In the Public Interest

The views expressed in this column are those of the author and not necessarily those of Public Interest Institute. They are brought to you in the interest of a better-informed citizenry.

Vilsack has proposed several tax changes for the state that he believes will reform and simplify the tax system and help Iowa’s economy. Among the Governor’s ideas are the elimination of federal deductibility from state income taxes (the subject of last week’s In The Public Interest column) and changes to the state sales tax system.

The Governor’s sales tax proposal extends the state sales tax to services such as accounting and engineering that are not currently taxable. In return, he promises to gradually lower the sales tax rate.

While the Governor’s overall goal of simplifying the tax system in our state is admirable, this is the wrong way to achieve that goal.

Expanding the sales tax to additional services may also result in double taxation. Florida State University Economics Professor Randall G. Holcombe explains in a recent study for the James Madison Institute:

“The problem with taxing these services is that they are intermediate services that go into the production of retail services, and because of that they get taxed twice. For example, if a company pays for advertising, that cost must be recouped in the final price of the advertised goods. So the advertising is taxed once when it is initially sold to the business, and it is taxed a second time when its cost is included in the price of the business’ retail sale.

This double taxation is undesirable because it distorts economic incentives, making it relatively more costly to purchase these intermediate inputs. In addition, it gives companies an incentive to bring these activities in-house to avoid the sales tax. Big companies can hire their own advertising people, their own accountants... rather than dealing with independent firms and being subjected to the services tax. As a result, decisions that should be made on economic merits - such as whether to do bookkeeping in-house or hire an outside firm - end up being made for tax reasons. This is inefficient.”

The Governor’s proposal trades an income tax rate reduction for the elimination of federal deductibility and a sales tax rate reduction in exchange for widening the sales tax base - leaving the overall revenue level the same. However, I fear that tax increases will be in our future if the Governor’s plan is approved. What guarantee do Iowa taxpayers have that future Governors and Legislators will not increase the income or sales tax rates again? None. Do we want to trade this deduction away and agree to a wider sales tax base for a promise of lower taxes that can be easily taken away in the future?

Reform and simplification of the tax code are important goals, but not at the expense of fairness and the greater risk of future tax increases.

Amy K. Frantz

Senior Research Analyst, Public Interest Institute,

Mt. Pleasant