Wild Mood Swings in Iowa

Last year Iowa lawmakers came up with a simple solution for the ailments of their state income tax: stop taxing young people. (Blogged here). A Republican plan would have exempted everyone under 30 from paying state income taxes. This idea went down in flames, as it should have.

This year, Iowa lawmakers came up with a radically new solution for the state's income tax woes: stop taxing old people. And this time it went through.

Iowa was already much nicer to seniors than they were to young people. On top of the generous exemption for most Social Security benefits allowed by federal income tax rules, Iowa exempted still more benefits. A married couple could exempt up to $12,000 of pension benefits on top of the Social Security break-- with no comparable tax break for working seniors' wages. These tax breaks created an inequity worth fixing, by shifting the tax load from retired seniors to working seniors-- but the new law just makes this inequity worse.

This year's bill makes two changes: first, it completely exempts Social Security benefits from tax. Since only wealthier seniors paid tax on Social Security benefits to begin with, this makes the state tax system more unfair. Second, the bill creates a higher no-tax floor for seniors than for non-elderly Iowans. Married couples over 65 won't pay income taxes next year until their total income (from taxable and non-taxable sources) exceeds $24,000. This no-tax floor will gradually increase to $32,000 by the end of the decade.

By comparison to the Social Security break, which complicates the Iowa income tax while providing nothing to most seniors, the higher no-tax floor looks like rocket science-- all the benefits go to low- and middle-income seniors.

Probably the best thing one can say about the "no-tax floor" provision of the bill, however, is that it makes the existing pension and Social Security tax breaks virtually superfluous to most low- and middle-income seniors. For Iowa policymakers seeking to raise the banner of income tax simplicity in the 2007 legislative session, repealing or paring back these retirement income tax breaks would be a good place to start. So while the bill may be a lemon from the perspective of tax fairness, it gives reform-minded legislators a chance to make some terrific lemonade next year. Click here for an aging, but still relevant, report outlining options for simplifying the Iowa income tax.

In advance of the final vote on this bill, the Iowa Policy Project issued a terrific report that systematically dismantled anti-tax arguments that tax-motivated seniors were fleeing the state. Unfortunately, lawmakers don't seem to have heard this message at all.