The benefits of a flat tax go beyond tax relief and economic growth. It makes the tax code simpler, more transparent, and more neutral, reducing both the burden of citizenship and the affliction of social division.
On January 1, 2025, Iowa will transition to a 3.8 percent single-rate flat tax. Not only will this historic change provide tax relief for taxpayers, but it will also improve Iowa’s economic competitiveness. The benefits of a flat tax go beyond tax relief and economic growth, however, making the tax code simpler, more transparent, and more neutral, reducing both the burden of citizenship and the affliction of social division.
While the flat tax is new to Iowa, the very idea of any income tax at all is, itself, a relatively new idea. Wisconsin passed the first state income tax in 1912. At the time, agrarian populists and political progressives argued the wealthy were not “paying their fair share.” Iowa enacted its progressive income tax in 1934. Its first sales tax was also enacted, with the claim that both taxes would provide property tax relief and alternative sources of revenue, especially in response to the severity of the Great Depression.
At first, the tax structure had five brackets, with the lowest starting at 1 percent and the highest finishing at 5 percent for those earning $4,000. Over time, the structure fluctuated, and 1975 hit an all-time high, with 13 income brackets, ranging from 0.5 percent to 13 percent for income $75,000 and above. Moving forward to 2018, Governor Kim Reynolds and the legislature enacted a series of income tax reforms that reduced rates. Then finally, in 2022, the legislature passed and Governor Reynolds signed the largest, farthest-reaching tax cut in Iowa history, which gradually phased the progressive income tax into a single flat tax.
Iowa’s 3.8 percent flat tax will be the sixth-lowest income tax rate in the nation among states that have any income tax. Iowa is one of five states that have recently transitioned from progressive income taxes to flat taxes, and additional states are considering the transition. Even prior to this state “flat tax revolution,” a flat tax was not an unusual or radical idea. By 2025, 13 states will have flat income tax systems. In fact, Colorado, Michigan, Illinois, and Pennsylvania protect their flat taxes constitutionally.
The most common argument against a flat tax is that a single rate, however low, benefits the wealthy at the expense of the poor and middle class. The most recent income tax report from the Iowa Department of Revenue, for tax year 2022, provides important context on who actually bears the heaviest tax burdens.
In tax year 2022, 59.4 percent of Iowa taxpayers paid taxes at a rate of 4.14–7.44 percent. These rates cover income between $6,972 and $78,435. Households with income above that range represent 29.5 percent of all taxpayers, and they pay the top rate of 8.53 percent on income at that margin. Meanwhile, taxpayers in the lower brackets (0.33 percent to 2.25 percent) represented just 11.1 percent of taxpayers, with incomes ranging from $0 to $6,972. (See Figure 1, “Tax Year 2022 Aggregate Taxable Income of Iowa Residents by Tax Rate and Tax Bracket,” on page 8.)
Iowa taxpayers who would be considered working and middle class pay some of the highest effective rates. Table 3, “Tax Burden by Adjusted Gross Income, All Taxpayers and Iowa Resident Taxpayers” (page 15), shows that Iowa residents with income in the range of $75,000–99,000 pay an effective rate of 3.8%, with the next group ($100,000–249,000) paying 4.2%. Together, these two brackets pay 50% of the total tax liability of all residents.
Meanwhile, for those in the lower brackets, tax credits are likely to mean receiving back more than they pay in taxes. (See Table 1-A, “Total Pay and No-Pay Returns,” on page 31.) Iowa’s transition to a flat tax does not eliminate the standard deduction or other tax credits.
Other benefits of a flat tax beyond the money should not be forgotten. It will make the income tax system simpler, more predictable, and more transparent. A single flat tax rate applied to all income makes it easier for taxpayers to estimate their liability and pay their taxes. This is especially important for small business owners who pay their income taxes through the individual income tax rates.
Predictability is essential for businesses. One current cause of economic uncertainty for many businesses provides a helpfully stark example. If Congress allows the federal Tax Cuts and Jobs Act (TCJA) to expire in 2025, individual and small business taxpayers will experience a substantial tax increase, and not knowing whether this will happen makes planning challenging.
Likewise, the complexity of Iowa’s progressive tax system can be difficult for even experts to understand. People making decisions can therefore find themselves at risk of underpaying or paying more than they should. Often Iowans must make decisions for their lives and their investments based not on what makes the most sense for them, but on when and how they will collect income.
The complexity makes possible a constant escalation of taxes, as high rates are cushioned by numerous tax credits. The combination of marginal brackets and tax credits can disguise government’s attempts to manipulate the public into behavior that is politically favored, rather than productive or moral. In contrast, a flat tax is also more difficult for politicians to increase. With everybody equal and subject to the same rate, the class warfare arguments that plague tax policy debates are eliminated. Under a progressive scheme, such division metastasizes into new taxes, such as “wealth taxes” or taxes on gains that haven’t even been turned into income.
Finally, the simplicity of a flat tax will improve the ability of policymakers and Iowa’s Revenue Estimating Conference to predict future revenue. This clarity will help for budgeting and for understanding the impact future income tax rate cuts might have on revenue. While estimating revenue is never a straightforward process, a flat tax will reduce the chance of bad assumptions.
Perhaps the most important benefits, however, are the economic growth and productivity likely to result from implementation of a flat tax. A progressive income tax with high rates punishes productive activity, while high tax rates deter economic growth. The more you tax something, the less you will get of that product, service, or work.
The Tax Foundation argues a progressive income tax system “reduces the payoff to work and [for] investment on the margin by imposing higher tax rates on higher levels of marginal income, [whereas] flat taxes treat all taxable income neutrally and are less likely to discourage additional work, investment, and other activities that contribute to economic growth.”
Its low flat tax rate will encourage work and investment in Iowa, making the state even more competitive. Iowans — struggling during this period of high inflation — will be able to keep more of their hard-earned income.
The evidence is clear from states that have high progressive income tax rates. California, Minnesota, and New York are just a few examples of high-tax states seeing an exodus of people and businesses leaving as a result of high taxation. While Illinois has a 4.95 percent flat tax, its other high tax rates and complex tax system have a similar effect. These states’ tax-and-spend systems do more economic harm than good.
Policymakers must remember that the purpose of taxation is not wealth redistribution, but to pay for the necessities of government services without hindering our state’s economic advancement. Governor Reynolds and Iowa legislators seem to understand that concept well, as they insist they aren’t finished with income tax reform. Going forward, they should look for opportunities not only to lower the 3.8 percent rate, but also to protect the flat tax in the state constitution. Along these lines, the legislature has already passed two important taxpayer protection amendments. The first would require a two-thirds majority vote of the legislature to approve an income tax increase, and the second would constitutionally protect the flat tax.
Voters protecting the flat tax in the constitution is important because it would prevent a future legislature from reinstating a progressive tax. Additionally, the political difficulty of increasing a flat tax rate needs the reinforcement of making increases more difficult. Moreover, constitutional protection will discourage potentially harmful new policies such as wealth taxes.
Constitutionally protecting the flat tax would be an important taxpayer protection. Iowa is a national leader in state tax reform; our state has achieved the most transformational reform in recent history. We owe this success to responsible tax reforms combined with conservative budgeting. Constitutionally protecting the flat tax will safeguard this legacy and ensure future pro-growth reforms.
Starting in 2025, Iowans who are not familiar with the concept of flat taxes will start seeing the benefits as they keep more of their hard-earned income. A victory for taxpayers, Iowa’s historic and transformational 3.8 percent flat tax will make Iowa more competitive and create economic opportunity. As they enjoy this historic and significant policy achievement, Iowa’s taxpayers should be encouraged to understand the foundation of smart policy and support more of it.
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