Tax bill: Know five points

The new tax plan abandons real tax reform for costly changes slanted heavily to the rich. It is more likely to hurt the Iowa economy than to help it.

Here are five things you need to know about the final version of the tax bill now scheduled for a vote in the Iowa Legislature this Saturday: (1) It is not income tax reform, (2) It is not a middle-class tax cut, (3) It is more skewed to the richest Iowans than previous bills, (4) It is very expensive and will force cuts in education, public safety and other services, and (5) It is more likely to hurt the Iowa economy than to help it.

As we have pointed out previously, real income tax reform would rein in expensive business tax credits that have little effectiveness, eliminate federal deductibility, increase recognition of the costs of raising a family, and raise the Iowa standard deduction — which would both simplify taxes for thousands of Iowans, and target tax cuts at lower and middle-income taxpayers. The tax bill does none of these things for the next four years.

Earlier versions of the House bill would have increased the standard deduction and eliminated federal deductibility, but those provisions were jettisoned in favor of $40 million in corporate tax cuts and more tax preferences for high-income business owners. The bill does little to reform business tax credits, which have doubled in five years. It adds a new and expensive loophole — a deduction for pass-through income from certain businesses.

For the next four tax years the bulk of the tax savings go to the most well off. In 2021, almost half of the tax cuts will go to the richest 2.5 percent of Iowa taxpayers, those making $250,000 or more. Their taxes are reduced by 18 percent, over twice the cut for those in the middle. For those making over a million dollars, the tax cut will average $24,636.

Meanwhile, those in the middle will see income tax cuts of $100 to $300 over the next four years, much of which will be taken back in increased sales taxes of $35 to $60.

All of this comes at a high cost to the state — over $400 million a year by 2021. With over half the budget going to education, this means the underfunding of our public schools and the rising tuition and debt for our community college and university students will continue.

The bill’s only “trigger” does nothing to guarantee fiscal sustainability, its purported purpose. The $400 million hit to the general fund will happen no matter how slow the Iowa economy, and state revenues, grow. We could hit a recession in the next two years, and those tax cuts will remain in place.

The only trigger governs an additional round of tax cuts for 2023. If the revenue target is met (and it would require growth rates of over 5 percent per year) then the annual cost of the bill jumps to $643 million. Only then would federal deductibility end, and the higher federal standard deduction come into play.

If the bill’s backers are counting on growth to come to the rescue, they are willfully ignoring all evidence to the contrary. The last major income tax cuts in Iowa, in 1997-98, not only failed to stimulate growth, but likely contributed to the subsequent slowing of the state’s economy. The tax cuts in Kansas led to slower growth.

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

Big costs, few real breaks

Despite all the hoopla, the average taxpayer would hardly notice the effects of this bill — another $3 or $4 a month.

The latest tax bill to emerge from the Iowa House would take $90 million from the state budget, robbing the ability of the state to adequately fund education, mental health, and public safety. And yet Iowans will see so little in return that most will not even be able to tell they got a tax cut.

By the time the House bill’s provisions  are fully phased in (fiscal year 2021), the income tax cuts and sales tax modernization measures will result in about $90 million a year less revenue flowing to the state’s general fund than was projected before the federal tax bill was passed.[1] After years of revenue shortfalls and budget cuts, the House bill would guarantee that those problems will continue.

Iowa is one of only three states where you can deduct your federal income tax before computing your income subject to Iowa tax. As a result, the federal tax cut bill will reduce that deduction and increase your Iowa taxable income and your Iowa income tax. But that effect is tiny. If the state were to do nothing at all, taxpayers would still keep 94 to 98 percent of the federal tax cut (see table below).

House plan offers little break for individuals, at great cost to services
Combined effects of Iowa House tax plan and federal tax changes

ia_finalhousebill_results-2.jpg

Source: Institute on Taxation and Economic Policy, Washington, D.C.

The House bill goes beyond what would have been needed to restore the small tax increases due to federal deductibility. It makes a number of changes in the income tax, including an increase in the state standard deduction. Overall, it reduces income taxes for those in the middle three-fifths of Iowa taxpayers by about $100 to $155 a year. The bill also modernizes the state sales tax, and those measures would bring in about $73 million a year from Iowa residents, and cost the middle income taxpayer $37 to $60 a year.

The net effect of all of this is an average tax cut of just $29 to $53 a year for those in the middle three-fifths of Iowa taxpayers, and smaller amounts for others. In other words, despite all the hoopla, the average taxpayer is going to hardly notice the effects of this bill — another three or four dollars a month.

Let’s just walk that through for a household with income of $53,000, which would put them right in the middle of all Iowa households. They can expect to pay $860 less in federal taxes, with federal deductibility taking back just $26 of that in state income taxes — they get to keep 97 percent. Then they get a $122 income tax cut and a $47 sales tax increase from the House tax bill. Net effect: $860 less in federal taxes, $49 less in state taxes.

While the tax savings are insignificant — three or four dollars a month — the House bill will take all that back and much more for many Iowa families. Tuition at public universities and community colleges will continue to rise because public funding will not be able to keep up with costs. School districts will be forced to enact more cuts as state funding fails to keep pace with inflation. Mental health initiatives will remain underfunded.

[1] Iowa Department of Revenue memo to Jeff Robinson, April 17, 2018. This is the net revenue loss compared to projected revenues before the federal tax bill was passed. The revenue loss compared to Iowa tax revenue including the windfall gain from federal deductibility ($178 million) would be $269 million in FY2021.

2010-PFw5464Peter Fisher is research director of the nonpartisan Iowa Policy Project. pfisher@iowapolicyproject.org

Reality on Iowa teacher pay

Serious analysis shows Iowa doesn’t rank as high on teacher pay as the Governor and some media are reporting.

The experience of Wisconsin school districts in the years following Governor Walker’s gutting of collective bargaining for public workers does not bode well for Iowa. School districts are reportedly having difficulty finding teachers. Teachers have been leaving the state, not just for higher pay but because they want to work where their efforts are appreciated and they are respected.[1] Some left for Iowa, and are now wondering where they should go next, as Iowa repeats the folly of Wisconsin.

If we are to keep the best college grads in the state, and attract them here from elsewhere, a good starting salary is part of the picture, even though the prospect of raises down the road seems much dimmer with the end of serious collective bargaining here. So how does Iowa stand in terms of starting salary?

The average starting salary in Iowa for the 2016-17 school year was $35,776. That was good enough to rank Iowa near the middle of the pack — 32nd when compared with other states and the District of Columbia. But some have argued that Iowa has a low cost of living compared to other states, so we don’t need to pay as much. Fortunately, the U.S. Bureau of Economic Analysis (BEA) produces a cost of living index for each state. They recommend using that index to make wage comparisons across states, to reflect differences in purchasing power.

The BEA index for Iowa was 90.3 in 2015, the most recent year available. That means it costs Iowans 9.7 percent less than the national average to live. The starting salary of $35,776 would then be equivalent to $39,608 in a state with an average cost of living. Comparing all states in terms of the starting salary properly adjusted for cost of living differences, Iowa ranks 21st.[2]

What about the overall average salary? Unfortunately, the Governor has been citing a bad statistic. A recent NPR report focused on how states ranked on teacher pay when you take into account the cost of living in each state. But they did it wrong. Instead of using the standard cost of living index produced by the BEA, NPR asked a company called EdBuild to do the analysis, and EdBuild used a proprietary index — the Cost of Living Index produced by the Center for Community and Economic Research (C2ER) — that is not reliable and produces sometimes dramatically different cost of living indexes. For example, their index for 2013 (according to EdBuild) had Iowa with an above-average cost of living[2], while for 2015 it was 11 percent below the national average.

What happens if we use the correct adjustment for the cost of living? Iowa’s average teacher salary ranks 15th in the nation[3], not eighth as EdBuild calculated and as NPR reported. NPR is looking into the issue; we await their correction.

[1] David Madland and Alex Rowell. “Attacks on Public-Sector Unions Harm States: How Act 10 Has Affected Education in Wisconsin.” November 15, 2017. Center for American Progress.
https://www.americanprogressaction.org/issues/economy/reports/2017/11/15/169146/attacks-public-sector-unions-harm-states-act-10-affected-education-wisconsin/

[2] IPP calculations using the National Education Association starting salary data for 2016-17 and the BEA Regional Price Parities for 2015.
[3] Average starting pay of $33,226 was adjusted downward to $33,120, meaning that the cost of living in Iowa was lower than average. http://viz.edbuild.org/maps/2016/cola/states/#salary
[4] IPP calculations using the average salary data for 2015-16 cited in the NPR report and the BEA Regional Price Parities for 2015.

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

Don’t emulate North Carolina, either

Tax and budget cuts are a formula for decline, not prosperity. Let’s hope Iowa does not follow either Kansas or North Carolina down the path of chronic budget crises and underfunding of education, health and public safety.

The ideologues advocating for large state income tax cuts haven’t given up defending the Kansas experiment, despite overwhelming evidence that it forced drastic budget cuts while doing nothing to stimulate growth. Now they would have us believe that North Carolina provides an even better example of the benefits of the tax-slashing strategy. It doesn’t.

Two recent analyses of the North Carolina tax cuts, which took effect in 2014, show pretty clearly that the cuts did not boost the economy, and that they will soon precipitate large budget shortfalls. Prior to the tax cuts, the state’s economy generally grew at a comparable rate to the surrounding states, despite North Carolina having higher personal income tax rates than its neighbors. And it outpaced the national economy, jobs in North Carolina growing at 5.8 percent from late 2001 through the end of 2013, compared to 4.2 percent for the nation.

Since the tax cuts took effect in 2014, has North Carolina’s economic performance become even more impressive? On the contrary; since 2014, North Carolina has lagged behind the nation in growth in jobs and GDP, and has also lagged behind neighboring Georgia and South Carolina.

The tax-cut advocates are fond of saying simply that since the tax cuts, North Carolina has experienced rapid growth. The state has certainly grown faster than Kansas, but nothing in the evidence suggests that the tax cuts boosted growth; in fact, relative to its neighbors and to the nation its performance declined after taxes were cut.

The North Carolina tax cuts were phased in from 2014 through 2019, and by next year will cost the state 15 percent of the general fund budget. Major fiscal challenges now loom on the horizon. The state’s budget analysts project a structural budget shortfall of $1.2 billion in 2020, with the shortfall rising after that.

Tax and budget cuts are a formula for decline, not prosperity. Over the past decade, North Carolina has cut per student funding for education — K-12 by 7.9 percent, higher education by 15.9 percent, when adjusted for inflation — and the tax cuts will make it difficult, if not impossible, to restore those funds, no less to increase its investments in the state’s children. They are putting the long-term prosperity of the state at risk.

These results are not surprising. Tax cuts have budget consequences; they do not pay for themselves through growth. In fact, the preponderance of serious research finds that the effects of state income taxes on state growth are negligible.

Let’s hope Iowa does not follow either Kansas or North Carolina down the path of chronic budget crises and underfunding of the state’s responsibilities for education, health and public safety.

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

A poisoned process

As early as today, a bill may be debated in the Iowa Senate to drastically slash revenue for public services — phased in at a cost of over $1 billion a year, or about one-seventh of the state’s General Fund.

The Senate bill, as does any legislation with a fiscal impact, comes with a “fiscal note.” This analysis by the Legislative Services Agency, using Department of Revenue data, was made available sometime late Tuesday. The legislation itself was introduced a week ago today, and passed out of subcommittee and full committee the following day.

The legislation is so complex that it took the state’s top fiscal analysts a week to put together their summary, which includes four pages of bullet points in addition to tables of data about various impacts. The nonpartisan analysis finds that the wealthiest individuals and most powerful corporations once again are the big winners.

The timing of the official fiscal analysis was only the latest example of cynical approach to public governing that has slapped brown paper over the windows of the gold-domed sausage factory in Des Moines.

This General Assembly was elected in 2016. It is an understatement to suggest that this legislation could easily have been developed through the 2017 legislative session or the months leading up to this session. The public who will be affected, and advocates across the political spectrum, could have weighed in, and independent fiscal analysis considered.

Many have tried to educate the public about what is at stake for Iowa — including the Iowa Fiscal Partnership, which among other activities brought in experts from Kansas last year to show what has happened there with similar tax slashing. IFP also offered a reminder in October of what real tax reform could include, and later about both open government and the folly of Kansas’ course. Last week, we warned about the fiscal cliff ahead.

Everyone knew the legislative leadership and Governor wanted to do something to cut taxes, but no specifics were available, just a couple of hints with no real context. The session opened in the second week of January, and it wasn’t until most had left the building on the second-to-last day of February that a fiscal analysis magically appeared.

With a more transparent and deliberate process, everyone — including and especially the legislators who will be voting on it — would have had a chance to get full information about its impacts.

Instead, it is being rammed through. Regardless of whether the legislation itself is good or bad, the process has poisoned it. And perhaps it has poisoned governance in Iowa for years to come.

There are elements of the commentary defending and opposing this legislation that show general agreement on two key points of what meaningful, responsible tax reform would entail. On both sides, there is recognition that:

•  removing Iowa’s costly and unusual federal tax deduction would enable a reduction of top tax rates that appear higher than they really are; and

•  corporate tax credits are out of control and costing the state millions outside the budget process, while education and human services suffer.

The process, however, has shielded from public view a clear understanding of how the specifics of this legislation would affect two principles central to good tax policy: (1) the purpose of raising adequate revenues for critical services, and (2) raising those revenues in a way that reflects ability to pay — basic fairness of taxation, where Iowa (like most states) has a system that shoves greater costs on low-income than high-income taxpayers.

It also has raised to the altar of absurdity a ridiculous image of the competitiveness of Iowa taxes, which independent business consultants’ analysis has shown to be lower than half the states and in the middle of a very large pack that differs little on the state and local business taxes governed by state policy. (chart below)

Ernst&YoungFY2016

As the process moves from the Senate to the House, these concepts of good governance need to be central to timely debate, not just fodder for editorial pages afterward.

2017-owen5464Mike Owen is executive director of the nonpartisan Iowa Policy Project, and project director of the Iowa Fiscal Partnership, a joint initiative of IPP and the Child & Family Policy Center in Des Moines. mikeowen@iowapolicyproject.org

 

Cliff ahead: Learn from Kansas

Despite chronic revenue shortfalls that have forced a series of mid-year budget cuts, senators are moving a tax-cut bill forward without even an analysis of its impact.

The Iowa Senate is poised to move a massive tax cut bill out of committee today, in the belief that somehow what was a disaster in Kansas will be a big success in Iowa.

Despite chronic revenue shortfalls that have forced a series of mid-year budget cuts over the past two years, and the prospect of a tight budget for next year, Senate Republicans propose to cut $1 billion a year from the state budget. They are moving the bill forward without even an analysis of its impact.

Proponents claim this will make Iowa more competitive and boost the economy. There are two problems with this claim. First, two major accounting firms that rank states on their level of business taxation continue to put Iowa right in the middle of the pack, or even better. We are already competitive. Ernst & Young (below) ranks Iowa 29th, while Anderson Economic Group’s measure ranks Iowa 28th — in both cases, showing little difference across a broad middle range of the scale.

Second, there is good reason to expect the bill to have negative effects on the economy, not positive. When Kansas enacted major cuts to state income taxes in 2012 and 2013, the Governor and his friends at ALEC (the American Legislative Exchange Council) lauded this experiment — which five years later has proven to be a dramatic failure.

Abundant evidence shows the tax cuts failed to boost the Kansas economy. In the years since the tax cuts took effect Kansas has lagged most other states in the region and the country as a whole in terms of job growth, GDP growth, and new business formation.

When confronted with the Kansas failure, the bill’s proponents respond that the only problem in Kansas was that they failed to cut services sufficiently to balance their budget. But here’s the problem: Their constituents were up in arms over the cuts they did enact; they would not have stood for anything more drastic.

In order to bring the budget somewhat back in balance, Kansas borrowed from the future, using up reserves, postponing infrastructure projects, and missing contributions to the pension fund. Schools closed weeks early when state funding ran out. Had they cut spending further, that would have put a bigger dent in the economy, as recipients of government contracts were forced to retrench and workers laid off spent less in the local economy.

A supermajority of the Kansas Legislature voted to end the experiment last year, recognizing it as a failure and responding to the demands of Kansas citizens to restore funding to education, highways, and other state services they rely on. That decision no doubt saved the state economy from performing even worse in the years to come.

The Senate bill would harm Iowa in much the same way. Education accounts for over half of the state budget. Tax cuts of this magnitude would have very serious consequences for our public schools, and would force tuition up drastically at community colleges and regents institutions. Our court system would be forced into further personnel cuts, meaning long delays for those seeking justice. We would see more children suffer as family service workers face ever higher caseloads.

Proponents claim the Senate plan is “bold.” So is jumping off a cliff.

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

 

Related from Peter Fisher:

The Lessons of Kansas

The Problem with Tax Cutting as Economic Policy