States without an income tax are garnering a lot of attention for their economic growth and ability to attract people who are making an exodus from high tax states. Tax climates are important because they determine the overall economic health of the state. For every dollar that is taken by government in taxes is one less dollar individuals or businesses have to save, invest, or spend. Several states, including Iowa, have been initiating pro-growth tax reform to lower rates and allow taxpayers to keep more of their income while making their states more competitive. Some states are considering eliminating their income tax all together and joining the “no income tax state” club. This is a worthy policy goal, but eliminating a state income tax is not easy, and policymakers should realize that alternative pro-growth tax reforms can be just as effective.
Mississippi Governor Tate Reeves recently revealed an ambitious goal of eliminating the income tax in order to make his state more economically competitive. “Let's eliminate the income tax, which is one huge speed bump to long-term economic growth and recovery for Mississippi," stated Governor Reeves. He argues that eliminating the income tax would save “nearly $2,000 per year for Mississippians earning $40,000.”
Mississippi is already working towards this goal. The Taxpayer Pay Raise Act is phasing out the 3 percent income tax and is scheduled to be fully repealed by 2022. In his budget proposal, Governor Reeves outlined that the 4 percent income tax rate would be phased out over a five year period and the 5 percent rate would be phased out by 2030. Revenue triggers will be used to help phase out the income tax. The revenue triggers will help protect the budget to safeguard funding for priorities such as “education, law enforcement, health care, and transportation priorities.”
Mississippi is not the first state to try and eliminate the state income tax. Arizona and North Dakota are two recent examples of states that have tried, but failed to advance legislation which would have eliminated the income tax. Iowa could consider legislation to repeal the income tax. Currently, Iowa has a progressive income tax with high individual and corporate rates.
Lowering tax rates is never easy and it must be approached carefully. Repealing Iowa’s income tax will be difficult. Iowa relies heavily on income tax to fund state government. It is estimated, in Fiscal Year 2021, 57.3 percent of state revenues will be generated from income (individual and corporate) taxes, while 33.1 percent will originate from sales taxes.
Eliminating the income tax would be a pro-growth tax reform policy change. Nevertheless, the difficult part of any tax reform is it must simultaneously consider spending. Taxes and spending are linked and Jonathan Williams, Chief Economist at the American Legislative Exchange Council (ALEC), describes them as “opposite sides of the same fiscal coin.” In other words, “broad-based tax relief must be paired with responsible prioritization of spending,” noted Williams. Lowering and controlling the growth of spending is vital to any tax reform.
For Iowa to repeal the income tax, it would require substantial reform to the tax code. This would include either broadening the sales tax base or designing an income tax rate reduction system based on triggers that would protect the budget. Arizona during the last legislative session considered a bill to phase out their income tax. The proposed legislation would ratchet down income tax rates after specific revenue triggers were met.
Broadening the sales tax is another option, but policymakers must be careful not to increase the sales tax rate in the process. As part of Iowa’s 2018 tax reform law, the legislature broadened the sales tax base to include online purchases. Sales taxes are considered less volatile than income taxes, especially during economic downturns. Iowa’s sales tax revenue has been stable throughout the pandemic.
Yet, numerous sales tax exemptions remain and all of them would need to be evaluated to see if enough revenue would be generated to replace the income tax. It is estimated that repealing most of the sales tax exemptions would raise $1.2 billion in additional revenue. The more tax carveouts and exemptions the more difficult it is to broaden the sales tax base and to lower rates.
Even if eliminating the income tax is sound policy, there are other ways to achieve the same goal. Iowa can look to other states who have enacted pro-growth tax reforms without eliminating their state income tax. Utah, North Carolina, and Indiana are examples of states that have both broadened their tax base and lowered income tax rates. These states and their citizens are benefitting from pro-growth tax reform Utah, North Carolina, and Indiana are also states which are economically competitive because of their tax friendly business climates. Utah, as an example, has almost tripled its gross domestic product since 1999. Patrick Gleason, Vice President for State Affairs at Americans for Tax Reform, argues that “spending restraint, coupled with income tax cuts based on revenue triggers,” are effective tools that states such as North Carolina have used to enact pro-growth tax policies.
Eliminating the state income tax is a worthy policy goal for Iowa. Iowa has the potential to build upon recent pro-growth tax reforms that place taxpayers first and make our state more competitive. Whether Iowa follows Mississippi in trying to eliminate the income tax or follows North Carolina’s approach in lowering income tax rates, our state has the potential to become a leader in the Midwest for pro-growth tax reform.