Politically Popular, But Misguided

We've discussed in earlier posts much of what Iowa's Governor Vilsack had to say about tax and budget issues in his Condition of the State Address. While the Governor stayed away from the "T" word (tax) in his speech, State legislators are doing a lot of talking about taxes and saying so. In fact, this week the Cedar Rapids Gazette reports that the Legislature will debate eliminating the tax on pensions and Social Security income. One House plan would completely phase out the tax on pension and Social Security income over 5 years.

There are several reasons why this proposal is misguided.

• It's just not necessary: As the Iowa Policy Project writes in their backgrounder "Older Iowans, Economic Security, and State Fiscal Policy" Iowans already enjoy a generous pension exclusion ($6,000 for singles and $12,000 for married filers). Also, about 2/3 of Iowans currently pay no tax on Social Security according to this issue brief. The poorest Iowans are already exempt from paying tax on their pension and Social Security income.
• Revenue Loss: The Gazette article says that by the time these taxes are fully repealed the cost to the state will be about $197.8 million. This means $197.8 less investment in Iowa, less education dollars, and less infrastructure for Iowa residents. As the baby boomers age the backgrounder above notes that reliance on state health care services will increase, yet the people most in need of those services won't be paying for them through the taxing of Social Security and pension income.
• False Hopes: On the other hand, backers of the plan to completely eliminate these taxes say that retirees and seniors will be likely to stay in the state because these taxes will be repealed. They argue that in fact the plan will eventually be revenue neutral. This simply isn't true. As this paper by Policy Matters Ohio notes it simply isn't true that families do or don't move to other states because of individual state tax structures. This policy issue brief from Iowa Policy Project notes that Seniors mostly just "stay put" as they age - elderly Iowans simply aren't likely to move to another state because of tax policies.
• Diminishing Tax Base: As the ITEP Guide to Fair State and Local Taxes says, "A narrow-based tax applies to fewer items...In general, broader tax bases are a good idea. At any given tax rate, a broad-based tax will raise more revenue than a narrow-based tax--because more is taxed." Not taxing these two forms of retirement income will create two huge holes in Iowa's personal income tax base, thus shifting the tax burden onto people without retirement income.
• Fairness: Fundamentally taxes should be based on people's ability to pay. Already, the poorest in Iowa are exempt from paying taxes on their retirement income. If wealthy Iowans have retirement income, why shouldn't they pay taxes on this money?

While it may be politically popular to completely eliminate the taxation of pension and Social Security income the passage of this legislation would result in increased unfairness in the tax code, an unnecessary change to the tax structure, huge revenue loss, and a diminished tax base.