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November 24th, 2009

Fong: An Iowa Tax Revolution

Christian FongA dangerous illusion is that Iowa’s economy is healthy.  Over the long-term, our jobs are being lost as businesses move jobs to lower-cost states.  Wage growth, relative to the rest of the nation, has stagnated even as living costs rise – an economic situation known as “stagflation.”  In fact, most counties have been experiencing outright contraction for decades, and Census projections show Iowa losing population and jobs at a dramatic pace by the year 2020.

But I am optimistic that Iowa can be the next great economic engine of America.  We can be a gateway to trade in Asia, which has the largest, fastest growing markets for our products.  We can see Iowans’ paychecks rise and our poverty rate fall.  But we are running out of time to turn our economy around.

The key to rescuing Iowa’s future is to replace an economic system based on low-wage labor with an economy based on productivity.  Economists from Gregory Clark to Alan Greenspan identified that efficiency and productivity are the overwhelming cause of real income growth.  Iowa will see long-term job and wage growth only if we abandon our outdated economic development policies that do not reward productivity and profitability.

For these reasons I propose my 2020 Vision Plan so we can restore the Iowa Dream:

Restore job and population growth in all 99 of our counties, instead of just the 14 that have grown since the Farm Crisis years of the early 1980s.  (How does your county fare?  See Below.)

Reverse the “Brain Drain”, which is occurring at the 4th fastest rate in the nation.  Iowa must be a place where our youth can find world-class opportunities.

Eliminate the state income tax.  This is the most important step to transform our economy to provide those opportunities.

Economic growth is a competitive, state-by-state, endeavor.  Iowa is losing this competition, despite having the raw ingredients to turbo-charge growth:  A world-class workforce and the ability to innovate and take risk.  Yet we rank near last in the nation in tax competitiveness.  The Tax Foundation ranks us #46 in the nation in Business Tax Climate.  Even worse, we have no single tax that is competitive, so we struggle to attract any type of business to our state.

Bottom line…Iowa must get competitive.  We should match tax policy to the economic future we desire.  Eliminating the state income tax will transform our economy, will create rapid job and wage growth in new and old industries and will make Iowa a powerhouse in the world economy.

Taxes: The Power to Destroy

We can tax three things: consumption, ownership and productivity.  Consumption taxes are sales tax and user fees.  Ownership taxes are property taxes.  Productivity taxes are income taxes. How does Iowa rank in each of these areas?  Poorly in all: #31 in property tax, #33 in sales tax, and worst in productivity taxes, where we rank in the bottom 10 for both corporations and individuals.  (See the Tax Foundation data.)

Taxes slow, or even destroy, the activity being taxed.  Productivity is the very worst thing to tax, and the income tax most destructive to our future.  Here is why:

1)      Income taxes penalize hard work, education and innovation.  In Iowa, we earn higher incomes when we work hard, stay in school and innovate.  In taxing, and thus penalizing, the things we otherwise celebrate, the income tax is the most “anti-Iowan” of taxes.

2)      Iowa’s economic transformation depends on productivity.  Economists know that high productivity drives economic transformation and fast wage growth.  High income taxes slow productivity growth and close the door to economic transformation.   We have to stop taxing productivity in order to see transformation to the high-growth economy of the future.

3)      New business formation flocks to competitive advantages in productivity. An example: Why are ethanol plants in Iowa?  Because they want to be close to the highest yielding cornfields in the nation.  Where we have productivity advantages, supply chain business partners come to us and new ventures thrive around those competitive advantages.  This is the future of Iowa’s economy.  Lower income taxes encourage high productivity ventures to thrive.

4)      Businesses vote with their feet, and so do people. Gateway Computers moved across the Missouri River , because South Dakota has no income tax. .  A businessperson in Northeast Iowa told me he was moving his business to Texas, with its zero state income tax, as soon as his Iowa Department Economic Development tax credits expired.  Businesses are voting with their feet.  So do people, as those with entrepreneurial talent seek out places where their talents are not penalized by high income taxes.   My own story bears this out; at Dartmouth College, we openly talked about state tax rates since low tax states were more attractive to graduates.  Many of the top entrepreneurs stayed in New Hampshire, with its zero state income tax, rather than go to Boston.

5)      Lower income taxes lead to long-term wage growth. While an economy must always have property, such as land, manufacturing plants, and equipment, today’s economy is increasingly based on the value of people’s know-how and innovation.  In the long-term, that sort of people-based economics leads to higher wages (the accompanying Economic Return formula demonstrates this).  Conversely, competing on the basis of increasing the economic return to property, through lower property taxes, is to commit to the current capital-intensive economy and fail to see long-term wage growth.

Hockey star Wayne Gretzky explained the key to greatness, “Skate to where the puck will be!”  Every major country, and many states, have cut income taxes in recent years.  Iowa is falling behind.

A Necessary Transition

In Eagle Grove, where I was the keynote speaker for their Chamber of Commerce dinner, I was asked the question, “How are we going to replace the jobs we are losing at Electrolux?”

My vision for the restoration of jobs in Iowa is clear.  Our competitive advantage is our ability to work faster, more efficiently and smarter.  To put it in  more Reagan-like language, the solution to stagnation is the competitive advantage of supply-side productivity!   It will lead to higher wages, more companies that are profitable, and the addition of high-wage jobs.  To get there, we must phase out taxes on productivity, which is to say, to reduce and eventually eliminate the income tax.  That is a Reagan-like attack on high income taxes.

The stakes are high, and time is short.  We can get competitive now, or face stagflation and the death of our most vulnerable communities over the next ten years.  We shouldn’t have to go there, and under my leadership, we will not.  By 2015 we can be solidly growing our job base, and by 2020 our economy will lead the nation as we see incredible growth in every county.  Our wages will grow at 4-5% per year, every year.  Our job and population growth will be explosive.  We will phase out the income tax responsibly, reducing tax rates as the economy and tax base grows and the size and reach of state government is cut.  That is a 2020 Vision that should get Iowa excited and a vision that restores the Iowa Dream.

The choice is Iowa’s.  I’m ready to lead Iowa through this economic overhaul, but I need your help.  Please visit and support our campaign.

Exhibit A – County Growth

Census Year highest Population Map

Exhibit B – Major Components of State Business Tax Climate, 2010

Components of State Business Tax Climate, 2010

Exhibit C – Rate of Return, why productivity = wage growth.

Overall economic return is based on the following Economic Return formula:

R(t) = R(p) + R(c) + R(l)

R(t) = Total Economic Return

R(p) = Return on the property component, including land, machinary and equipment

R(c) = Return on capital, including both the equity and debt components.  In the long-term, R(c) is constant, regardless on what percentage of equity and debt makes up the capital structure.

R(l) = Return on labor, or better thought of as wages, paychecks and profits.

In the short-term, innovation can drive productivity gains in any of the three areas.  One can boost R(p) by getting more yield out of cropland or making a machine produce more “widgets” per hour.  One can increase R(c) by finding a cheaper loan or being close to venture capital.

But in the medium-term to long-term, advantages and gains in R(p) and R(c) are temporary.  In “A Farewell to Alms: A Brief Economic History of the World”, economic historian Gregory Clark proved that R(p) and R(c) are relatively constant, with short-term gains reverting to the mean.  And yet productivity has marched forward, with fields, factories and businesses more productive now than ever before.  Who benefits from increases in productivity?  Productivity gains have inevitably flowed to R(l).  That is, productivity leads to above-average wage growth.  Economists call this phenonomen “The Great Divergance” in understanding why some regions have great wage growth, leaving other regions behind.

Economists now know that, in the long term, innovation that is captured and turned into productivity, will lead to higher wages.  This intersection of the Economic Return formula, a knowledge of economic development and economic history is where the most competitive players in the global economy are positioning.  Any given state or country can position themselves here.

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The Iowa Republican

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