Will flat income tax help Iowa water quality?

Iowa should consider adopting a flat income tax rate — and at the same time boosting the state sales tax 1 cent — to help fix two big problems: the loss of wealth from the state and water quality issues, according to a report from a think tank formed by Cedar Rapids Mayor Ron Corbett.

But some economists say a flat income tax helps the wealthy and hurts low- and middle-income Iowans.

Peter Fisher, research director at Iowa Policy Project, said the proposal would eliminate an earned income tax credit for nearly 150,000 Iowans.

"It would just create large windfalls for people at the highest income levels," Fisher said.

Corbett's group, Engage Iowa, released a report this week saying Iowa has lost nearly $4 billion over 21 years from Iowans moving to other states with lower marginal tax rates.

For example, Iowa lost about $373 million from residents moving to South Dakota and $678 million from Iowans moving to Florida, according to the report written by Dermot Hayes, an Iowa State University economist.

"It's hurting our ability to attract and retain people in our state," Corbett told a group of Rotary members in Cedar Rapids Monday. "Iowa needs a simple flat tax."

Corbett said Iowa's marginal tax rate of nearly 9 percent, ranked fourth highest nationally, is seen as burdensome, even though Iowans pay a much lower rate after deductions such as taxes paid to the federal government are calculated.

The study looks at setting a flat income tax rate between 2.86 percent and 3.27 percent.

The report also says Iowa's progressive tax system — designed so residents who earn more pay higher rates to help provide needed services — isn't working.

The report says Iowans earning $40,000 to $50,000 annually pay a higher effective tax rate than Iowans earning more than $1 million.

The effective tax rates drop for the wealthiest in Iowa, in part because the state's federal tax deductibility, said Dave Swenson, an ISU economist.

Iowa could eliminate federal tax deductibility and cut Iowa's marginal tax rate, Swenson said.

"The federal deductibility gives the appearance Iowa is a high-tax state, when we're not," he said. "It's a political failure."

Swenson and Fisher said tax rates are not driving Iowans to move to other states; people move for jobs, to be closer to family members, and retire in warmer climates, among other reasons.

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Corbett said Iowa would be more competitive with other states with lower tax rates. "We place too much burden on income, and not enough on consumption," he said.

Boosting the sales tax by a penny could enable the state to drive the flat tax rate below 3 percent.

The report outlines using three-eighths of a cent for water quality initiatives, and five-eighths to make the lowest tax rate revenue neutral.

Voters approved creating the Natural Resources and Outdoor Recreation Trust Fund in 2010, which includes improving water quality efforts, but lawmakers have failed to provide the sales tax outlined to support the fund.

Corbett said Iowa is struggling with high nitrate levels in the state's rivers and streams, which is contributing to the dead zone in the Gulf of Mexico.

"We really have a water crisis on our hands," said Corbett, who is on the board of the Iowa Partnership for Clean Water, a group that opposes a lawsuit by the Des Moines Water Works.

The utility is suing three counties in north Iowa, claiming drainage tiles there act as conduits, sending high levels of nitrates from farm fields into the Raccoon River, a source of drinking water for 500,000 residents in central Iowa.

The report says the sales tax could create $80 million for water quality initiatives annually. Corbett calls for a 50 percent match from corporate partners.