Iowa's controversial new manufacturing tax breaks could cost way more than expected

Brianne Pfannenstiel | The Des Moines Register

A controversial Iowa tax law change benefiting manufacturers could cost the state $80 million more this year than projected, said one of the state's top fiscal analysts.

The unexpected expense — the result of an expanded sales and use tax exemption on goods consumed in the manufacturing process — comes as Iowa wrestles with a nearly $250 million budget shortfall that forced the state to makes $118 million in program cuts and pull another $131 million from reserve funds.

“Everything else in the economy seems to still be growing," said Jeff Robinson, senior fiscal legislative analyst for the nonpartisan Legislative Services Agency. "But sales and use tax has flattened out. And it happened at exactly the time that you’d expect if this exemption expansion was larger than thought."

Robinson said with the information available to his department there is no way to say for certain what is causing Iowa's sales and use tax receipts to level off.

But a combination of factors leads him to believe it could be the result of the state's decision to expand the manufacturing tax breaks.

Other economic indicators, including income tax withholdings, wage growth, taxable fuel sales and residential building permits, are maintaining or surpassing average growth numbers, Robinson said.

That tells him that Iowa should be seeing average growth in sales and use tax receipts. Instead, the amount of money coming in fell off "abruptly" in August 2016 — one month after the tax change took effect.

The trend suggests that sales and use tax revenue will fall off by about $100 million this year, which is $80 million more than expected, Robinson said.

The Department of Revenue, which provided the initial cost estimate for the tax exemption, projected a $21.3 million reduction in tax revenue to the state general fund.

David Roederer, director of the Department of Management, said he has not seen the numbers from the Legislative Services Agency. He said his department is looking into the leveling off of sales tax revenue.

State revenue forecast declines Director of Management David Roederer and Sen. Charles Schneider discuss dealing with a decline in the state's revenue forecast on Tuesday, March 14, 2017.

"The one thing that is going on nationally as well as in Iowa (is) the online purchasing," he said. "That’s having an impact on the sales tax, and the scope of that I’m not sure … we fully know what all those dynamics are."

Nationally, the National Conference of State Legislatures estimated that in 2012 the value of foregone sales taxes stemming from online sales was $23.3 billion.

Iowa’s share of that was an estimated $180 million.

But Robinson argued that issue was well-known to Iowa and should have been accounted for in its revenue projections.

"Generally, people were talking about … the competition from online sales," Robinson said. "Well, that didn’t start July 1. That’s been going on a long time.

"Sure, there’s other reasons out there (for Iowa's decline). That’s why you can’t say definitively that this tax law change was more expensive than projected. But it sure looks like it could have been."

The expansion of the manufacturing tax break, finalized during the 2016 legislative session, broadened the definition of "supplies."

Department of Revenue officials have said the new change simply clarifies existing law, arguing that the term "supplies" had been misinterpreted for years. The change, they said, ensured Iowa manufacturers were getting the tax breaks they should have been getting all along.

Advocates of the change say it's good tax policy to place a sales tax on the final product, rather than on the goods that go into producing it.

Some of those intermediary goods were taxed and some were not, which leads to a high number of protests from manufacturers, Department of Revenue officials have said.

A department representative could not be immediately reached for comment Friday.

Rep. Guy Vander Linden, a Republican from Oskaloosa and chairman of the House tax-writing Ways and Means Committee, said he's not concerned with the potential increased cost of the break.

"We should be thankful that the manufacturers didn’t sue us to say, 'Oh, by the way, we should have been doing this in years past,'" he said. "So if we’re not getting the revenue that we would have been getting, frankly illegally, I don’t have a problem with that."