Peter Orazem, professor of economics, Iowa State University
Peter Orazem, professor of economics, Iowa State University

Iowa’s economy will be buffeted by the same global and national fiscal turbulence as the rest of the nation this year. But some smart policy decisions at the Statehouse could set the stage for how well the state fares economically for years to come, say two of Iowa’s most seasoned economists.

Peter Orazem, an Iowa State University economics professor, says Iowa should fare well in 2013 with its traditional core strengths of agriculture, manufacturing and financial services. However, the state must address some key issues, such as broadening its tax base through effective tax reform, to ensure strong economic development in the future.

Mike Lipsman, an independent economist who formerly headed the Iowa Department of Revenue’s tax research and program analysis division, says the state’s manufacturing base is less diverse than it was a decade ago, which could make Iowa more vulnerable in future recessions. He believes the state should use a portion of its billion-dollar budget surplus to better fund its public universities and create better collaboration between industry and researchers. He also warns against corporate and property tax cuts, which past experience has shown actually hurt Iowa’s economy.

If the latest manufacturing numbers are any indication, the U.S. economy appears poised to grow in 2013, Orazem said.

Although employment growth in manufacturing was largely stagnant in 2012, that sector managed to add 25,000 jobs nationally in December. In Iowa, the manufacturing, financial services and construction sectors each added several hundred jobs in December over the previous month.

“We’re still sputtering, but at least we’re sputtering in a positive direction rather than a negative direction,” Orazem said. “Internationally, it looks like China and India are slowing down. We’re going to need better news across the oceans if we’re really going to have a strong 2013.”

Two of the best indicators of growth, sales and income tax receipts, have been “pretty solid” in the state for the past couple of years, Orazem said. Retail sales tax revenue for the quarter ended June 30, 2012, were up nearly 4.9 percent compared with the year-ago period, for instance. But Iowa is not an economic island, and it will only fare marginally better or worse than the rest of the U.S. economy.

“I think number one, we have to pray that our customers are doing well,” Orazem said. “If you look at the financial sector in Des Moines, the insurance companies are in a much stronger position coming out of the recession than their counterparts in other parts of the country. But if we have continued lethargic growth on the coasts or decline in Europe, that’s not going to bode well for the financial sector, nor for the manufacturing sector.”

Agriculture, traditionally an area of strength for Iowa in an otherwise weak economy, could become a liability in a prolonged drought.

“The impact of two or three more years of drought could probably have one of the most negative impacts on the state’s economy,” Lipsman said. “So I think for Iowa, the weather is probably the biggest worry right now. If you start losing farm income, it’s going to be the suppliers that are hurt. Main Street retailers will be hurt and the state treasury will be hurt.”

Lipsman, who retired from state government in November 2011, headed the tax research bureau that developed the Iowa Leading Indicators indexes, and regularly briefed the state’s Revenue Estimating Conference. He now works as a consultant for the economic analysis firm led by former State Economist Harvey Siegelman.

For Iowa, “the bright spot, obviously, is the housing market,” Lipsman said. “In terms of number of new units, we’re back to where we were in 2002, and in price, we’re back to where we were in the 2005-06 period. Where I live in an area of West Des Moines, they’re framing (a townhouse development) right now.”

As the economy continues to recover, manufacturers that are suppliers to the housing industry, such as Pella Corp., should fare better as well. However, though output has increased nationally in the past decade, manufacturing employment has actually decreased due to productivity gains. “It just doesn’t take as many people to produce the same amount of output,” Lipsman said.

Additionally, Iowa’s manufacturing sector is less diverse than it was a decade ago because of the loss of large appliance manufacturers such as Electrolux AB and Maytag Corp.

“A lot of the growth has been in the manufacturing companies that produce equipment for the agricultural industry,” Lipsman said. “So if the ag sector tanks, we’re going to see a lot of other sectors in Iowa adversely affected.”

Policy decisions

Orazem said state legislators should consider broadening the tax base to effectively moderate commercial and residential property tax rates to help boost economic development.

“The state, unlike the federal government, doesn’t have the luxury of running a deficit,” he said. “I think there’s going to have to be some sort of broad-based agreement to broaden the tax base. Not just the rates, but also to look at the exemptions that people get.”

Lipsman contends that cutting commercial property tax rates would actually hurt the state’s economy, because a good portion of that money would end up leaving the state. It would have a similar negative effect as that of a 10 percent across-the-board reduction in individual income tax and S corporation tax breaks instituted by Gov. Terry Branstad in 1998.Until those tax cuts, the state’s growth rate had mirrored the national growth rate, but then plummeted, Lipsman said.

“So we had a much worse recession at that time, and I think this was the reason,” he said. “The way those tax cuts were structured and when they occurred, they sent hundreds of millions of dollars out of Iowa. And the same thing could happen again.”

A corporate tax cut would have a similar effect, said Lipsman, noting that he conducted an analysis shortly before he retired from the state that indicated about two-thirds of any such reduction would flow out of the state.

“There is a very small group of companies that pay corporate income tax in Iowa, and almost all of them are big national companies that are here to capture consumer dollars.” he said, among them Wal-Mart Stores Inc. “But whether they get a tax break or not, it’s not going to influence how many more people they’re going to hire or how many more buildings they’ll build.”

Lipsman sees opportunities for Iowa – which emerged from the Great Recession with less damage to its economy than most other states – particularly if it uses the current budget surplus wisely.

“We really haven’t used those resources well in Iowa, and I’m afraid we’re not going to use them well in the future,” he said. “To me, I really think the cuts in the universities have long-term implications for the future.”

Lipsman advocates creating a manufacturing extension service that parallels the types of outreach and research that Iowa State University’s agricultural extension does. “With a combination of state and federal money, they should be building a manufacturing extension service to really look at issues such as the cost of manufacturing in Iowa versus other areas of the country,” he said.

The Center for Industrial Research and Service (CIRAS) at Iowa State already provides a wide range of services and resources to assist manufacturers in improving their products. However, Lipsman said more non-proprietary research is needed.

“In one of the last tax credit evaluation studies I did while I was at (the Iowa Department of) Revenue, we found that there’s very little interaction between the big manufacturers in the state and the universities,” he said. “The problem is, when the manufacturers do the research, they don’t share it because it’s proprietary. Whereas when it’s done at the universities, there is a spillover effect. It think if we had had something like this 10 or 15 years ago, we could have kept Electrolux here.”

The view past the cliff

The “fiscal cliff” agreement that was reached by Congress will be pretty beneficial for Iowa, said Mike Lipsman, an economist with Strategic Economics Group Inc.

“We’re one of only three states that gives 100 percent deduction for federal taxes,” he said.

“If they had let all of the Bush-era tax cuts expire, our (state) budget would have been hit pretty hard. But we have so few people making over $400,000 as singles and $450,000 as families that the impact of them paying a little more in tax at the federal level is not going to have much of an impact on revenue flow in Iowa. The fact that it’s going to leave more money in the pockets of the lower- to moderate-income people is actually good for Iowa because they’ll continue spending. Obviously, seeing the payroll tax go back up to 6.2 percent is going to be a hit, but everybody knew that was coming.”

On the spending side, significant cuts in military spending are likely, Lipsman said, and in Iowa, that will hurt Cedar Rapids-based Rockwell Collins Inc. the most.

“So there are some areas where we can get hurt,” he said, “but states that are more dependent on military spending will be hurt far worse. But if those states are hurt, Iowa won’t escape that. We may do a little bit better or a little bit worse based on local conditions.”

Orazem acknowledged the 800-pound gorilla still facing Congress: putting the country’s fiscal house in some semblance of order.

“I don’t view this current (fiscal cliff) agreement as doing much of anything at all,” he said. “They still haven’t addressed the overall problem; you still have the Simpson-Bowles recommendations that haven’t been touched.”

With government spending having grown to about 24 percent of the nation’s gross domestic product, the United States faces a mounting risk of economic disaster, Orazem said.

“We have to confront that, and it’s not going to be costless,” he said. “Inflation hasn’t happened yet, but in part because we haven’t had enough demand pull. If the government is borrowing as much as it has, it will crowd out private investment and permanently slow the pace of growth in the economy.”