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On the Hill With Klein

By Jarad Klein

Week 5
February 9-13, 2015
This week’s newsletter will be a little longer than usual, but I think it’s good information for you to have as we work through the process.  I am going to give some history to highlight today’s situations.  I will also outline important legislation on its way to the governor that will impact your 2014 taxes.
As Iowans continue to discuss the proposed state budget for fiscal year 2016 and the level of funding for Iowa schools, some in the education community and other departments are urging legislators spend beyond ongoing revenue to meet local school needs.  This point of view seems to forget the past 30 years of Iowa history and ignore the state’s economic condition.
In the 1980s, Iowa’s economy was suffering the full effect of the farm crisis.  State finances suffered due to the loss of revenue and questionable accounting practices.   Schools and local governments were forced to borrow money while they waited for state aid payments, while the Legislature made financial promises it could not keep.  The crisis reached a head when the Legislature enacted major budgeting reforms during two special legislative sessions in 1992.
A central tenet of these reforms was the creation of two reserve funds to avoid the mistakes of the 1980s.  The first of the reserve funds is the Cash Reserve Fund, which allows the state to make on-time payments to schools, local governments, health care providers, and others, and is required to have an amount deposited in it equal to 7.5 percent of the General Fund budget that year.  The Economic Emergency Fund is required to have an amount equal to 2.5 percent of the General Fund budget.  It is to be used when the state is experiencing an economic disaster.  Each year this amount rises to equal a total of 10 percent of the General Fund budget.  For Fiscal Year 2015, the amount in the two reserves rose by nearly $50 million to just under $700 million.  
When I took office in 2011, Iowa’s two reserve funds were not filled to the statutorily required levels.  Gov. Culver and the previous majority party had spent from the two funds to maintain their spending practices which spent more than the state collected.  This fundamentally flawed approach left the two reserve funds $105.8 million short of their statutorily required levels in fiscal year 2011.
Thanks to fiscal discipline and a strengthening economy, we were able to restore both the Cash Reserve Fund and the Economic Emergency Fund to their required levels.  Maintaining that same fiscal discipline has allowed the state to end the succeeding fiscal years with additional funds in its ending balance. Improving Iowa’s fiscal house has also allowed the state to utilize ending balances in several significant ways.
When states receive federal disaster aid, they are required to pay a matching rate for the funds.  This is known as “performance of duty.”  These payments are not made when the federal disaster aid is received, but when the funded projects are completed.  This makes planning for repayment problematic, as the yearly totals can range from less than $10 million to over $50 million.  In 2011, the Legislature decided that it made more sense to have these payments come from the Economic Emergency Fund, since they were addressing disaster aid, which would then be refilled by the General Fund’s ending balance.
Also in 2011, the Legislature created a new fund - the Taxpayer Trust Fund.  This fund can have up to $60 million a year deposited in it when actual state revenues exceed what the state’s Revenue Estimating Conference has projected for the year.  This happened in fiscal years 2012 and 2013, depositing a total of $120 million into the Taxpayer Trust Fund.  
Funds deposited in the Taxpayers Trust Fund are then returned to Iowa taxpayers through a tax credit on their income tax returns. It is the only permanent mechanism to return the ending balance to the taxpayers.  When Iowans filed their income tax returns in the spring of 2014, they each received a credit of $54.  This spring, Iowans will get a credit of $15.  The amount is smaller because in Fiscal Year 2014, actual state revenue did not exceed the REC projection and thus no deposit was made in the Taxpayer Trust Fund.
In 2013, the state had a significant ending balance due to a spike in state income tax payments related to the federal fiscal cliff tax deal and record high farm commodity prices.  In response to this, the Legislature passed legislation paying off a series of state bonds.  The state paid off over $100 million of bonds for prison construction, Honey Creek State Park, and a part of the Culver I-Jobs program.  Paying these debts off early freed up General Fund and Infrastructure funds that had been used to make the annual debt payments.  
In the same bill, the state made a series of strategic investments in critical state programs.  Leading this was a $20 million investment in the state’s water quality initiative.  Addressing the inequity in state university funding was also a priority, as the University of Northern Iowa received $10 million to maintain its programs.  And a number of infrastructure projects and equipment investments at the three state universities were made.
With all this activity, the state still ended fiscal year 2014 with an ending balance of $708.6 million.  Some have pointed to this one-time funding source as a way to increase ongoing funding to schools.  But this approach ignores what has happened in fiscal year 2015.  
Since the Legislature adjourned in May, state revenue has not met expectations.  2014 ended almost $200 million below the revenue forecast, and the latest projection is that revenue in 2015 will be around $140 million below spending.  As of today, the estimate for the fiscal year 2015 ending balance is $451.1 million.  If the state had previously spent the entire ending balance, as some in the minority have suggested, Iowa schools, health care providers, and universities would be facing budget cuts like they experienced during the previous era.  
Also, President Obama signed into law major revisions in the federal tax code.  Iowans expect that the state’s tax code will match up with federal tax law. Without the ending balance, that would not have happened with this year’s tax changes.  These revisions, Senate File 126, will provide significant tax relief to farmers and small businesses, the engine of Iowa’s economy.
Iowa’s General Fund ending balance is the backstop for a slowing Iowa economy.  Shortsightedly emptying the ending balance for a one-time rise in school funding is exactly the approach taken during the Culver era.  It led to across-the-board budget cuts then and it will lead to long-term problems in the future for all state programs - including the very schools intended to be helped.
Senate File 126, as mentioned before (formerly House File 125), passed the House this week by a vote of 95-0 after passing the Senate last week. The bill updates Iowa law to conform to certain tax provisions Congress finally enacted in December for tax year 2014.
The bill updates the provisions in the Iowa Code for the Iowa research activities credit to include revisions in the federal research credit (the basis for the Iowa credit). The federal research credit was extended for the 2014 tax year in the Tax Increase Prevention Act.
Senate File 126 also updates the Iowa income tax code to couple with the 2014 federal changes (with the exception of bonus depreciation). The more significant federal tax cuts that this bill couples with include:
• deduction of up to $250 for out-of-pocket expenses for teachers;
•    tuition and fees deduction for higher education expenses;
•    election to deduct state sales/use tax in lieu of state income tax as an itemized deduction;
• deduction for mortgage insurance premiums as deductible qualified residence interest;
• nontaxable IRA transfers to eligible charities
The most significant tax cut in Senate File 126 allows small businesses to expense (instead of depreciate) the first $500,000 of equipment cost (known as Section 179 expensing). Section 179 of the federal tax code allows businesses to deduct the full cost of qualifying equipment or software purchased or financed during the tax year. That way, if a business buys (or leases) a piece of qualifying equipment, the full purchase price can be deducted from gross income. This was a tax cut created to incentivize businesses to invest in themselves.

The bill does not couple with the federal provision for 50 percent bonus depreciation for both individual and corporate income tax for assets acquired in 2014. This is the same stance that has been taken since 2008. It is fitting that the first bill sent to the governor for his consideration this year is a bill that provides nearly $100 million in tax benefits for teachers, homeowners, and small business owners.

If you have any issue, call or text my cell phone at 515-689-5430.  My email is jarad.klein@legis.iowa.gov, please include your name and address in order to ensure a prompt response.