules guarantees complete absence of evaluation and accountability

  • While the sales tax break has been promoted as an economic development incentive, creating it by administrative rule eliminates even the minimal level of accountability established by the Legislature for the periodic review of tax credits. There will be no review, no evaluation of its effectiveness, not even an annual accounting of its cost.

Tax breaks erode support for public investments in our future

  • The proliferation of tax incentives and business tax cuts over the past two decades has resulted in several hundred million dollars each year cut from the state budget. This has undermined the state’s ability to support quality education, from pre-school through public colleges and universities, which in the long run will have serious consequences for state economic growth and prosperity.