Lost in the shuffle: Federal tax reform's impact on Iowa tax revenue
Posted on 04/19/2017 at 11:00 AM by Cody Edwards
With the outcome of the 2016 election and the swift demise of Obamacare repeal, there is talk on the street that federal tax reform may actually happen. The House Republicans have introduced their 35-page “GOP Blueprint” and President Trump outlined his plan (the “Trump plan”) in a four-page document. While both plans set forth broad ideas, neither has been memorialized into legislative language so we are left guessing about the details. To be sure, the plans have differences, but they do have similar themes such as reducing individual and corporate tax rates, reducing the number of tax brackets, increasing the standard deduction, and limiting itemized deduction.
With respect to corporate tax only, President Trump has proposed to reduce the corporate income tax rate from 35 percent to 15 percent; the GOP Blueprint proposes to switch to a 20-percent “destination-based cash-flow tax” that taxes corporations based on where they sell their products (more information on DBCFT can here found here). Both the Trump Plan and GOP Blueprint have proposed to allow certain assets, such as equipment and buildings, to be immediately expensed rather than depreciated over time; changes to other tax deductions are possible.
While the headlines covering federal tax reform are primarily focused on the impact to federal revenue, the impact of federal reform on state revenue is often overlooked and could be significant. Indeed, the Tax Foundation has found that under both the GOP Blueprint and the Trump Plan, assuming states do not change their tax regimes, state tax revenues from individual income taxes will increase significantly while the effect on corporate revenues is unclear; the net effect, however, will be an increase in state tax revenues.
To understand why federal reform can affect state taxes, it is important to note that the vast majority of states piggyback, to some extent, off the Federal tax code for their tax administration. Thus, any changes to the federal tax code could affect state tax revenue. This includes Iowa. For example, Iowa allows federal deductibility for individual income tax and uses as its starting point for corporate income tax federal taxable income before net operating losses.
Federal Deductibility A quirk of Iowa’s individual income tax regime is federal deductibility. Generally speaking, federal deductibility allows a deduction of federal taxes paid from state taxable income. As a result, Iowa’s tax rates look much higher on paper than they are in reality, and, some argue, this affects workers’ behavior (whether state tax rates deter workers from moving into, or cause taxpayers to leave, Iowa is a topic for another day). Federal tax reform that reduces the federal tax rate will cause Iowa tax rates to appear even higher relative to lower federal tax rates and, arguably, may cause behavioral changes to Iowa’s workforce or potential workforce.
More significantly, the reduction in the federal tax rates, and thus a reduction in federal taxes paid, would reduce the federal deduction on Iowa individual tax returns, thereby increasing Iowa tax revenue. With this extra revenue, the Iowa legislature would be left to figure out what to do with this extra revenue, which may not be a problem given the latest budget crisis. If the Iowa Legislature wants taxpayers’ state tax burden to remain the same, it could reduce the tax rates while retaining federal deductibility. Or, the Iowa Legislature could do away with federal deductibility completely and reduce rates even further.
Federal Taxable Income before Net Operating Losses Iowa uses as its starting point for corporate income tax federal taxable income before NOLs. Thus, federal reform that affects federal taxable income, such are reductions to or elimination of tax deductions, would have an impact on Iowa corporate taxes. The Trump Plan and the GOP Blueprint would allow for immediate expensing of certain items, which would reduce federal taxable income and Iowa’s starting point for calculating Iowa corporate income tax. Other changes to federal tax deductions would further affect federal taxable income. Again, the Iowa Legislature would need to determine the impact of the change in federal deductions on Iowa’s tax revenues and decide whether, or how to, conform to the federal changes.
The above two examples are just two of many of how federal tax reform could impact Iowa’s tax revenue. To complicate things, other proposals would have the opposite effects on federal and state tax revenues, with the net effect of all the proposals combined on federal and state revenues being unknown.
Federal tax reform is less than certain and what provisions make up a final reform package is unclear. However, it is clear that federal tax reform is likely to have an impact on Iowa’s tax revenues. The Iowa Legislature should recognize the potential impact of federal tax reform on Iowa’s revenues and be ready and willing to change Iowa laws to ensure federal tax reform does not have a detrimental impact on Iowa’s tax revenues.
The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.
- Cody Edwards
Categories: Table SALT, Cody Edwards, Taxation Law
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