Flat income tax rates – such as the one passed in 2022 in Iowa – are proposed to lower taxes, particularly for the wealthy, an analyst from the Urban-Brookings Tax Policy Center said during an OpenSky webinar Thursday.

Under a flat tax, all taxable income – from one’s first dollar to their millionth dollar – is taxed at the same rate, research analyst Richard Auxier said. In a progressive tax system, which Nebraska presently has, income is taxed at higher rates as it increases. By flattening the tax rate, higher incomes are taxed at lower rates and this by nature provides the greatest benefit for those who make more money, Auxier said.

That’s why flat tax proposals always call for a rate lower than a state’s current highest tax rate, Auxier said, noting that “I’ve never heard someone propose a 15% flat tax rate.”

Modeling shows wealthy would get largest share of flat-tax benefit

Iowa in 2022 passed a 3.9% flat income tax rate that will be phased in over the next few years. Some in Nebraska have mentioned passing a similar measure despite having just passed the largest tax-cut package in state history in the 2022 legislative session.

Urban-Brookings modeling shows that a hypothetical 4% flat tax in Nebraska would provide the vast majority of tax savings to those at higher incomes, Auxier said.

The story is the same in Iowa, said Mike Owen, Deputy Director of Common Good Iowa. Once fully implemented, Owen said, more than a third of the tax cut will go to the wealthiest 2% of the tax filers in the state while only 12% of the tax cut would go to the 67% of Iowa residents with annual incomes of $50,000 or less.

Tough discussions about service cuts often don’t happen 

And while Iowa lawmakers did choose to provide massive tax cuts to wealthy residents, they neglected to have the toughest part of the tax conversation, Owen said.

“They’re not talking about what services are going to be given up,” Owen said. “They’re simply saying, ‘let’s take away the money.’”

Once fully implemented, the flat tax passed in Iowa will take away about 20% to 25% of the state budget, the majority of which goes to fund schools, health care and other services that are vital to Iowa residents, Owen said.

“As those services are affected, what does that do to your permanent ability of your state to be a place of opportunity where people want to stay or locate to?” he asked. “Without those services it’s going to be a hard sell.”

Stimulus-induced surpluses sparking tax cut talk nationwide 

As states experience strong revenues thanks to the impact of massive federal pandemic relief efforts, many – including Iowa and Nebraska – are having conversations about tax cuts and returning money to residents, Auxier said. Tax rate cuts, he said, are risky in this situation because the strong revenues are being caused by a temporary condition while rate cuts are more permanent. This could leave states in a precarious spot in the future when the federal dollars dry up and tax rate cuts continue to deplete states of revenue, he said.

Policymakers looking to get money back into the hands of taxpayers may want to consider more sustainable options such as direct one-time rebates, increases to the state Earned Income Tax Credits, the use of state Child Tax Credits or tax credits for seniors, Auxier said.

You can watch the full webinar below and download slides that Owen referenced during his comments here.