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The Elbert Files: Iowa’s tax troubles


It’s time for a reality check at the Statehouse.

Less than a year after Iowa Republicans approved the most sweeping tax law rewrite in two decades, it appears that one key aspect of the new law may be in jeopardy.

Iowa’s 2018 tax bill had three key provisions.

It adjusted tax rates to prevent state government from taxing for more than one year the windfalls Iowans received from the 2017 federal tax bill.

It also extended Iowa’s sales tax to a wide array of goods and services purchased over the internet.

Finally, it created a mechanism for ending the long-standing perception that Iowa’s income tax rates are among the highest in the country.

That perception exists because Iowa is one of a handful of states that allow taxpayers to deduct federal income taxes on their state tax returns.

By deducting federal taxes, Iowans are able to reduce their net incomes enough to qualify for lower tax rates. So, while Iowa’s income tax rates are among the nation’s highest, the effective rates that we actually pay are closer to average.

Reformers contend that if Iowa eliminated federal deductibility, the state could lower its tax rates, take in the same amount of money and have rates closer to other states.

It’s an economic development argument that’s been around since at least the 1970s. But it never got much traction until last year.

The 2018 tax law was designed to change that high income tax rate perception, but not immediately. For reasons too complicated to explain here, state finances have been under stress for some time and that’s caused a variety of problems.

To eliminate federal deductibility, Iowa needs a revenue cushion. Gov. Kim Reynolds created one by agreeing to delay the change until net state tax revenue increases a minimum of 4 percent a year for four consecutive years.

The first year of that four-year period is now, and it was supposed to be a slam-dunk because of the additional income created by the new tax on internet sales.

But it isn’t happening.

State officials say revenue growth slowed dramatically during January and February, the seventh and eighth months of the current fiscal year.

During the six months ended Dec. 31, net tax revenue grew at a rate of 7.8 percent. But two months later, it had slowed to a little less than 3 percent.

Iowa’s Legislative Services Agency said the slower growth in January and February was the result of the lower tax rates implemented on Jan. 1 in response to the 2017 federal tax cuts.

But there’s another factor.

Taxes on internet sales were supposed to generate roughly $100 million in new revenue, which would have been enough to ensure 4 percent revenue growth for the first year.

As of Feb. 28, though, sales tax receipts from all sources, including internet sales, had increased only $41.5 million, which is about what you would expect in a normal year without including internet sales.

A big chunk of the sales tax shortfall may be the result of a little-publicized tax law change approved in 2016. That change widely expanded a corporate sales tax exemption to include consumables used in manufacturing, such as saw blades, filters, jigs, coolants and lubricants, among other items.

Officials predicted that the change would reduce sales tax revenue by about $50 million this year. The Iowa Revenue Department has not disclosed what the actual loss is, but there are indications it may be as much as twice that amount.

If that’s true, it throws a monkey wrench into last year’s efforts to reform Iowa’s tax code. Four percent growth is difficult enough to achieve without lopping off a big piece of the existing tax base.  


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