Further lowering the 3.8 percent flat tax rate would provide meaningful relief to every Iowan rather than favoring select earners through narrow and targeted exemptions.
The popularity of President Donald Trump is influencing state policy, as legislators and governors across the nation seek to replicate the Make America Great Again agenda. Some of the most prevalent fiscal initiatives include state-level versions of the Department of Government Efficiency (DOGE) and adopting tax proposals, such as “no tax on tips” and “no tax on overtime pay.” Currently, three “no tax on tips” bills and two “no tax on overtime pay” bills have been introduced in the Iowa legislature.
Notably, the Iowa bills have bipartisan support, including sponsors from both parties. These tax policies were key promises President Trump made during the 2024 presidential campaign, appealing directly to the working class. On the surface, both proposals may seem like reasonable policies.
Before diving into these specific policy proposals, it’s worth remembering our earlier warning about passing tax reforms before Congress takes action: If Iowa modifies its tax code before Congress finalizes federal tax policy, the state risks implementing redundant or conflicting policies, leading to confusion for taxpayers and businesses.
Currently, individuals are subject to income and payroll taxes on both overtime pay and tips. Any income from tips must be reported, even if received in cash. That means when you leave a tip for a barista at Caribou Coffee (or Starbucks, or Smokey Row), the recipient is required to report it as taxable income. At the federal level, any cash tips over $20 per month must be reported.
Lawmakers deserve credit for working to lower taxes and helping workers keep more of their hard-earned income. However, conservative tax reform should benefit all workers, not just specific groups. These exemptions shrink the tax base, reduce state revenue, and make future rate reductions more challenging. Further lowering the 3.8 percent flat tax rate would provide meaningful relief to every Iowan rather than favoring select earners through narrow and targeted exemptions.
Another concern, particularly with the “no tax on tips” proposal, is its technical implementation. Overtime pay is regulated and tracked by employers, but tip income is far more fluid. What exactly qualifies as tip income? Are service charges considered tips? Would the exemption be limited to a certain income level to prevent high earners, such as lawyers or lobbyists, from reclassifying part of their income as tips to avoid taxation?
Alex Muresianu, a Senior Policy Analyst with the Tax Foundation, raises additional questions:
“Several key considerations will dictate the cost of not taxing tips. Does ‘no tax on tips’ mean no income taxes, or no income taxes and no payroll taxes? It also matters whether the untaxed tips represent all income classified as tips or just tips earned in specific service industries that historically rely on tips, like food services or hospitality.”
Beyond the technical complexities, there are additional considerations. Iowa’s tax code automatically accounts for the large federal standard deduction, among other provisions, meaning many workers who rely on tips may not even be paying income taxes under the current system. As a result, these policies may provide little to no benefit to the workers they aim to help while unnecessarily complicating the tax code and creating obstacles for future, broader tax reforms.
While it may be politically popular to exempt tips from taxation, a far better policy would focus on creating an environment that supports higher wages and new employment opportunities. Lowering the 3.8 percent flat tax is a more effective approach, as it would benefit all taxpayers and provide greater economic advantages. The ultimate goal should be higher wages and better opportunities for Iowa workers.
The best path forward for income tax relief in Iowa is to continue lowering the flat tax, ensuring that all Iowans benefit through increased wages and economic opportunities.
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