Say Goodbye to Federal Deductibility

Senate Democratic Leadership is making a bold move by recently announcing that they will attempt to eliminate federal deductibility. The message signals that Iowans should brace themselves for a tax increase. Based on the most recent information, eliminating federal deductibility would be a tax increase of $594 million. An Iowa household earning $45,000 would receive an average of a 5% increase in their taxes or $222.

Iowa is one of a handful of states that allows a 100% deduction for federal income tax payments on the state individual tax return. It protects Iowans from paying a state income tax on money used to pay their federal income tax. It is the largest way some Iowans may lessen their tax burden.

Democrats have tried to disguise the potential change by claiming it is tax simplification and it makes the system fairer. It looks like the Democrats’ definition of simplification is different from the taxpayer’s definition since this elimination actually raises taxes.

Proponents of the elimination of federal deductibility claim the deduction allows “wealthy” Iowans to avoid paying their “fair share” of Iowa personal income taxes. This data shows that the top income earners in the state are already paying a significant share of the total Iowa personal income tax burden. In fact, the top 10% of Iowa taxpayers pay about 40% of all Iowa personal income taxes. The next 20% pay about 30% of the burden, the next 20% pay less than 20%, and the bottom 50% of all Iowa income taxpayers pay less than 10% of the total Iowa personal income taxes.

Proponents have also argued that if Democrats eliminated federal deductibility and then lowered the tax rates it would make the state more attractive to persons looking to relocate themselves and along with their business in Iowa. This argument is a bit of a stretch. It’s hard to believe that an someone looking to relocate is only going to base their decision on the tax rates on their tax return. There are so many other factors that influence business including effective tax rates, business environment, accessibility to transportation, and quality of life - to name a few.

We’re still waiting for legislation to be introduced. And with Democrats looking for a way to pay for more of their state spending, the elimination of federal deductibility could be their ticket to get back in the black. When talk turns to eliminating federal deductibility and promises to reduce tax rates, Iowans should understand it is simply a shell game and they should get ready to pay more.