Iowa Approves Property Tax Reductions, New Tax Credits

June 13, 2013

A new tax package in Iowa has been signed into law, constituting, according to Governor Branstad (R), Iowa’s biggest tax cut ever. SF 295 has three major components: reduction in business property taxes, limitations on increases of residential property taxes, and credit expansions in individual income taxes. These changes are expected to reduce taxes by over $4 billion over the course of the next decade.

As much as Iowans may like their tax break, the reform itself includes provisions that raise some concern. While we have speculated before about why taxpayers so dislike the property tax, the tax itself has many positive features. Property taxes fulfill many of the principles of sound tax policy: they are usually relatively simple, easy to understand and transparent, can readily be made economically neutral, and provide reasonably stable revenue flows: all positive features.

Iowa’s new tax law, however, has a mixed record on these principles. As of 2012, commercial property in Iowa was taxed at about 2.25 times the rate of residential property: ranked 40th out of the 50 states. Thus, a relative reduction in business property taxes could, theoretically, make the tax code more neutral. While SF 295 does offer such a relative reduction, it is hard to say how large it will be: the relationship between exempting a share of commercial property’s value from and reducing assessment growth for residential properties is complicated. A better proposal would have been to simply move away from separate tax categories for residential versus commercial property, such as the system established under Proposition 13 in California, which has one of the most neutral property taxation systems in the nation.

However, the large reduction in property taxes coupled with a smaller reduction in income taxes will shift the burden of taxation more heavily onto income: a less stable and more distortionary tax. Furthermore, SF 295 creates or expands several new credits, funds, and preferential treatments in the tax code, exacerbating the problem of non-neutrality, and its distortionary effects.

In sum, the law is a mixed bag. The Governor has indicated another look will be taken at the income tax later this year: hopefully the problem of excessive and distortionary credits can be resolved then. And, if not, then Iowa may have to sit tight at 42nd on our State Business Tax Climate Index, maintaining the 4th highest top income tax in the nation, and the highest corporate tax rate.

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