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Flat tax: What is it, what will it mean for Iowa

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Condition of the State Iowa

Iowa Gov. Kim Reynolds delivers her 2022 Condition of the State address before a joint session of the Iowa Legislature at the Statehouse in Des Moines.

DES MOINES — In four years, every Iowan’s income would be taxed at 4% by the state under a new proposal from Gov. Kim Reynolds.

Reynolds introduced her flat income tax proposal during last week’s annual Condition of the State address to the Iowa Legislature, encouraging the lawmakers to pass her idea.

“Flat and fair,” Reynolds proclaimed during the speech.

The idea of a flat tax has been around for years, and has its fair share of both supporters and critics.

Steve Forbes ran on a national flat tax platform as part of his 2000 presidential campaign. Supporters say a flat tax is fair and simple. A common pitch has been that a flat tax would make filing taxes simple enough to fit on a postcard.

Critics say a flat tax is unfair because it asks the lowest wage-earners to pay the same rate on their taxes as high wage-earners. They prefer a more progressive tax structure that taxes higher wager-earners at higher rates than low-income workers.

Ten states have a flat state income tax, including Iowa’s eastern neighbor, Illinois. The list includes more blue states like Michigan and Massachusetts, but also red states like Kentucky and Utah.

Eight states have no state income tax. The remaining states, including Iowa, have varying forms of progressive, or graduated, income tax structure.

In 2021, Iowa had nine state income tax rates, tied for the second-most in the country. Most Iowa workers’ income was taxed at between 4.14%, with rates increasing as income increased to a top rate of 8.53% for those earning more than $78,435 of taxable income.

As a result of tax reform passed by the Legislature and signed into law by Reynolds in 2018, the number of tax brackets will be reduced to four, ranging between 4.4% and 6.5%.

Under Reynolds’ new plan, top state income tax rate would be eliminated each year over the next four years, until in 2026 every Iowa worker, regardless of income level, pays 4%.

“There’s never been a better time in Iowa for bold, yet practical tax reform that meets the priorities of the state, allows Iowans to keep more of what they earn, and creates a highly competitive tax system,” the governor’s state budget book reads.

The plan would reduce state revenue by $226 million in the first year, and by $1.6 billion at full implementation, according to the state’s nonpartisan fiscal and legal analysis division. The current state budget — which funds things ranging from education to the justice system to state-run mental health institutions — is just more than $8 billion.

The governor’s staff insists that if state revenues and spending continue to grow at their recent average rates, the flat tax plan can be implemented without forcing reductions in state spending.

“That’s money that can be reinvested into our economy and used to promote the prosperity of every Iowan,” Reynolds said during her speech. “Yes, we’ll have less to spend once a year at the Capitol, but we’ll see it spent every single day on Main Streets, in grocery stores, and at restaurants across Iowa. We’ll see it spent in businesses instead of on bureaucracies.”

Tom Sands, a former Republican lawmaker who chaired the Iowa House committee that deals with tax policy and is now president and chief executive officer of the Iowa Taxpayers Association, called Reynolds’ flat tax proposal “bold” and “a good one.”

“Moving to a flat tax is something that a lot of us have talked about over the years, but it’s been hard to get there,” said Sands, who was a state lawmaker from 2003 to 2016. “(A 4% flat income tax) makes us a lot more competitive as a state.”

Peter Fisher, research director for the liberal-leaning policy advocacy group Common Good Iowa, said of Iowa’s three tax systems — income tax, property tax and sales tax — only the current income tax system is somewhat progressive, in that it asks high-income workers to pay a greater share of their income than low-income workers. The flat tax would change that.

“So if you lower that at the top, you’re just skewing the system even more in favor of higher incomes,” Fisher said.

Fisher noted a transition to a flat tax would be a significant reduction for high-income workers — the top rate would drop from 6.5% to 4% — and only a modest reduction at best for lower-income workers, whose rate would drop from 4.4% to 4%.

In other words, the highest-paid workers would see a 38.5% income tax reduction, while some lower-income workers would get just a 9% reduction.

“It’s highly skewed in favor of top incomes,” Fisher said.

The governor’s office has said that all Iowans would see a reduction in state income taxes, and the average Iowa wage earner’s tax burden would be lowered $1,300.

Fisher, however, said that average number is skewed by the large reductions that high wage earners will receive. Fisher said the median Iowa taxpayer will see a reduction of just $600.

“Half of the taxpayers are going to get $600 or less,” Fisher said.

The governor’s office said that, according to its calculations, the median — or middle — tax reduction will be $900.

Many Republicans have argued that lowering the state’s income tax — or eventually eliminating it altogether, as some Senate Republicans have established as their goal — will make Iowa more attractive to people to work and live here.

They point to data that shows New York and California were among the states with the highest percentage of lost population in 2021, while Texas — which has no income tax — was among the states with the largest percentage of growth.

It is a particular point of emphasis for state policymakers, given Iowa’s sluggish population growth.

Iowa grew by 4.7% from 2010 to 2020, which was well below the national average of 7.1% although better than the Midwest region as a whole, which grew just 3.1% in that time, according to U.S. census data.

“One thing we do know is states with either no income tax or low income tax are a destination place for other people to move,” Sands said.

Data does not fully support that opinion, which many supporters of tax cuts often espouse. For example, in 2021 Illinois — which has a flat income tax — was among the states with the highest share of residents who moved out of the state, according to an annual study by the moving company United Van Lines.

Meantime, Vermont — which has the fourth-worst total state tax burden, according to the Tax Foundation — had the highest share of people moving there, according to the United Van Lines study.

“There have been a lot of studies, and what you find is overwhelmingly people move because of climate, because of a job, because if they’re retirees they want to be near their kids,” Fisher said. “For some people (taxes) matter, but overall this is not going to suddenly get people to come to Iowa because the top income tax rate is lower.”

Republican legislative leaders praised Reynolds’ proposal and said they are eager to begin working on legislation. Reynolds’ proposal has not yet been produced in bill form, but should be soon after it goes through the legislation-making channels at the Statehouse.

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