Federal Deductibility

Federal Tax Deductibility in Iowa: Who Benefits and Why it Should Continue

by Jonathan Miltimore

Executive Summary

Currently, Iowa is one of nine states that allow federal income taxes, all or a portion thereof, to be deducted from their taxable state income.[1] This means that Iowa citizens pay state income tax on their real income, not on earnings unrealized. Iowans are not required to pay a tax on a tax.

The primary rationale for federal deductibility is fairness. Proponents of the policy argue that citizens should not be required to pay taxes on the federal government’s takings. This portion of earnings is not the workers’; they never saw these dollars or possessed them in any tangible sense. Hence, proponents ask, why should they be required to pay taxes on them?

Yet there are some in Iowa who would change this policy, and prevent Iowans from deducting federal income taxes from their tax liability. Opponents of federal tax deductibility offer myriads of explanations for their position that often include such nouns as “simplicity,” “fairness,” and “stability.” However, the main complaint from critics of federal deductibility is that it is not “progressive.” A progressive tax is one that involves a worker paying a proportionately higher percentage of his or her income to the government as he or she earns more.

This study will address and answer the following questions: Who benefits from allowing Iowans to deduct their federal income taxes from their taxable state income? What consequences would repeal of federal deductibility have on Iowa’s economic competitiveness? What is the purpose of taxation and how would repeal of federal deductibility affect Iowa’s tax structure and overall tax burden?

A careful analysis of the policy of federal tax deductibility and its use in Iowa reveals the following:

1) Federal deductibility is an economically fair policy that benefits the vast majority of full-time working Iowans, particularly in their life stages when they are most productive.

2) History shows that repealing federal deductibility could raise Iowa’s overall tax burden and make it less hospitable for entrepreneurship, even if income tax rates are marginally or temporarily reduced in conjunction with repeal.

3) Federal deductibility in Iowa is a policy that is harmonious with and runs congruent to the Lockean philosophy of taxation adopted at our nation’s Founding.

Endnote

1) Iowa Code, 422.9; State Tax Handbook, CCH, 2006.

Jonathan J. Miltimore is a Research Analyst with Public Interest Institute.

Public Interest Institute’s POLICY STUDY, Federal Tax Deductibility in Iowa: Who Benefits and Why it Should Continue, can be viewed at http://www.limitedgovernment.org/publications/pubs/studies/PS-07-3.pdf.

Reprinted by permission from INSTITUTE BRIEF, a publication of Public Interest Institute.”
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