March 2012

Iowa’s in the Top 10 list – But Not the Good One!

by Deborah D. Thornton

Each year the Tax Foundation publishes a State Business Tax Climate Index, which evaluates and ranks each state’s tax systems to determine which is “most hospitable to business and economic growth.”[1]  Business taxes are a fairly narrow barometer of current and potential economic growth, and because they are determined by state Legislatures, are flexible.  Changes in business taxes can be implemented almost immediately and as a result have immediate positive or negative impact.  For fiscal year 2012 Iowa ranks number 41, in the top ten states for bad taxes – worse than all but Maryland, Wisconsin, North Carolina, Minnesota, Rhode Island, Vermont, California, New York, and New Jersey.[2]  This is not a place our Governor and State Legislature should want us to be!

According to the Tax Foundation, “taxes paid by businesses should be a concern to everyone because they are ultimately borne by individuals through lower wages, increased prices, and decreased shareholder value.” [3]

Research by Timothy J. Bartik of the Upjohn Institute for Employment Research documents that taxes have a negative impact on business start-ups. Importantly, he found that property taxes, because they are paid regardless of profit, have the strongest negative effect on business.  Even though the business many not turn a profit for several years – property taxes must still be paid and are a continuing drain on capital resources.  High property taxes, including personal property, are therefore an influential factor in business location decisions.

Bartik’s tax and business growth model predicts that a ten-percent cut in tax rates will increase business activity by 1 to 5 percent.[4]  This research lends support to the current legislation, House File 2274, proposing significant (40 percent) commercial property tax reductions over the next eight years.[5]  Unfortunately, at this time HF2274 is not supported by the Democrat members of the Iowa House of Representatives and was passed on a strict party-line vote, 59 Republicans in favor and 40 Democrats opposed.[6]

Additionally, property taxes, whether business or personal, are considered by individual taxpayers as the second most unfair state or local tax.[7]  This is partly because, if property values decrease (as they did in the recent recession) elected officials tend to not accept lower revenue and cut budgets, but to raise the tax rates in order to collect the same amount of revenue.  So not only are workers dealing with the negative effects of increased unemployment and stagnate wages – they see more of their income taken in taxes.

Another important part of the business tax discussion is that taxes in Iowa must be compared to taxes in our neighboring states, as well as nationally. Because of this, the Tax Foundation ranking of Iowa in the top 10 worst business tax states is especially troubling.  They emphasize that, “every change to a state’s tax system makes its business tax climate more or less competitive compared to other states, and makes the state more or less attractive to business.”[8]  Our neighbor to the northwest, South Dakota, ranks as the second best business tax climate in the nation – after Wyoming.  Neighbors to the north and east, Wisconsin, Minnesota, and Illinois do not fare as well for a variety of reasons.  Minnesota (45) and Wisconsin (43) are with Iowa in the 10 worst tax climate states, and Illinois (28) is not far behind and catching up quickly. Because of the out-of-control tax and spending habits of the Illinois Legislature and Governor, they moved down 12 places from 2011 to 2012, from 16 to 28.  By improving the tax climate in Iowa it is possible that businesses from these states will chose to expand or relocate here.

The State Business Tax Climate Index has five main components:

  • Corporate Tax
  • Individual Income Tax
  • Sales Tax
  • Property Tax
  • Unemployment Insurance Tax

Each component is scored on a zero (worst) to 10 (best) ranking. Within the five major categories are a total of 118 different variables.  Then the five are weighted “based on the variability of the 50 states’ scores from the mean.”  The components with a greater variability have heavier weightings.

The weighting of each of the five major components is:

33.1% — Individual Income Tax

21.4% — Sales Tax

20.3% — Corporate Tax

14.1% — Property Tax

11.1% — Unemployment Insurance Tax[9]

 Corporate Tax Situation

As the Tax Foundation details, “a state’s corporate tax is levied in addition to the federal corporate income tax rate, which varies from 15 percent on the first dollar of income to a top rate of 35 percent. This top rate is the second-highest corporate income tax rate among industrial nations. In many states, federal and state corporate tax rates combine to levy the highest corporate tax rates in the world.”[10]

Not only is Iowa in the top ten worst overall business tax states, we are the number one worst state in corporate taxes. “Iowa’s 12 percent corporate income tax rate qualifies for the worst ranking among states… followed by Pennsylvania’s 9.99 percent rate.  Other states with high corporate income tax rates are the District of Columbia (9.975 percent), Minnesota (9.8 percent), Illinois (9.5 percent), Alaska (9.4 percent), and New Jersey and Rhode Island (9 percent).”  Colorado has the lowest national rate at 4.63 percent.[11]

Federal Alternative Minimum Tax (AMT)

Evidence shows that the AMT is an inefficient way to prevent tax deductions and credits from totally eliminating tax liability. The AMT “nets little money for the government, imposes compliance costs that in some years are actually larger than collections, and encourages firms to cut back or shift their investments.” (Chorvat and Knoll, 2002)  It also increases regulatory and paperwork complexity.  Tax complexity is outlined by the Tax Foundation as a “competitive disadvantage” for states.  The AMT is an important part of this complexity disadvantage.

Iowa, unfortunately, has an AMT for both corporations and individuals. There are only nine states with an AMT on corporations.  The others are Alaska, California, Florida, Kentucky, Maine, Minnesota, New Hampshire, and New York.[12]  We are also one of nine with an individual AMT including California, Colorado, Connecticut, Maine, Minnesota, Nebraska, New York, and Wisconsin.[13]

Inflation Indexing

An important part of the tax structure, which was changed at the national level under President Ronald Reagan, is indexing tax brackets for inflation. According to the Tax Foundation, “for states that have multiple-bracket income tax codes, it is important to index the brackets for inflation. That prevents de facto tax increases on the nominal increase in income.”[14]  Without inflation indexing taxpayers and businesses creep into ever-higher brackets without realizing it.

Iowa not only has multiple levels of corporate income taxes, but along with 15 other states, (Alaska, Arkansas, Hawaii, Kansas, Kentucky, Louisiana, Maine, Mississippi, Nebraska, New Jersey, New Mexico, North Dakota, Ohio, Oregon, and Vermont) does not index for inflation.[15]

The table below details the Iowa ranking for the five main tax categories evaluated by the Tax Foundation, and the key sub-categories within them.

Iowa_Business_Tax_Climate_Index

Summary

As demonstrated by the overall 41st place ranking by the Tax Foundation, Iowa does not exhibit many of the “good” tax structures or regulations.  Instead we rank among the worst on several key factors, including commercial property tax, corporate tax rates, the Alternative Minimum Tax, and both personal and corporate tax indexing.  While Governor Branstad and the Legislature are attempting to address some of these issues, much work remains to be done.  In the current competitive economic environment, it is critical that they have the personal and political will to make the necessary changes and that we as taxpayers see to it that they do.

Deborah D. Thornton is a Research Analyst at Public Interest Institute. 

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation.  They are brought to you in the interest of a better-informed citizenry.

[1] Mark Robyn, “2012 State Business Tax Climate Index,” Tax Foundation, January 2012, Number 62, <http://taxfoundation.org/files/2012_tax_foundation_index_bp62.pdf> accessed on February 20, 2012.

[2] Robyn, p. 1.

[3] Robyn, p. 9.

[4] Timothy J. Bartik, “Small Business Start-Ups in the United States: Estimates of the Effects of Characteristics of States,” Southern Economic Journal, 55(4), April 1989, pp. 1012 and 1014.

[5] House File 2274, Bill Book, The Iowa Legislature, <http://coolice.legis.state.ia.us/Cool-ICE/default.asp?Category=billinfo&Service=Billbook&menu=false&hbill=HF2274> accessed on February 17, 2012.

[6] House Journal, State of Iowa, February 14, 2012, p. 265, <https://www.legis.iowa.gov/docs/pubs/hjweb/pdf/February%2014,%202012.pdf> accessed on February 17, 2012.

[7] Matt Moon, “How do Americans Feel about Taxes Today? Tax Foundation’s 2009 Survey of U.S. Attitudes on Taxes, Government Spending and Wealth Distribution,” Tax Foundation Special Report, No 199, April 2009.

[8] Ibid.

[9] Robyn, p. 9.

[10] Scott Hodge and Andre Dammert, “U.S. Lags While Competitors Accelerate Corporate Income Tax Reform,” Tax Foundation Fiscal Fact, No.184.

[11] Robyn, p. 12.

[12] Robyn, p. 14.

[13] Robyn, p. 19.

[14] Robyn, p. 14.

[15] Ibid.