December 13, 1995
Third and last meeting
Minutes prepared by Kathy Hanlon, Legal Counsel
Organizational staffing by Mike Goedert, Senior Legal Counsel
Call to Order. Co-chairperson Senator Tom Vilsack called the third meeting of the Business Taxation Meeting to order at 9:40 a.m.
Adjournment. Upon a motion by Co-chairperson Representative Halvorson, the meeting adjourned at 2:40 p.m.
Next Meeting. Co-chairperson Vilsack altered the agenda in order to move through the items swiftly. With the adoption of recommendations at the end of the meeting, the Committee agreed to cancel the fourth meeting, which was to be held on December 14.
Professor William Oakland of the Department of Economics at the University of Tulane presented members with a regional comparison of state business taxation competitiveness. His presentation points, he said, are based on conclusions he drew from 1992 census figures and from computations made in working on business taxation with the Federal Reserve Bank of Chicago. The 1992 census figures are taken from the states that constitute the 7th District of the Federal Reserve System: Iowa, Illinois, Indiana, Michigan, and Wisconsin.
Elements of a Business Tax System. The business taxes considered by Professor Oakland included corporate income tax, sales and use taxes on business purchases, real and personal property taxes, unemployment insurance taxes, motor fuel taxes, and miscellaneous and license taxes.
Iowa Relies on Business Taxation. In FY 92, Iowa collected between $1.8 billion and $2.1 billion in business taxes, or between 32 and 37 percent of the total number of tax dollars collected in Iowa in 1992. Iowa, he said, is comparable to other states in its region, but is slightly high nationally, relying more on business taxation than the nation generally does.
Business Tax System Criteria. Professor Oakland described the criteria on which he judges a business tax system as follows:
| IOWA BUSINESS ORGANIZATION: | |
|---|---|
| Corporations who pay tax | 17,606 |
| Corporations not paying tax | 19,965 |
| S Corporations | 19,545 |
| Partnerships | 19,527 |
| Proprietorships | 183,248 |
| a. Sum 1-4 | 77,043 |
| b. Sum 1-5 | 260,291 |
While acknowledging the political risks, he suggested that achieving neutrality in Iowa may require reducing business taxation levels by several million dollars and placing the burden on households.
Tax Levels vs. Expenditure Benefits. The use of business taxation to defray the cost of government objectives other than business services increases the cost of doing business in Iowa by 1.25 percent. Professor Oakland observed that business should not be expected to subsidize education, except for certain vocational programs. Iowa spends less on social services than other states, and expends a remarkably small amount on public safety, he said. Iowa, he noted, is competitively in step with the rest of the states, both regionally and nationally. However, Iowa's three major business taxes penalize new investment, he said. He recommended that Iowa increase venture capital opportunities.
Subchapter S Corporations. The subchapter S corporation proposal, Professor Oakland said, creates further inequity within the personal income tax system. He argued against any proposal that would permit a subchapter S corporation to apportion income as regular corporations are allowed under the corporate income tax. A more attractive option, he suggested, would be to lower personal income tax rates. The best option, he said, is to adopt a fair tax climate, which will result in an overall low tax rate.
Distribution of Business Taxes by Major Tax Source -- Iowa. The following chart, compiled by Professor Oakland, indicates the distribution of business taxation in Iowa:
| SHARE | |
|---|---|
| Sales Tax | 11% |
| Corporation Income | 11% |
| Property Tax | 55% |
| Unemployment Tax | 8% |
| Motor Fuel | 7% |
| Other | 8% |
| SUM 1-3 | 77% |
Solutions. Professor Oakland suggested the repeal of all business taxes, except business tax on land, and separating land from building taxes. He further suggested that Iowa tax businesses according to a more general indicator of their size, measuring by weighted evaluative or business activities tax. He advised the state to retreat from single sales taxation. He also suggested taxing firms according to size, not capital investment.
Professor Oakland proposed that if Iowa adopts a tax based upon a firm's business capital and payroll, the state could raise present business taxes with a tax rate of 2.2 percent, and if property taxes were retained, the figure would be approximately 1.1 percent. The result would mean that a firm's tax bill would be proportional to its output, the climate would be neutral with respect to technology and business form, and new investment would be taxed at 2.2 percent, which, he said, is well below existing levels.
As a partial fix, Professor Oakland suggested the elimination of present taxation of capital purchases by any business, including building materials, and the elimination of the present corporation tax, imposing instead a business license tax based upon the size of a firm's business assets. Alternatively, he said, the state should impose a payroll tax of 1 percent on all firms doing business in the state.
Professor Tom Pogue of the Department of Economics at the University of Iowa spoke on the issue of business taxation in Iowa.
Property Tax Relief. Professor Oakland suggested that Iowa could afford some property tax relief, but he did not encourage property tax relief. Professor Pogue observed that the state has followed national trends and done much to take the pressure off property taxes over the years, which has had the effect of increasing property valuations. Property tax in Polk County has gone up only 1.55 percent since 1979 after adjusting for inflation, he noted. Agricultural land taxes are 21 percent less than they were in 1979. Iowa's tax system is evolving from taxes on real property and corporate tax and toward taxes on sales and wages. Tax individuals directly, he noted, and the opportunities to export those taxes are reduced. Co-chairperson Halvorson noted that, ironically, the person on the street would rather pay the personal or sales tax rather than the property tax. Professor Pogue observed that those taxes which were increased to reduce property taxes have been increasing at a much greater rate than property taxes. He warned that the effect will be to boost farm values for people who probably are not actually farming the property and who are nonresidents. The state's tax system has shifted to placing the tax burden more on individuals in Iowa, he said.
Tax Incentives/Employment/Education. Professor Pogue compared government business tax incentives to the socialistic policies of Russia prior to 1990. Socialized government, he said, subsidizes inefficient means of production because it takes away the incentive to worry about the bottom line. Tax incentives generally just make businesses more profitable, he said, and they would have located in the state regardless. The reason states most often give for providing incentives is to increase employment in a specific area. Professor Pogue argued that incentives merely shift jobs; they do not create jobs. Education will not create jobs in a region either, he said. Education can enhance a worker's chance for employment, but is an investment program for the individual, and increasing the supply does not solve the state's problems. States can use training programs to get a business to locate in a certain area, but the business has already established the demand for the product that it is producing. Incentives can also act to increase business costs. For example, labor costs may increase when a state increases personal income tax to offset the revenue lost by tax incentives that reduce business taxes. Business locates where costs are low. Iowa is very competitive compared to other parts of the country, with lower cost than almost any other area, better government and schools.
Professor Tom Pogue agreed that, with few exceptions, taxes should be neutral, or uniform. He noted that if businesses face the same tax burden regardless of location, businesses will locate where they can efficiently meet market demands. He argued that states should coordinate tax rates and tax base definitions to minimize interstate differences.
Reducing Tax Competition. States need to negotiate interstate agreements to eliminate tax breaks and other incentives to attract business from each other. The General Assembly also needs to eliminate tax increment financing (TIF) and urban revitalization.
Taxation's Relation to Public Services. Professor Pogue observed that taxes should be high enough to provide public services -- education, public safety, and infrastructure -- that Iowa's citizens need and for which they are willing to pay. Curtailing spending for education and infrastructure investment in order to cut taxes, he cautioned, may slow economic growth according to a number of recent studies of the tax-growth linkage. Iowa's taxes are not high relative to other states, he said, and the fraction of income devoted to public sector services is at the national average. He also observed that the growth rates of personal income are highest in neighboring states with high rates of taxation, lowest in those that tax the least. Therefore, he argued, a fair tax system will not impair the private sector.
Tax Reform vs. Tax Cuts. Professor Pogue indicated that Iowa needs to reform business tax to provide for neutral taxation. He suggested broadening income, sales, and property tax bases, and reducing tax complexity. He also advised increasing the stability and predictability of taxes, because businesses are reluctant to make investments and other long-term commitments when tax laws are subject to frequent change.
Flat Tax. Professor Pogue stated that the flat tax will shift tax burdens from individuals with higher income to those of middle income. He said he prefers the progressive system. A flat tax system would help reduce complexity for individual taxpayers, he said, but would not help corporate citizens. He noted that over two-thirds of the nation's citizens can use a postcard-size income tax return. To assist the corporate citizen, he observed, states should develop and use one formula for interstate corporate business. He also suggested that adopting the federal concept of income would simplify tax returns.
Representative Myers proposed that the General Assembly scrutinize local assessment processes. He noted that in his county, independent decisionmakers are identifying certain agricultural areas they surmise will one day be divided into city development lots, and the agricultural areas are being taxed as such. People may seek relief through the board of appeals, but the situation should not occur in the first place, he said. Co-chairperson Vilsack suggested that legislators study the entire tax system, rather than breaking the system into its elements, because of the interlocking effect the taxes have on all of Iowa's corporate and individual citizens.
Co-chairperson Vilsack moved that the Committee make the following recommendations to the General Assembly:
Co-chairperson Halvorson seconded the motion, which was unanimously approved.
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