It’s almost Labor Day, and that means it’s time for another edition of The State of Working Iowa.
Be watching this weekend in Iowa media and on the Iowa Policy Project website for The State of Working Iowa 2011. Authored this year by Noga O’Connor, Colin Gordon and Peter Fisher, the report takes a look at how Iowa is doing in recovery from the 2007 recession, the challenges ahead and potential policy options to deal with them.
The federal income tax collects the most when you are in your prime earning years and can most afford it, and leaves you with all or most of your money when you are struggling and really need it. … That’s the way it ought to be.
Let’s get one thing straight. Everyone pays taxes.
Even the lowest-income one-fifth of Americans pay about 16 percent of their income in taxes; they pay gas taxes if they drive, part of their rent goes to pay property taxes, they pay sales taxes when they go to the store, some pay state income taxes. There is no such thing as a class of people who pay no taxes.
Some would like to focus the debate just on the federal income tax, and have succeeded in creating the impression that there is a large, permanent class of people who never pay federal income taxes. But they ignore the fact that most of those paying no income taxes this year will pay plenty of taxes later in life, or already paid a substantial share. They may be paying no taxes this year because they are young, starting out in a low-paying job, have young kids, and therefore need every penny they earn to pay for child care and to get by until they move up the career ladder.
Or perhaps they are old, living mostly on Social Security, and are done paying taxes, which they did for most of their working lives. Many pay no income taxes because they are out of work through no fault of their own, or because they are sick or disabled and unable to work.
All this is not mere speculation. Of those who will pay no income tax this year, half owe no tax because subsistence level income is untaxed and because of deductions for dependents. Of the remainder, nearly three-fourths pay no tax because they are seniors, or because of tax credits for children and the working poor.
Imagine that when you first left home and faced a lifetime of supporting yourself and perhaps a family, you could choose what kind of tax system you would be under for the rest of your life. For most people, thinking about life’s uncertainties and risks, something like our federal income tax would be the logical choice. Why? It is based on the principle of ability to pay. The federal income tax collects the most when you are in your prime earning years and can most afford it, and leaves you with all or most of your money when you are struggling and really need it. And it is small business friendly as well. If you are just starting your own business, or the recession wipes out this year’s profits, you owe little or no tax, but if the business does well, you will pay your share.
That’s the way it ought to be. And if the result is that this year, when so many people are facing economic hardship, nearly half pay no federal income tax, remember who those people are. All of them are paying state and local taxes to support our schools and fire departments and roads. And they will have their time to contribute to federal income taxes as well, as many already have.
Lawmakers often hear — and voice — complaints about the competitiveness of Iowa’s tax system. In fact, Iowa’s taxes on business already are very competitive.
“Pay no attention to that man behind the curtain!”
So said the Wizard of Oz, to distract his visitors from how he was manipulating them.
Well, thank goodness for Toto’s work in exposing the fraud.
Likewise, IPP’s Peter Fisher and others doing real research have exposed the myths about corporate taxes in Iowa that justify every political claim of a supposed need to reduce taxes on business. The fact is, it’s simply not a problem, as noted in the Iowa Fiscal Partnership backgrounder, “Iowa’s Businesses Already Are Taxed Lightly.”
Few States Tax Businesses Less Than Iowa
State Corporate Income Tax: Percent of Private-Sector GDP — Comparison to U.S. Average
Sources: IPP analysis of data from the U.S. Census, State Government Tax Collections; and the Bureau of Economic Analysis, Gross Domestic Product by State
Lawmakers often hear — and voice — complaints about the competitiveness of Iowa’s tax system. In fact, Iowa’s taxes on business already are very competitive. Whether one focuses only on the corporate income tax (above and linked here), or the whole range of taxes falling on business, Iowa’s state and local taxes are well below average, and have been for some time. (See state and local ranking of all states)
Iowa’s corporate income tax in recent years has been considerably lower than the national average level of taxation and lower than all but 11 states. The best summary measure of the level of corporate income taxation from one state to another, that takes into account all features of the tax code, is the amount of tax collected as a percent of the private economic activity generated in the state, as measured by state private sector GDP (gross domestic product).
In Iowa, this fraction fell from 0.31 percent in the mid-1990s to 0.24 percent over the last five fiscal years, as shown in the graph above. On this measure, Iowa’s rank among the 50 states fell from 36th to 40th. (For the most recent year, 2009, Iowa ranked 36th.) In both periods, Iowa taxed well below the average for all 50 states. Similarly, the conservative Tax Foundation found that Iowa ranks 43rd among the states in its level of corporate income taxation, measured as corporate taxes paid per capita on average for fiscal years 2004-2008 (and 36th for 2008).
Social Security has an enormous surplus, not a deficit. It is the rest of the federal government that is running deficits.
The short answer: Because Social Security is not the cause of deficits in the first place.
So then why do so many commissions and politicians insist on including Social Security “reforms” on their lists of things to do to reduce the federal deficit? Because it is a politically convenient way to force cuts in Social Security benefits onto the public agenda.
In actual fact, Social Security has an enormous surplus, not a deficit. It is the rest of the federal government that is running deficits. Social Security has been financing part of the federal deficit by investing the surplus in federal bonds.
Now let me tell you a story. One day a guy named George lent a friend $1,000 for a year. He didn’t need the money now, but he would in a year’s time to pay tuition when his daughter started college. But when the time came for his friend to pay George back, the friend said, “Geez, that’s a problem; if I have to actually pay you back the money you lent me I’ll be short, and it will be your fault, for demanding that I repay the loan. I think the fair thing is for you to cut back by not sending your daughter to college so you can afford to roll over my loan indefinitely.”
Would anyone take such an argument seriously? Of course not. Yet many people seem to take seriously the argument that it will be Social Security’s fault if at some point Social Security needs to be repaid some of the money it lent the federal government. And that the solution is to lower the standard of living of future retirees so Social Security can continue to buy federal bonds.
In a few years Social Security will be paying out more in benefits than it is collecting from payroll taxes. Then it will have to sell some of those bonds held by the Trust Fund to pay full benefits. This is precisely what the Trust Fund was set up to do: to be drawn down to ease the burden of paying baby boomer retirement benefits. But Social Security will still not be contributing to the deficit; it will simply no longer be helping to finance it.
How large the federal deficit will be will depend largely on how well we contain rising health care costs and other expenses, and whether we continue to renew tax cuts to the wealthy. Who will finance that deficit is a reasonable question. The important point is that when the Social Security Trust Fund is no longer purchasing federal bonds, and is cashing in some of the bonds it holds, the size of the national debt will not be one dollar larger because of that. The only thing that changes is who holds the debt. The Trust Fund will hold less, private investors and foreign governments will hold more.
As for the benefit-cutting deficit hounds, I am thinking about asking them if I can borrow $1,000. Just to conduct a little experiment in logical consistency.
The case for cutting public services to finance tax cuts for business cannot be sustained.
My purpose here is to provide some important context for the current debate over the Iowa budget. Contrary to what many people have asserted, Iowa taxes its residents and its businesses at a lower level than the average state in the U.S. Furthermore, the size of state government, if measured by employment, has actually fallen, and state spending represents a smaller share of the state economy now than at any time since at least 1990.
The state has cut important public services for two years in a row in response to declining revenues brought about by the recession. The case for further cuts to this year’s budget, and more cuts next year and the year after, has been premised on assertions that state government has grown too much, that spending is “out of control,” or that taxes are too high or uncompetitive. The evidence does not support such claims.
Throughout the 1990s, state general fund spending remained between 6.1 and 6.4 percent of state personal income. In other words, as the economy grew — more people, more economic activity, more incomes – state government grew along with it, as one would expect, but the state accounted for about the same share of the economy. But since 2001, the state general fund has actually shrunk as a share of the economy, remaining between 5.0 and 5.4 percent from 2003 through 2009 before dipping to just 4.7 percent last year.[i]
Another measure of the size of government is the number of state employees. There has been no discernible growth in state employment since 1993, the total fluctuating around 52,000 to 54,000. At the same time, there has been modest population growth. Thus a better measure of the size of government is the number of state employees per thousand Iowans; this number peaked at 19.6 in 1997 and then fell to about 18 for most of the past decade, until budget cuts pushed it down further to 17.4 in 2009.[ii] State government has shrunk.
Finally, the tax argument. Iowa state and local governments together have taxed their citizens at a lower rate than the average for the past several years. In the early 1990s, state and local taxes represented 11.5 percent of personal income in the state, which put Iowa 12th among the 50 states. By fiscal year 2008, Iowa’s taxes had fallen to 10.4 percent of income, a 9 percent drop. We now rank 26th.
There have also been claims that our business tax system is uncompetitive. This is simply false. A recent study by Ernst and Young found that overall taxes on business in Iowa are lower than the national average, and in fact only 15 states tax business more lightly.[iii] The case for cutting public services to finance tax cuts for business cannot be sustained.
We should be having a debate about budget priorities founded on facts. The reality of the past 20 years is smaller state government, lower taxes overall, and quite competitive taxes on business.
[i] Andrew Cannon, Getting Public Value Out of Our Public Dollars. Policy Brief, October 7, 2010; the Iowa Policy Project, Figure 1, p. 2.
We must consider what tax breaks are already in place for commercial property.
Scare tactics about commercial property taxes in Iowa are nothing new. Legislators and governors of both parties have fanned that idea for years, appealing to businesses that pay tax on 100 percent of their property value, while residential homeowners pay on about half.
Of course we all want to retain and attract good jobs. But it is usually a mistake to simply look at one part of our tax code and make sweeping generalizations about the impact on business activity. Property taxes are just part of the overall system of state and local taxes, both for individuals and businesses.
Businesses that occupy commercial real estate are also taxed under the corporate or personal income tax. Iowa’s personal income tax level is about average, and the corporate income tax in Iowa is well below average. Research has shown that Iowa’s overall level of business taxation (including property taxes) is about average among the 50 states.
There are inequities in commercial property tax that we could fix — but we should do so strategically. And if we’re going to look at the rates, or consider rollbacks or other cuts, we must consider what breaks already are in place.
A good starting place: the out-of-control growth of tax abatements and subsidies through tax increment financing (TIF). While commercial property owners in general are expected to pay tax on the full assessed value of their property, TIF arrangements drastically reduce or eliminate commercial property taxes, but only for selected property owners. This creates a disparity, and equity issues within a community. One store pays little or no property tax; a competitor down the street pays the full rate.
Any substantial reductions in taxes on commercial property should also address the inequities and waste inherent in Iowa’s system of tax increment financing. There should be no commercial property tax relief without substantial TIF reform.