Iowa Can Keep Cutting Taxes Without Risking the Budget

What is next for income tax reform in the Hawkeye State? Governor Kim Reynolds, who has already been the most-significant pro-taxpayer executive to serve in Iowa’s history, ensured our progressive multi-rate tax system became a thing of Iowa’s past. Since 2018, the income tax rate has been reduced by nearly 60 percent, from 8.98 percent to 3.8 percent.

While the governor is not running for re-election in 2026, she has repeatedly expressed her desire to deliver more tax cuts. Iowa legislators should continue working with her to implement additional rate reductions. Yet the idea of further tax reform is often quickly dismissed by some policymakers who prefer to keep increasing spending. Others cite concerns about slowing state revenue due to a downturn in the agriculture sector and uncertainty in the national economy. Some may even believe the 3.8 percent flat tax is already low enough.

Rather than taking the easy way out and putting income tax reform on the shelf, lowering the 3.8 percent flat tax should remain a priority for elected officials. Iowa taxpayers benefit from their ability to keep their own money, and at this time, $3.6 billion of their tax dollars are waiting to be returned to them through the Taxpayer Relief Fund. More broadly, state economic competition is significant, and tax rates matter to families and businesses who want to hold onto more of what they earn. This year, several states enacted tax reform measures to lower their income tax rates.

Justifiable economic concerns should not prevent legislators from enacting further income tax reform, and several models are available. States including Iowa have utilized revenue triggers as a policy mechanism to lower taxes. Such triggers guide income tax rate reduction responsibly, and they serve as a protection for the budget against shortfalls or economic downturns. Iowa’s 2018 tax reform measure contained a trigger, but its 4 percent growth requirement before rate reduction created too high of a threshold; the legislature ended up repealing it.

Iowa’s Taxpayer Relief Fund may provide an even better policy alternative. This fund was created to capture over-collected income and sales tax revenue and return it to taxpayers in the form of income tax relief. The fund grows when Iowa has a budget surplus. After two other funds, the Cash Reserve and Economic Emergency Funds, are filled to their statutory maximums, the remainder of any surplus is dedicated to the Taxpayer Relief Fund. Through this approach, income rate reductions have resulted from excess growth in revenue. 

However, the fiscal year 2026 budget and an acceleration of the 3.8 percent flat tax forced the legislature to supplement the budget by drawing down the surplus and the Taxpayer Relief Fund. On the surface, the move is year-on-year deficit spending, but the Taxpayer Relief Fund was created to provide precisely this sort of smoothing. Nonetheless, slowing revenue amidst the current economic uncertainty makes it unlikely Iowa can continue to cut income tax rates out of revenue growth.

This is why an alternative policy is needed. Legislators should consider a surplus trigger that bases future tax cuts on surpluses, rather than revenue targets. Following implementation of a spending limit, the resulting surpluses are applied to income tax rate reduction. Vance Ginn, an economist and contributing scholar at ITR Foundation, describes how a surplus trigger could work:

• 90% of the surplus above the spending limit is directed to a Tax Relief Fund to reduce the income tax rate gradually over time. The fund can also act as a buffer to cover limited spending needs, if necessary. Any leftover funds go toward paying down debt, further strengthening the state’s financial health.
• The remaining 10% (or less) is left in the general fund or a rainy-day fund for unforeseen revenue shortfalls due to recession, natural disaster, or other reasons. However, the focus during those shortfalls should be reducing spending so more money remains for tax relief when people tend to be hurting the most.
• By splitting surplus funds between tax relief and rainy-day funds, states can provide immediate benefits while laying the groundwork for future prosperity.

Another approach, which Sam Aaron summarizes for South Carolina Policy Council, would establish “a baseline spending limit, and the previous year’s general-fund total is a good place to start. That figure would then be multiplied by the sum of population growth and inflation of the prior year. Any revenue collected above that level becomes surplus.”

Ginn argues “surplus triggers are far more reliable and sustainable” than revenue triggers. “They base tax cuts on actual fiscal surpluses rather than optimistic revenue projections and address the core problem of government: spending.” In Iowa, the existing Taxpayer Relief Fund policy could be reconfigured for this purpose.

Iowa already has a spending limit, too, although it is arguably too weak for the purposes of a surplus trigger. Currently, legislators can only spend up to 99 percent of projected revenue. A stronger spending limit, or the political will to limit spending, will generate more surpluses and result in rate reductions. “By keeping spending under control, surpluses naturally occur when revenues grow faster than the spending limit, creating the perfect opportunity for meaningful tax cuts,” states Ginn.

Ginn makes three fundamental arguments for why surplus triggers are a valuable and responsible policy for rate reduction:

• Stability Over Speculation. Revenue triggers rely on specific revenue targets, assuming continuous economic growth — a risky gamble. If revenue falls short due to economic downturns or other factors, tax cuts may be delayed or reversed, creating uncertainty for taxpayers and businesses. Surplus triggers, on the other hand, only initiate tax cuts when genuine excess funds remain at the end of the year. This approach ensures tax relief is stable, reliable, and based on real financial health rather than speculation.
• Encouraging Fiscal Discipline. A surplus trigger works hand in hand with a spending limit, which naturally generates surpluses by controlling government expansion. This ensures tax cuts are backed by actual savings, not temporary windfalls. Revenue triggers, by contrast, don’t address the root cause of fiscal instability: unrestrained spending. Without limits, even rising revenue can be outpaced by unchecked spending growth, leaving little room for tax relief. By focusing on spending, surplus triggers encourage long-term fiscal discipline, making tax reform sustainable.
• Reducing the Risk of Tax Reversals. Revenue-triggered tax cuts can be politically fragile. If revenue growth slows, lawmakers may feel pressured to raise taxes again, undermining the entire reform effort. Surplus triggers avoid this problem by tying tax reductions to fiscal conditions. This makes cuts less likely to be reversed, providing certainty for taxpayers and businesses alike.

As Aaron puts it, a surplus trigger “reinforces the principle that every dollar the government doesn’t spend should be returned to taxpayers because it is their money.” This process “makes clear to lawmakers that their decisions on spending directly affect how much money their constituents keep.”

Currently, Iowa’s Taxpayer Relief Fund is unprotected. That is, legislators could potentially use it for alternative purposes, such as additional government spending, aid to local government, or “buying down” property taxes. Some of these ideas have already been proposed. A surplus trigger would protect the original intent of the Taxpayer Relief Fund by ensuring it is used for income tax relief.

While a surplus trigger might not allow Governor Reynolds to achieve her original goal of eliminating the income tax, Iowa can continue to lower its 3.8 percent flat tax responsibly without creating a budget crisis.