Iowa is now the national gold standard leader in state tax reform. Iowa’s 2022 tax reform was not only the largest in state history, but it is also the most extensive in the nation. With the exception of the states that do not levy an income tax, by 2026 only four states will have a lower income tax than Iowa.
Patrick Gleason, vice president of state affairs at Americans for Tax Reform, has described recent developments as a “golden era of state tax relief.” Jared Walczak, vice president of state projects at the Tax Foundation, agrees, saying, “The past three years have seen the largest wave of state-tax cuts in the modern era, certainly since income taxes were created over a century ago at the state level.”
Tax reform in Iowa has been a lengthy battle. The Iowa legislature levied its first income and sales taxes in 1934, ostensibly to provide property tax relief. At that time, the progressive income tax had five brackets, with a top rate of five percent. The income tax was at its highest in 1975 when it reached a top rate of 13 percent with 13 tax brackets.
Iowa’s corporate tax has a similar story. The state first levied the tax in 1934, at a flat two percent. Eventually the progressive tax structure was applied to the corporate tax, which led to a top rate of 12 percent — the highest in the nation.
The burden of Iowa’s high tax rates was “disguised” by federal deductibility and numerous tax credits. In 2018, the legislature passed what was then the largest income tax cut in state history. The legislature surpassed this in 2022. The 2022 “flat tax” reform was not only comprehensive, but it will completely phase out the progressive income tax, replacing it with a flat 3.9 percent rate by 2026.
Further, the corporate rate will be lowered until it reaches a flat 5.5 percent. Reductions are tied to a revenue trigger, which has already resulted in a drop from 9.8 percent to 8.4 percent. According to current projections, the 5.5 percent flat rate will also be achieved by 2026.
With the 2022 legislation, Iowa’s tax reform was described by Gleason as “the most significant.” Prior, Iowa received poor rankings in regard to tax climate. The Tax Foundation’s State Business Tax Climate Index ranked Iowa in the top 10 states for the worst tax climate. Iowa’s ranking is improving and once the 2022 reforms are fully implemented, the Tax Foundation expects even greater improvement.
The formula for Iowa’s success rests with conservative budgeting. A sound tax policy must begin with limiting spending. Governor Reynolds has made this a priority. As a result, Iowa is anticipating a $1.7 billion surplus for 2023, building on a $1.9 billion surplus in 2022. The state forecasts an estimated $2 billion surplus in 2024. In addition, Iowa’s reserve funds are fully funded, and the Taxpayer Relief Fund is estimated to grow its balance to $3.5 billion in 2024.
Governor Reynolds has stated that Iowa is not finished with tax reform, saying her goal is to eliminate the income tax altogether. In keeping with this goal, Senator Dan Dawson, Chair of Ways & Means Committee, introduced a bill during the last legislative session that would not only speed up rate reductions, but eventually eliminate the income tax.
Senator Dawson’s proposal would lower the individual income tax to a flat 2.5 percent by 2028. It would also continue corporate tax rate reductions, with the goal of phasing down the rate to a flat 4.75 percent. Finally, the plan would also utilize the Taxpayer Relief Fund to eliminate the income tax. Senator Dawson has established a framework for further reform in 2024.
Iowa, once a high tax state, is now the gold standard for pro-growth tax policy.