The Case for Keeping the
Federal Income Tax Reduction on
Iowa Income Tax Returns
I. NO TAX ON A TAX
Federal deductibility is simple
fairness. Iowans should not be forced to pay a state income tax on money
used to pay their federal income tax. This is money the average taxpayer
never touches, sees, or has any discretion over how it is spent.
The federal deduction is not the only
example of this kind of fairness in the Iowa tax code. Those who itemize
their deductions also have the right to deduct property taxes on their
Iowa income tax returns.
Simple fairness says governments
should not tax income that is used to pay another tax. Federal
deductibility is one of the best examples of this philosophy and must
remain a part of the Iowa income tax code.
II. THE HISTORY OF TAX "REFORM"
There have been many proposals to
combine the elimination of federal deductibility with a reduction in
personal income tax rates. Some have attempted to be revenue neutral,
although they would change the distribution of the tax burden.
On paper, such a proposal can look
inviting. However, in practice, such a trade would soon lead to higher
The federal "Tax Reform Act of 1986"
is a painful example of what happens when you trade lower tax rates for
elimination of various deductions.
In the name of "simplification", many
tax deductions were removed, the definition of income was broadened, and
tax rates were lowered in return.
This tax "reform" was short lived. In
1990 and again in 1993 the income tax rates were raised.
Thus, taxpayers are now forced to pay
higher tax rates on an expanded income base that was originally
justified by a promise of lower rates. This is a mistake Iowans for Tax
Relief will work to avoid in Iowa.
This trade would not be tax reform—it
would be double taxation and would inevitably result in higher income
Iowans for Tax Relief favors
lowering actual taxes on all Iowa families and businesses.
III. IOWA INDIVIDUAL INCOME TAXES ARE ALREADY
Some persons attack federal
deductibility as an obstacle to a "progressive" individual income tax
structure. They argue we must eliminate federal deductibility in order
to make our income tax more "progressive".
In reality, Iowa’s individual income
tax system is already steeply "progressive"—even with the existence of
the federal income tax deduction. See Table 1 and Graph 1.
As Table 1 and Graph 1 clearly show,
when income rises, so rises the percentage of income that is paid in
Iowa personal income taxes. Iowans with an adjusted gross income (AGI)
of less than $10,000 pay about one percent of their taxable income in
Iowa personal income taxes, while those above $75,000 pay nearly 8% of
their taxable income in Iowa personal income taxes.
The deduction for federal income taxes clearly does
not prevent Iowa from having a "progressive" income tax structure.
Anyone who desires an income tax system that "soaks the rich" ought to
be extremely satisfied with Iowa’s current income tax law.
Opponents of federal deductibility
claim the deduction allows "wealthy" Iowans to avoid paying their "fair
share" of Iowa personal income taxes. This is simply false.
The data clearly show the top income
earners in this state are paying a huge share of the total Iowa personal
income tax burden. In fact, the top 10% of Iowa taxpayers pay over
45% of all Iowa personal income taxes.
The next 20% of taxpayers pay about
29% of the burden, the next 20% pay about 17%, and the bottom 50% of all
Iowa income taxpayers pay less than 10% of total Iowa personal income
We must also be careful how we use the
words "rich" and "wealthy" when discussing Iowa taxes. It takes only an
AGI of $50,000 to qualify as part of Iowa’s top 10% of income tax
filers. Thus, eliminating the federal deduction in an attempt to make
Iowa’s tax system "progressive" seems redundant. In fact, attempts to
"soak the rich" may indeed make them so "wet" that they will move to
states with a "drier" tax climate.
IV. FEDERAL DEDUCTIBILITY AND ECONOMIC GROWTH
It has been argued that the
elimination of federal deductibility and a lowering of Iowa income tax
rates would make Iowa more attractive to persons looking to relocate
themselves or their businesses. While this opinion is superficially
plausible, upon examination it comes up short.
With tax preparation software readily
available, it is inconceivable that an individual or business seeking to
relocate would limit research to a simple list of top tax rates. In
reality, an individual or business looking to relocate is very likely to
use available tax preparation software to determine the total tax
burdens in the states under consideration.
Also, federal deductibility and
marginal tax rates are not the only two components of the effective tax
rate. From state to state there are tremendous variations not only in
marginal tax rates, but also in income tax brackets, personal
exemptions, standard deductions, treatment of married couples, and other
factors—all of which have a definite impact on effective tax rates.
It is not simply a matter of do you or
don’t you have federal deductibility and how that affects your effective
tax rate. Such a narrow discussion would exclude many other important
factors that significantly influence a potential investor’s decisions.
Thus, trading federal deductibility
for lower rates would do little to enhance economic growth. It would
probably have the opposite effect. Any repeal or weakening of federal
deductibility would be seen as a defeat for Iowa taxpayers and a foot in
the door for higher income taxes. Potential investors would correctly
see it as a danger signal.
V. FEDERAL DEDUCTIBILITY IS NOT AN ISLAND
As previously stated, it is a mistake
to treat federal deductibility as an island — to focus on this one
deduction and ignore Iowa’s total income tax system.
When examining Iowa’s tax code we must
view federal deductibility as one of many determinants of actual tax
In Table 4, we measure the effect the
entire Iowa personal income tax code has on taxable income as a
percentage of adjusted gross income, for taxpayers at all income levels.
Does the tax code benefit some income
groups more than others? Or, are taxpayers treated about the same?
The data show that when you examine
the Iowa personal income tax code as a whole, taxpayers at all income
levels receive roughly proportional benefits from all the various
deductions, exemptions, and rates. The tax code, as a whole, treats Iowa
taxpayers roughly the same.
VI. THE PEOPLE INSIST ON KEEPING FEDERAL
Survey after survey has shown Iowans
strongly support keeping this important component of tax fairness.
When asked whether they wanted to keep
their right to deduct federal taxes on their Iowa returns, 94% of Iowans
said yes (Dec. 1997, margin of error +/- 3.5%).
Even when given the opportunity to
trade the federal deduction in return for lower income tax rates, 63% of
Iowans wanted to keep federal deductibility while only 26% were willing
to trade if for lower income tax rates (Nov. 1998, margin of error +/-
Federal deductibility is right in
principle. It is sound economics. It is fair. It is the will of the
people. It must be kept.
Iowans for Tax Relief will continue to fight
vigorously for every Iowan’s right to deduct all federal income taxes on