10/20/22
10/20/2022Cutting taxes has been a mainstay of Republican philosophy for decades. Iowa’s about to discover if it works.
The 2022 session of the Iowa Legislature, with Republicans comfortably in control, enacted a massive state income tax restructuring whose strictures will steadily reduce state revenues for the next five years. Governor Reynolds proudly touted the new law when she gave the Republican reply to President Biden’s State of the Union message last spring.
As a result of the change, five years from now the state treasury will take in about $1.9 billion less than its current level, a decline of about 20 percent from last year’s $9.8 billion revenue total. The nonpartisan Legislative Services Agency (LSA), a state government department, calculated that startling figure.
The income tax cuts take several forms. For many decades Iowa has employed a progressive income tax: that is, individuals and corporations with higher incomes paid taxes at a higher rate than those with more modest incomes. This year’s law changes that by replacing the progressive structure with a flat tax rate, regardless of income, for both individuals and corporations.
Because those with higher incomes had paid taxes at a higher rate, they will enjoy by far the lion’s share of the tax cuts. Just a few years ago, in 2018, the state operated with a maximum individual tax rate of 8.98 percent and a top corporate tax rate of 12 percent. Rates for those with smaller incomes were much lower.
After the new law is fully phased in in five years, all individuals will pay a flat state tax rate of 3.9 percent. Corporations will pay a flat rate of 5.5 percent. In addition, the alternative minimum tax provision and state inheritance taxes also disappear. Also gone will be retirement income taxes and certain farm rental income taxes.
The phase-out begins next year, with a reduction in the top individual income tax bracket to 6.0 percent. The reduction will benefit those who earn $75,000 or more. Also that year, retirement income will no longer be taxed. And the top corporate tax rate will drop from 9.8 percent to 8.4 percent.
The Legislature and the Governor are required by state law to budget based on projections by the state’s Revenue Estimating Conference, composed of three members with expertise in financial projections. Their latest estimates anticipate that state revenue will decline from $9.8 billion last year to $9.5 billion this year, then inch upward to slightly less than $9.6 billion next year. That means that revenues both this year and next year will be down from what they were last year.
Even so, that’s a whole lot higher than what the $1.9 billion drawdown will provide to meet the state’s needs five years from now.
A Republican member of the Iowa House Ways and Means committee said in Jefferson a few weeks ago that the projected revenue drop in five years will probably require some creative tax law adjustments between now and then. As possibilities, he mentioned changes to the sales tax and reducing or eliminating some current tax credits.
But some other GOP lawmakers have indicated their belief that future economic growth alone will maintain the treasury without a significant dropoff—in other words, a reiteration of supply-side economics. That theory has met with dubious success in the real world, especially at the state level.
Some points need to be made with regard to the new tax law and what the Legislative Services Agency projects will be the $1.9 billion slash to state revenues.
For one, the new tax cuts are taking effect despite the headwinds created by the highest inflation rate in the past 40 years or so, at more than eight percent. Individuals and businesses are not the only entities affected by inflation—every government beneficiary and agency is challenged the same way. Steadily declining state revenues simply can’t provide the same level of support that has been given up to now.
To my knowledge, Republicans have not indicated what expenditures they expect to cut as the result of smaller revenues. For example, over half of the state budget now goes to education. But money for the state’s universities has shrunk for several years, leaving it up to students and their parents to pick up the slack. That generates student debt too great for wage levels of most Iowa jobs to handle. The brain drain to states with higher salaries is the result, exacerbating Iowa’s shortage of workers.
Funding for the state’s public schools has also failed for years to keep up with higher costs, and Governor Reynolds seems determined to transfer some public school funds to private schools. It’s hard to figure how those trends can result in anything but educational decline, especially in the company of sharply higher inflation.
Another problem: public safety personnel, like the highway patrol and state prison guards, are already operating at inadequate staffing levels. Revenue cuts can only make that situation worse.
Another headache: if state aid to cities and counties shrinks, only the property tax can replace those funds (unless the federal government steps in). That would not be popular.
Another factor: the state has received significant federal money from COVID-related appropriations. Some of that money has gone for state expenditures, but the rest will run out before long. It certainly can’t be counted on to bolster the revenue shortfall.
Five years from now, if the tax cuts remain state law, we’ll know whether Republicans were correct in their insistence that Iowa and Iowans will be better off. ♦
