Tax credits: Just review them!

Iowa lawmakers are making the issue of tax credit reform much more difficult than it needs to be.

Put another way, consider tax credit reform as a different task: If we were setting out to design the first wheel, no cars would be on the road today.

The latest foot-dragging came in late October, with the first meeting of a so-called “Tax Credit Review Committee,” which if not for the delay was a rare, promising nugget in an ill-conceived, expensive and inequitable income-tax cut bill in 2018.

It was 10 years ago this fall that a scandal in the Iowa Film Tax Credit program led Governor Chet Culver to order a review of all state tax credits. A special panel of state department heads went through the credits and offered a set of reforms in January 2010.

Virtually nothing was done in response. Tax credits, particularly those for business, have gone merrily along, rising to a projected $434 million for this budget year. Of that, about 7 out of every 10 dollars, or $314 million, is for businesses. State revenue analysts expect under current law for these numbers to be similar through FY2024.

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While the tax credits themselves can be complicated, the fundamental issues are not.

  • Tax credits are expensive.
  • Tax credits are regularly and extensively analyzed by the Department of Revenue, making plenty of information available.
  • Tax credits, like any spending of public money — and this is, in fact, spending ordered outside the budget process — demand accountability and a demonstration of a public benefit.
  • The Legislature creates these exceptions to our tax code; thus, it falls to the Legislature to review them to determine if they meet their expected purpose.
  • Even if a given credit may benefit the public, it must be shown to be a better public expenditure than something else, like education or health care services.

As it is, the 2020 legislative session will open without anything serious being done about a review ordered two years before.

Truly it is easier not to do anything, to keep the gravy train running for the corporate lobbyists who benefit from these credits. But if you’re going to talk the talk about accountability in public spending, you should walk the walk.

The low-hanging fruit that could start lawmakers on that path is the Research Activities Credit, or RAC. The RAC is a refundable credit, which means that if you have more credits than you owe in taxes, you get a check from the state for the balance. The annual cost of the RAC is about one-fifth of the cost of all business and family tax credits.

As we have shown repeatedly — using data from an annual state report by the Department of Revenue — most of the RAC is paid as so-called “refunds,” not of taxes owed, but of tax credits not needed, and most of the benefit goes to very large firms.

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DOR evaluations — here and here as examples — provide evidence that is at best sketchy on whether the RAC promotes significant new research in the state. Companies that benefit from the RAC have to do the research anyway, just to be in business, or they wouldn’t bother with it.

In the case of a small startup firm, a credit for some period of time might help the firm get established. For multinational corporations with hundreds of millions or billions in profit, good luck proving the need.

Think of it this way: You could reduce or even eliminate the refundability of the RAC and not raise taxes on a single company or individual. But you’d have $40 million more available to put into public schools, or clean water projects, or any number of public priorities.

Incoming House Speaker Pat Grassley said tax credit reform “is kind of a long process.” But if one never starts, one will never design that wheel.

These are budget choices, ultimately. Why are legislators so afraid to even start on them?

MMike Owen is executive director of the nonpartisan Iowa Policy Project.

mikeowen@iowapolicyproject.org

Better target senior tax breaks

Why should a senior retired couple pay less income tax than a working couple with similar or even less income? That can be the situation in Iowa, and many other states.

Also see Iowa Fiscal Partnership news release

A new paper about state tax breaks for seniors shows one reason pre-2020 chatter about new tax breaks in Iowa is a bad idea.

Elizabeth McNichol of the Center on Budget and Policy Priorities (CBPP) notes in her report Wednesday that special income-tax breaks for seniors cost states 7 percent on average in 2013, a figure that will rise with growth in the population over 65.

As McNichol notes, “The senior tax breaks are poorly targeted because of their design: most states provide them regardless of the recipient’s income or savings.”

Put another way: Why should a senior retired couple pay less income tax than a working couple with similar or even less income? That can be the situation in Iowa, and — as McNichol notes — in many other states as well.

It is a point Peter Fisher and Charles Bruner have made in Iowa Fiscal Partnership (IFP) analysis over the years about Iowa’s special breaks for pension income, and as legislators phased out what had already been a limited tax on Social Security income.

Already, Iowa has freshly passed, costly and inequitable tax cuts scheduled to be phased in over the next few years, yet state legislators just last week were talking about bigger cuts in 2020. Given attempts to expand senior breaks in 2018, but not adopted in the final package, there is a danger that new income-tax cuts in 2020 could include the new senior breaks.

Among changes considered in 2018 was an expansion of Iowa’s already generous pension exclusion from $6,000 (single) and $12,000 (couple) to $10,000 and $20,000, respectively.

McNichol’s paper notes Iowa is one of 28 states that already completely exempts Social Security income from tax, and one of 26 that exempts at least some pension income.

Iowa, in short, is already quite generous to retirees. Also as McNichol notes, for some this might make sense — seniors at low incomes. But not all.

“A large share of these costly breaks go to higher-income seniors who need them the least. States should reduce this expense by better targeting relief to seniors with low incomes,” she wrote.

Bruner and Fisher noted this problem in their IFP paper last year:

Iowa has adopted a number of special provisions benefiting seniors. While the elderly and disabled property tax credit is available only for those with low income, the other tax preferences are not based on ability to pay:

•   All Social Security benefits are exempt from tax.

•   The first $6,000 in pension benefits per person ($12,000 per married couple) is exempt from tax.

•   Those age 65 or older receive an additional $20 personal credit.

•   While non-elderly taxpayers are exempt from tax on the first $9,000 of income, for those age 65 or older, the exemption rises to $24,000. For married couples, the threshold is $13,500 for the non-elderly, but $32,000 for seniors.

Iowa Fiscal Partnership analysis of tax policy and tax proposals is always grounded in fundamental principles of taxation, among them fairness: Similarly situated taxpayers should be treated similarly in tax policy.

What matters more to measure a taxpayer’s ability to pay is the amount of income, rather than its source. To tax income from wages at a higher rate than retirement income violates that principle.

Mike Owen is executive director of the nonpartisan Iowa Policy Project and director of the Iowa Fiscal Partnership, a joint effort of IPP and the nonpartisan Child and Family Policy Center in Des Moines. mikeowen@iowapolicyproject.org

Tax-cutters’ lack of confidence

Plans for election-year tax cuts expose tax-cutters’ lack of confidence that (1) cuts they already made will deliver prosperity, and (2) they will hold power beyond 2020.

In the confidence game of cutting taxes, where the world is promised to all but delivered mainly to the wealthy, Iowa’s tax-cutters are showing how little confidence they have in their own political talk.

State Senator Randy Feenstra of Hull is backing off his chairmanship of the Senate Ways and Means Committee as he runs for Congress in 2020, leaving the door open to Senator Jake Chapman of Adel.

Both have been big talkers painting the glories of tax cuts while running down Iowa’s competitive tax structure, and they have been successful using that political spin to make big changes — many of which are scheduled but yet to take effect.

Even then, they apparently will waste no time in rushing through new tax cuts, as evidenced by this story in the Cedar Rapids Gazette. There, Chapman is quoted that “he expected the Legislature would continue next session ‘to reform income taxes and reduce some of the highest tax rates in the country.’”

Before addressing the fundamental inaccuracy of the senator’s comment, one must wonder at least two things:

•   Are they not confident what they have passed already will not deliver what they promised?
•   Are they not confident they will retain political power through the Statehouse (the House is a much closer partisan split than the Senate) past the 2020 election?

Answering “yes” to either would explain their perceived need to rush more ill-advised tax policy into law.

In a very short span, Iowa lawmakers have eroded revenues with new tax giveaways to the wealthy and powerful, leaving scraps to working families in the middle and below. This has come with changes in personal income taxes, corporate income taxes and property taxes.

As Peter Fisher and Charles Bruner pointed out in an Iowa Fiscal Partnership analysis, the income-tax cuts passed in 2018 give almost half of the overall benefit to the highest-earning 2.5 percent of taxpayers — those making $250,000 or more.

Senator Chapman plays games with the term “tax rates” as if the highest tax rate is what anyone ever paid on all their income. It’s an illusion.

The highest rate — already reduced from 8.98 percent to 8.53 percent this year under the 2018 law — is a marginal rate; it is paid on only the highest share of income. The same taxpayer who pays the highest rate on one share of income also pays the lowest rate on the share of income where that rate applies.

In short, it’s a mix of rates — and they are applied to taxable income, which has many adjustments to lower that amount. Most notable among those is Iowa’s unusual provision to allow taxpayers to deduct federal income tax from state taxable income, which benefits higher-income people the most.

The tax-rate myth promoted by Senator Chapman is an old game, but the people who want to reduce public services and investments in the future keep playing it. And why not? They’re getting away with it.

The 2018 legislation includes ongoing rate cuts — if revenues reach high-enough levels. One reason to pass rate cuts again in 2020, before that deadline, is that you don’t expect the revenue targets to be met.

These changes have come at great cost to public services, including poor funding of public education from K-12 through community colleges and universities.

Looking ahead to the future of our state, and beyond the next election, would be the wisest course for Iowa tax policy. That is not what we’re getting.

Mike Owen is executive director of the nonpartisan Iowa Policy Project and director of the Iowa Fiscal Partnership, a joint effort of IPP and the nonpartisan Child and Family Policy Center in Des Moines. mikeowen@iowapolicyproject.org

Tax cuts: Already tried, failed

Iowa’s coming tax-cut experiment has been tried before and failed. Research showed the tax cuts appear to have slowed growth, taking money out of the economy.

Former Iowa Department of Revenue official Michael Lipsman discusses tax issues at a public forum last week at the State Capitol as former Senator Charles Bruner, left, and Senators Joe Bolkcom, Janet Petersen and Amanda Ragan listen. The institutional memory of experts such as Lipsman has been lost as legislators have rushed into plans to overhaul Iowa’s tax system, with most discussions taking place outside public view and earshot.

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Twenty-one years ago the Iowa Legislature enacted an across-the-board 10 percent cut in state income tax rates. That tax cut not only failed to spur economic growth, but bears a share of the blame for the under-performance of the Iowa economy in the years following. And it led to recurring revenue shortfalls and budget cuts.

Some in the Iowa Senate aim to repeat the experiment, this time with an 8 percent cut. There is no reason to expect a different result.

A 2004 report by Michael Lipsman, then head of the Tax Research and Program Analysis Section of the Iowa Department of Revenue, explains why the tax cuts of 1997 and 1998 had a negative effect on the economy.[1] That legislation cut all income tax rates by 10 percent, expanded the exemption for capital gains income, increased the pension exclusion, and exempted lineal ascendants and descendants from the state inheritance tax.[2]

The tax cuts were expected to reduce state revenue by $318 million in 2019. But Lipsman estimates that the effect of all these tax provisions was a reduction in revenue exceeding $600 million a year by 2002. Why the larger number? Because not only did the state take a smaller share of Iowans’ income in taxes, but income grew more slowly than it would have without the tax cuts.

This runs counter to the ideology of supply-side economics, which predicts that tax cuts will always spur growth. But Lipsman’s point is that it depends on the nature of those cuts — how much goes to non-residents, how much to high-income residents, where savings are likely to be invested, and where goods are produced.

The Iowa tax rate cuts, the pension exclusion, and the capital gains preference all concentrated their benefits on higher income taxpayers, and over a third of the inheritance tax benefit went to non-residents. The 3 percent of Iowa taxpayers with over $100,000 income got 24 percent of the benefit from the rate cuts, and these are the taxpayers most likely to invest their tax cut rather than spend it locally. It is likely that much of the tax savings was invested outside the state. Furthermore, most of the high-value consumer goods purchased by upper-income Iowans are produced outside the state.

At the same time, the tax cuts reduced state and local revenue, and public-sector employment dropped as a result. State and local government payrolls in Iowa decreased 16 percent from 1997 to 2002, over twice the rate of decline for the country as a whole. And state and local governments spend primarily within the state of Iowa, helping to boost the state economy. Cuts in public sector spending hurt the state economy directly (reduced purchases from local suppliers) and indirectly (reduced local purchases by public sector workers).

The upshot is that the tax cuts appear to have slowed growth, taking money out of the economy that ultimately ended up invested elsewhere, or went directly to non-residents, or was spent on goods produced elsewhere, instead of supporting Iowa businesses. In the five years leading up to the tax cuts, the Iowa economy grew at a rate nearly identical to the national economy: 28 percent. In the five years following the cuts, Iowa’s growth fell to 22 percent, compared to the national rate of 27 percent.

The massive tax cutting experiment in Kansas produced similar results — the Kansas economy slowed rather than accelerated. The experiment was a failure, and was ended by the Legislature.

The latest House tax bill would shower three-fifths of its benefits on taxpayers with income over $100,000, much more skewed to the top than the 1997 legislation. The Senate bill is likely to be skewed as well; it includes a pass-through income loophole that would cost $100 million, four-fifths of that going to the richest 5 percent of taxpayers.

Doing the same thing and expecting a different result is not the definition of rational policy making.

[1] Michael A. Lipsman. The Economic Effects of 1997 and 1998 Iowa Tax Law Changes. Tax Research and Program Analysis Section, Iowa Department of Revenue, July 2004.

[2] These are the major provisions, accounting for 90 percent of the cost. The bills also increased the personal credits and the tuition and textbook credit.

Peter Fisher is research director of the nonpartisan Iowa Policy Project. pfisher@iowapolicyproject.org

Senate bill: Short of rhetoric

Despite a proposed improvement in the Child Tax Credit, the Senate tax bill doesn’t live up to proponents’ rhetoric to support families with children.

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Despite Child Tax Credit change, Senate Tax Bill Doesn’t Live Up to Rhetoric in Supporting Families with Children

One of the few provisions in the proposed Senate tax bill that has bipartisan support is increasing the Child Tax Credit (CTC), which has been designed to better reflect the costs of raising children. It has been cited as a major benefit to working and middle-class families with children.

Like other provisions, however, this change is done in ways that provide almost no help to working low- and moderate-income families, while providing huge breaks for very wealthy ones. For middle-income families, the gains from a higher child tax credit are mostly offset by losses in personal exemptions, and some middle-class families would actually pay more under the proposals than under current law.

The Senate and House versions both provide information needed to calculate the taxes different tax filers would pay on their 2018 income (the year the changes go into effect) and to then compare these with the taxes they would pay under current law.

In the Senate version, the partially refundable portion of the CTC is unchanged, except that it would be indexed for inflation going forward, increasing to $1,100 in 2018. The nonrefundable credit is increased by $1,000 per child, making a maximum credit per child of $2,000 (the House version provides only an additional $600 credit, in addition to also indexing the partially refundable portion to $1,100). Both bills extend eligibility for higher income families (from a current phaseout beginning for married joint filers at $110,000 of adjusted gross income to $500,000 in the Senate version and an even higher level in the House version).

Performing the comparison of what tax filers in 2018 would experience from the CTC increase, a single mother with two children working full time and making a little above the minimum wage, $16,000 per year, gets no benefit under the House version and only $75 under the Senate version, compared with current tax law. A married couple with two children making $29,600 only receives the additional $100 per child of the refundable credit under the Senate and House versions. That the CTC provisions largely leave behind low and moderate-income families is particularly unfortunate, as these are the families that live paycheck to paycheck and could most benefit from additional support in raising their children.

Meanwhile, a married couple with two children making $300,000 per year gets the full benefit of the tax credits, $4,000 for the two children under the Senate version. This is on top of a tax cut from other changes in the tax code of at least $8,639 (which would be more if the family has extensive itemized deductions or tax-exempt income). Overall, this family is at least $12,639 better off after doing its taxes, compared with current law, $4,000 due to its new eligibility for the CTC.

For simplicity, these examples assume that all income is earned income and that the filers all take the standard deduction. If, because of buying a home, paying state and local taxes or a combination of the two, middle-income taxpayers now itemize their deductions, the increase in the standard deduction may not help at all and the loss of personal exemptions may mean they pay more taxes.

A married couple starting out with a young child and $60,000 of income, for instance, who now claims $24,000 as an itemized deduction ($18,000 in mortgage interest and property taxes, $4,000 in state and local taxes, and $2,000 in charitable contributions or other deductions) would owe $359 more in federal taxes under the Senate version. Although the family would benefit from the increase in the CTC, that would be more than offset by other changes, such as the loss of personal exemptions.

The chart below shows the specific impacts on these families of the changes in the child tax credit itself but also the changes of the overall tax changes to their individual income tax:

Tax proposals should be examined both in terms of individual provisions and in terms of their overall impact. On the former, under the Senate version the benefits of raising the Child Tax Credit are highly skewed toward the highest income tax-filers. This needs to change, by making the CTC refundable and not extending it so dramatically to the highest income families.

On the latter, the overall structure of the tax provisions largely negate the positive impact expansions of the CTC have for many middle-income families, while bestowing even more benefits on high income ones. Tinkering with the CTC without major changes in other provisions in the tax proposal cannot correct these flaws.

Rather than adding CTC provisions to a bill with other fundamental flaws, Congress should start with how it can make the CTC better reflect the cost of raising families. There exist different bipartisan proposals that would do this, but the proposal before Congress goes in the opposite direction.

Charles Bruner of Ames, a former member of the Iowa House and Senate, is director emeritus of the Child and Family Policy Center in Des Moines. CFPC, he worked with the Iowa Policy Project to form the Iowa Fiscal Partnership. Find his commentary on current issues at childequity.org. Contact him here.

Beyond Battelle: Let’s broaden the dialogue of Iowa economic health

The Battelle Report raises only the business perspective on economic development. More Iowans need an invitation to the table.

As Iowa legislators this week start work on a course to a more robust and diversified economy, discussion already has focused on a new privately funded report, Iowa’s Re-Envisioned Economic Development Roadmap.[1]

Produced by Battelle Technology Partnership Practice and commissioned by the Iowa Partnership for Economic Progress,[2] the $400,000 report makes some important points and deserves a careful look.

It focuses heavily on the importance of business to promote economic activity, but its core message acknowledges the significant role of public investments in providing the foundations for Iowa’s economy. This includes the education system needed to develop the skills, talents and capacity of the current and future workforce, including those who will become the future entrepreneurs and leaders for the 21st century.

While the report acknowledges the centrality of an educated and skilled workforce and a high quality of life to making Iowa an environment for business to flourish, it places very little focus upon how government can deliver on that role. It falls to government to educate that future workforce — at the early childhood, primary and secondary, and higher education levels.

The report does not adequately address the challenges Iowa faces in creating that higher skill level among its emerging workforce — in particular, the need to address lagging and stagnant educational achievement. To do so takes resources, and the report’s emphasis is to leave in place a business subsidy structure that has increasingly reduced the state’s ability to meet those needs.

The report itself was overseen largely by business leaders and economic development agency staff. However, these are not the only stakeholders in Iowa’s economic future; many others need to engage in the dialogue about Iowa government’s role in economic development.

The Battelle Report raises one perspective on economic development. Lawmakers, the media and the public need to insist that other perspectives and expertise also are fully considered and vetted.

More Iowans need an invitation to the table.

08-Bruner-5464Charles Bruner is executive director of the Child & Family Policy Center, www.cfpciowa.org, part of the Iowa Fiscal Partnership, www.iowafiscal.org.

Note: This piece also ran as an “Iowa View” in The Des Moines Register, Jan. 14, 2015.

[1] Technology Partnership Practice, Battelle Memorial Institute, December 2014, “Iowa’s Re-Envisioned Economic Development Roadmap.” http://www.iowaeconomicdevelopment.com/battelle
[2] Iowa Economic Development Authority, News release, Dec. 18, 2014, “Governor, IPEP Release Findings of 2014 Battelle Report, a New Economic Development Roadmap for Iowa,” http://www.iowaeconomicdevelopment.com/newsdetails/6051