Iowa Senate unveils plan to cut state income taxes

Proposal phases out ability to deduct federal taxes, but lowers rates

Internal Revenue Service (IRS) 1040 Individual Income Tax forms in New York on Feb. 17, 2016. MUST CREDIT: Bloomberg photo by Michael Nagle.
Internal Revenue Service (IRS) 1040 Individual Income Tax forms in New York on Feb. 17, 2016. MUST CREDIT: Bloomberg photo by Michael Nagle.

DES MOINES — Senate Republicans are working on a plan to shrink state income tax brackets from nine to three, phase out federal deductibility to cut rates and provide at least $500 million in relief to Iowa taxpayers by 2022.

But expected changes to the federal tax code and a tighter than forecast state budget likely will push back consideration of the plan until the 2018 legislative session, a key architect said Thursday.

“I have advised the Legislature to wait until next year just because of this uncertainty,” said Sen. Randy Feenstra, R-Hull, chairman of the Senate Ways and Means Committee, who has done multiple runs on various options to reduce and simplify Iowa’s individual income tax code.

“We believe that how you grow the economy is to lower rates,” he told The Gazette in an interview. “Once you lower rates, that should drive an economy, injecting more revenue coming into the state. So that is the whole goal. I fully believe that next year is the best opportunity to go down that path of comprehensive tax reform.”

Feenstra said the plan he is fashioning would reduce Iowa’s top rate of 8.98 percent for those earning $77,040 or more annually to 5.65 percent. Iowans would not pay any state tax on income below $6,848, and the rate would be 2.08 percent on income up to $25,680, 5.20 percent on income from $25,680 to $34,240 and 5.65 percent on income above that.

Currently, Iowa has nine tax brackets that begin with 0.36 percent on the first $1,712 earned, and gradually work up to the 8.98 percent top rate, which is high among other states but is closer to an effective top rate of about 6 percent when federal deductibility is factored in.

Iowa is one of a handful of states that allow taxpayers to deduct their federal tax liability on their state income tax return — a feature backed by groups like Iowans for Tax Relief, but one that business groups say skews Iowa’s position in national rankings and makes the state appear uncompetitive.

“The goal is to reduce rates to a level that’s competitive with our Midwest neighbors. This would give us a very strong rate system that we could compete,” Feenstra said. “Our whole goal is to stimulate the economy where we’d have a roaring economy that would bring in dramatically a lot more revenue that we could further fund our schools and mental health and the Department of Corrections or so forth.”

Feenstra said the proposal being formulated by Senate Republicans would gradually phase out federal deductibility over five to seven years, with proceeds going to lower rates and provide overall savings of at least $500 million by 2028, with the possibility of the relief growing as high as $700 million.

Another feature would be to increase the amount of pension income that was exempt from taxation. Iowa has phased out the tax on Social Security benefits. and Senate Republicans now propose to raise the thresholds of exempt income from the current $6,000 to $11,000 for single filers, and from $12,000 to $22,000 for joint filers.

“We believe that this is very necessary to keep our retirees in the state of Iowa,” Feenstra said.

The plan also proposes to eliminate the alternative minimum tax and slow the growth of tax credits.

As part of the effort to reduce state taxes, the Senate Ways and Means Committee chairman said, the Senate GOP plan would put in place a “trigger” on state tax collections so if they grow by 3.5 percent or more, the excess would be directed to income tax reduction. Another feature would be to eventually put in place an Iowa Section 179, which allows small businesses to deduct some expenses.

Feenstra said he has a bill drafted and ready to “drop” into the legislative process, but he expects to wait a year and work with the governor and the House over the summer to get it into a form that could be adopted next session.

Rep. Guy Vander Linden, R-Oskaloosa, chairman of the House Ways and Means Committee, concurred that the prospects for taking up comprehensive tax reform this session are not good.

“If revenues recover, absolutely we’ll be looking for that kind of legislation,” he said. “This year it ain’t going to happen. We’ve got enough stuff on our plate right now to be worrying about that in the short term.”

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