Iowa Senate Democrats yesterday released draft legislation (SSB 3205) that they say is a “framework” for a compromise they have reached with Governor Branstad to reduce business property taxes. The bill cuts commercial property taxes over five years by 25%, while more than doubling the Iowa Earned Income Tax Credit. The Iowa EITC is currently 7% of the federal credit. The bill would increase that to 15% of the federal credit.
Iowa’s high commercial property taxes have long been perceived as a problem for attracting and growing Iowa businesses, and reforming them has been the Governor’s top legislative priority. Senate Democrats have been insisting that the price would be an increase in the Iowa earned income tax credit. The Governor vetoed an increase in the credit last year.
While often described as a “tax break for the working poor,” the EITC is best understood as a welfare program. The credit is computed based on the wage or self-employment income of taxpayers, and is lost if they have too much investment income. It is “refundable,” meaning that if it exceeds income taxes — and it often does — the government writes a check for the difference. That makes it a welfare program, rather than just a tax break.
The refundable aspect makes it a fraud magnet. Government reports indicate that as much as 25% of the EITC claimed is fraudulent or improper. Until the recent ID-theft fraud binge, EITC theft was probably the most common low-end tax fraud scheme.
The EITC is phased out as income rises. The phase-out creates a high hidden marginal tax rate. Over a large income range, the combination of increased taxes and lost EITC costs earners more than 50 cents out of each additional dollar of income. This has the perverse effect of punishing EITC recipients for getting raises.
House Republicans have balked at the bill, but not because of the EITC provision (they passed the EITC increase vetoed last year, after all). They want to also add residential property tax relief to the bill.
More coverage from Radio Iowa
Prior Tax Update coverage: Incentives to stay poor