The last few years have been historic for state-based tax reform. The Tax Foundation reports that 43 states passed some form of tax reform in 2021 and 2022. In 2022, Iowa led the way with passing the most comprehensive tax reform measure in the nation. Iowa led the way in what has been referred to as the state “flat tax revolution.” Governor Kim Reynolds and the legislature passed a comprehensive tax reform measure that will phase out the current progressive nine-bracket income tax system and replace it with a flat 3.9 percent rate by 2026. Under the law, the flat rate phases in as follows:
- 2023: four tax brackets, with a top marginal rate of 6.00 percent
- 2024: three tax brackets, with a top marginal rate of 5.70 percent
- 2025: two tax brackets, with a top marginal rate of 4.82 percent
- 2026: a single (flat) tax bracket, with a rate of 3.90 percent
In addition, the tax reform measure will lower the corporate tax rate from 9.8 percent to a flat 5.5 percent. Already, because of higher-than-expected corporate tax revenues, the rate has fallen to 8.4 percent.
Just this week the Iowa Senate introduced a measure to lower both individual and corporate tax rates and place the individual income tax on a path to elimination. Eliminating the income tax has been a policy goal of Governor Kim Reynolds and many Iowa Republicans.
State Senator Dan Dawson, who chairs the Ways & Means Committee, has introduced a serious measure that will continue Iowa’s historic tax reform progress. Senator Dawson’s bill calls for the individual income tax to be lowered to a flat 4 percent in 2025 and then falling to 3.9 percent in 2026. By 2027 the rate would fall to 2.95 percent and by 2028 the rate would be lowered to 2.5 percent.
Once the 2.5 percent flat rate is implemented then the individual income tax would be placed on a path to elimination. Senator Dawson does this by utilizing the Taxpayer Relief Fund. The Taxpayer Relief Fund was originally intended for the purpose of providing Iowans with income tax relief. Currently the Taxpayer Relief Fund has over $1 billion balance and that is expected to increase to over $3 billion in Fiscal Years 2023 and 2024. Senator Dawson’s measure would also rename the Taxpayer Relief Fund to the Individual Income Tax Elimination Fund. The Income Tax Elimination Fund will then be used to phase out and eliminate the income tax.
Senator Dawson’s proposal will actually use the Taxpayer Relief Fund for its intended purpose, that is, income tax relief. With so much taxpayer dollars sitting in the Taxpayer Relief Fund it provides temptations for policymakers to want to spend that money. This even includes using the Fund to “buy down property taxes” or to provide backfills to local governments. Senator Dawson is making sure that the Taxpayer Relief Fund will only be used to provide income tax relief.
Senator Dawson also proposes to revise the calculation used for corporate tax rate reduction. Under the 2022 law when corporate tax revenues exceeded $700 million any amount above would be used for rate reduction. This is why the rate fell to 8.4 percent this year. Senator Dawson is now proposing to lower the threshold from $700 million to $680 million with the goal of phasing-down the rate to a flat 4.75 percent instead of the 5.5 percent flat rate.
Governor Reynolds and legislative leaders have stated that Iowa cannot be complacent when it comes to tax policy. States are in fierce competition with each other over jobs and people. In addition, the evidence is clear from the mass exodus of people from high tax states that a tax and spend policy is a failure and discourages economic growth.
Already this year several states are considering tax reforms. Many state policymakers are looking at the goal of eliminating their state income tax, but realize that this takes time and prudence. Therefore, many states are moving toward a low flat tax rate with a pathway toward repeal.
In 2023 many states are considering tax reform measures. North Dakota is considering a tax reform proposal that if enacted would create a flat income tax of 1.5 percent, which would be the lowest in the nation. Arizona currently has the lowest flat tax of 2.5 percent. Wisconsin is considering a tax reform measure that could take them to a flat income tax rate of 3.25 percent. In addition, Nebraska is looking at moving to a 3.9 percent flat tax.
In Arkansas, Governor Sarah Huckabee Sanders is pushing to put the income tax on a path to elimination. North Carolina, which for years has been the gold standard for state tax reform, is even looking at further income tax reform. North Carolina already has a flat tax rate of 4.75 percent, and this rate will fall to 3.99 percent by 2026. However, legislative leaders are considering further rate reductions with the goal of matching Arizona’s flat rate of 2.5 percent. North Carolina’s corporate income tax is already on a pathway to elimination, and it will be fully repealed by 2030. These are just some of the states that are considering tax reform this year.
Senator Dawson has offered a responsible, pro-growth tax proposal, that will not only make Iowa even more competitive but allow taxpayers to keep more of their income.
