Apr.SFC Discusses Tax Reform Implications on State and Local Tax and Fiscal Policy
AT TODAY’S SENATE FINANCE COMMITTEE HEARING, lawmakers discussed the broader context of tax reform and its potential impact on state and local budgets. A substantial portion of questions asked during the question and answer session revolved around legislation introduced by various committee members, such as the Digital Goods and Services Tax Fairness Act, Marketplace Fairness Act, and the Wireless Tax Fairness Act.
Chairman and Ranking Member of the Committee, Sens. Max Baucus (D-Mont.) and Orrin Hatch (R-Utah), respectively, touched on the deductibility of state and local taxes, while Sen. Maria Cantwell (D-Wash.) discussed tax-exempt bonds and what effect eliminating the tax-exempt bonds status has on utility rates.
In his opening statement, Baucus said the federal government “has also long-played an indirect role boosting state and local governments through the tax code.” The exemption from interest on state and local bonds, which helps cover part of the borrowing costs of state and local governments, totals $55 billion a year. Income deductions for state and local income, general sales, excise and real and personal property taxes total roughly $66 billion a year.
In looking at tax reform, Baucus said state and local taxes “could potentially be allowed as above-the-line deductions, allowing taxpayers to benefit.” In addition, “we could also consider providing a uniform subsidy for bond holders,” which would mean that each taxpayer receives the same subsidy regardless of tax bracket, he said.
In his opening statement, Hatch said there is “no doubt” that states are facing difficult budgetary issues, “but it simply is not the responsibility of the federal government to address state budget shortfalls.” He added that unsustainable spending by states is a leading issue behind their budgetary problems.
Hatch went on to explain the fact that states “are already receiving significant support from federal taxpayers” through federal deductions to the tune of $347 billion according to the Joint Committee on Taxation (JCT) estimates for 2011 to 2015. While Hatch said he believed a state “should be free to set its own tax and spending policies,” state officials “need to take responsibility for their own spending decisions.”
Testimony
In his opening statement, Frank Sammartino, Assistant Director for Tax Analysis at the Congressional Budget Office (CBO), focused on the use of tax preferred bonds and the deductibility of state and local taxes.
Sammartino said tax preferred bonds have enabled governments to borrow “more cheaply than they otherwise could.” At the end of 2011, state and local governments owed roughly $3 trillion in the form of tax preferred bonds. He added, while a large majority of tax preferred bonds are traditional tax-exempt bonds, “such bonds are relatively inefficient mechanisms for the federal government to transfer funds to state and local governments.”
The deductibility of state and local taxes provides a further means of federal support and acts as an “indirect subsidy” by lowering the net cost on most state and local taxes, which encourages state and local governments “to impose higher taxes and provide more services than they otherwise would and to use deductible taxes in place of other taxes.”
Over the next several years, scheduled changes to tax provisions and the interaction of the regular income tax and the alternative minimum tax (AMT) “will change the number of taxpayers who claim the deduction and the associated loss of federal revenues because the AMT does not allow people to claim the taxes-paid deduction.” Sammartino added, without further changes to tax law, the expiration of the 2001 and 2003 tax provisions will increase regular income tax rates for most taxpayers which will raise the value of the taxes paid deduction for those who claim it and increase the associated revenue loss for the federal government.
As a result of the higher tax rates, taxpayers will shift from being subject to the AMT to being subject to the regular income tax “and will therefore be able to claim the deduction for state and local taxes paid.”
If certain tax policies that have recently been in effect were extended rather than being allowed to expire, as under current law, the revenue effects of the taxes-paid deduction would be different. If all tax provisions were extended at the end of the year and the AMT exemption levels were increased for a number of years, there would be two opposing effects on the taxes-paid deduction: 1) The lower regular income tax rates would reduce the tax savings and associated revenue loss for the federal government for taxpayers claiming the deduction; and 2) The higher AMT exemption levels would reduce the number of taxpayers subject to AMT, thereby increasing the number of taxpayers who would claim the deduction.
In her opening testimony, Kim Rueben, Senior Fellow at the Urban-Brookings Tax Policy Center, identified four points to the committee: 1) Federal tax policy and reform can help or hurt states; 2) Unstable federal tax policy trickles down to the states, and uncertainty is especially problematic; 3) Transition relief may be important for state and local governments if fundamental tax reform is undertaken; and 4) Congress can play a role in helping to coordinate or protect existing state and local tax base.
Elaborating further on her points, Rueben said the elimination of the state and local tax deduction could increase the costs to state and local governments in providing services. In addition, temporary extensions to certain tax provisions by the federal government complicates state and local budget forecasting. “Especially problematic has been uncertainty about future federal estate taxes and tax rates on dividends and income. Dividends and capital gains source as a volatile income for state governments.”
Rueben also said transition relief “might be important” for state and local governments. Understanding the short run effects of tax changes “may require slower adoption of certain policies or some fiscal relief.”
In his opening statement, Walter Hellerstein, Professor of Taxation Law at the University of Georgia School of Law, focused his remarks on horizontal tax coordination. In his testimony, Hellerstein also discusses vertical tax coordination.
Hellerstein said Congress should be guided by three objectives: 1) Congress should remove the unreasonable burdens that state taxes impose on interstate commerce; 2) Congress should not unreasonably restrict states from exercising their essential taxing powers to fulfill their constitutional obligations within the federal system; 3) Congress should strive to achieve both objectives at once.
Hellerstein also said the Mobile Telecommunications Act “is the poster child” for horizontal coordination and serves as a model for federal-state coordination.
In his opening testimony, Joseph Henchman, Vice President of Legal & State Projects at the Tax Foundation, said “states will put their own interest ahead of the federal interest every time. They have an incentive to shift tax burdens from physically present individuals and businesses to those who are beyond their borders.” Henchman noted his support behind a uniform apportionment standard.
In his testimony, Sanford Zinman, Owner of Zinman Accounting, discussed multi state residency issues, problems faced by individuals related to the AMT, employment taxes and sales and use taxes.
Question & Answer
In thinking about lower rates and a broadened the tax base, Baucus asked the panel to identify areas to cut tax expenditures.
Sammartino said the CBO has looked at various options in the past to limit the state and local tax deduction. “We found that various options from eliminating it completely to placing a cap on it, or converting it to a 15 percent credit, all would raise significant revenue over a ten year period.”
Sammartino said the CBO considered the same options with the AMT and found that “for all the options we looked at… except the option for the 15 percent credit, that if you both restricted or eliminated the taxes-paid deduction and eliminated the AMT, you would still raise revenues through that combination.”
He added that if the taxes-paid deduction and the AMT were eliminated “it would still be a net revenue increase for the federal government.” For the states “it is a problem because you’re reducing some of the subsidy to state and local governments.” Sammartino told the Committee that the CBO did not examine the impact of AMT elimination on the states.
Rueben added that if “you actually had consistent tax policy with reform of the AMT, it would be incredibly helpful for states.”
Hatch focused on itemized deductions to state and local municipalities, which the JCT estimated the revenue loss to the federal government to be $247 billion between 2011 and 2015. He asked Zinman how aware his clients are of the dynamics of the deductions.
Zinman said ten years ago “we did not talk about AMT at all,” but it has now become a typical conversation. If nothing happens to AMT, Zinman said it is projected that by 2013, 50 percent of Americans will be calculating taxes using AMT calculations. He said the number of individuals who are paying a higher amount of state and local real estate taxes, income taxes, and “they’re not getting the federal tax deduction they were hoping to get.” He added, “the federal income tax is not offset by what’s happening, and this is starting to trouble a lot of people.”
Hatch then focused on President Obama’s FY 2013 budget which reduces charitable deduction by proposing to take away up to 29 percent of itemized deductions from families that are either in the top two income tax brackets. “Charity should be the last thing the President should be attacking, in my opinion,” Hatch said. He added that the President is also going after individual’s ability to exclude interest on tax-exempt bonds from their income. Hatch asked the panel whether the President’s proposal would increase borrowing costs for state and local governments.
Sammartino said the CBO believes it will have a minor affect on borrowing costs. When state and local governments set an interest rate on the number of bonds they want to issue, “to clear the market they have to target that rate to taxpayers with lower marginal tax rates.”
He added that the rate “is something at or below 28 percent.” The President’s proposal to limit itemized deductions to 28 percent “would not affect taxpayers whose marginal tax rate is at or below 28 percent.” For those taxpayers above that percent, their alternative to buying tax-exempt bonds is to buy a taxable bond, and they “would still be better off buying the tax-exempt bonds at current rates, than buying a taxable bond and paying the tax.”
Cantwell asked the panel about tax-exempt bonds used to finance public power projects for capital investment and what impact eliminating tax-exempt bonds status would have on utility rates.
Rueben said she was unsure of what the precise rates would be, but added that whatever Congress does going forward, “if there is some switch in how we treat tax-exempt debt, it will be important to think about how specific localities will fare under these arrangements.” Having a transition period “will be pivotal,” she added.
If there were to be a transition, “having both systems in place… would be important, to see whether revenue bonds can be approved at minimal costs to investors and issuers,” she said.
At the end of the hearing, Hatch addressed Build America Bonds (BAB) in the President’s FY 2013 budget proposal. He noted that, according to the JCT, the administration’s proposal would increase outlays by $70 billion and taxes by $63 billion. He asked Sammartino whether the President’s proposal increases spending by $70 billion and increases revenues by $63 billion, and whether he agreed that outlays were spending.
Sammartino said CBO agrees that outlays are spending, but recognizes that “it’s not clear whether higher revenues from a reduction in the tax expenditure for state and local interest is really a tax increase or a spending reduction.”
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AT TODAY’S SENATE FINANCE COMMITTEE HEARING, lawmakers discussed the broader context of tax reform and its potential impact on state and local budgets. A substantial portion of questions asked during the question and answer session revolved around legislation introduced by various committee members, such as the Digital Goods and Services Tax Fairness Act, Marketplace Fairness Act, and the Wireless Tax Fairness Act.
Chairman and Ranking Member of the Committee, Sens. Max Baucus (D-Mont.) and Orrin Hatch (R-Utah), respectively, touched on the deductibility of state and local taxes, while Sen. Maria Cantwell (D-Wash.) discussed tax-exempt bonds and what effect eliminating the tax-exempt bonds status has on utility rates.
In his opening statement, Baucus said the federal government “has also long-played an indirect role boosting state and local governments through the tax code.” The exemption from interest on state and local bonds, which helps cover part of the borrowing costs of state and local governments, totals $55 billion a year. Income deductions for state and local income, general sales, excise and real and personal property taxes total roughly $66 billion a year.
In looking at tax reform, Baucus said state and local taxes “could potentially be allowed as above-the-line deductions, allowing taxpayers to benefit.” In addition, “we could also consider providing a uniform subsidy for bond holders,” which would mean that each taxpayer receives the same subsidy regardless of tax bracket, he said.
In his opening statement, Hatch said there is “no doubt” that states are facing difficult budgetary issues, “but it simply is not the responsibility of the federal government to address state budget shortfalls.” He added that unsustainable spending by states is a leading issue behind their budgetary problems.
Hatch went on to explain the fact that states “are already receiving significant support from federal taxpayers” through federal deductions to the tune of $347 billion according to the Joint Committee on Taxation (JCT) estimates for 2011 to 2015. While Hatch said he believed a state “should be free to set its own tax and spending policies,” state officials “need to take responsibility for their own spending decisions.”
Testimony
In his opening statement, Frank Sammartino, Assistant Director for Tax Analysis at the Congressional Budget Office (CBO), focused on the use of tax preferred bonds and the deductibility of state and local taxes.
Sammartino said tax preferred bonds have enabled governments to borrow “more cheaply than they otherwise could.” At the end of 2011, state and local governments owed roughly $3 trillion in the form of tax preferred bonds. He added, while a large majority of tax preferred bonds are traditional tax-exempt bonds, “such bonds are relatively inefficient mechanisms for the federal government to transfer funds to state and local governments.”
The deductibility of state and local taxes provides a further means of federal support and acts as an “indirect subsidy” by lowering the net cost on most state and local taxes, which encourages state and local governments “to impose higher taxes and provide more services than they otherwise would and to use deductible taxes in place of other taxes.”
Over the next several years, scheduled changes to tax provisions and the interaction of the regular income tax and the alternative minimum tax (AMT) “will change the number of taxpayers who claim the deduction and the associated loss of federal revenues because the AMT does not allow people to claim the taxes-paid deduction.” Sammartino added, without further changes to tax law, the expiration of the 2001 and 2003 tax provisions will increase regular income tax rates for most taxpayers which will raise the value of the taxes paid deduction for those who claim it and increase the associated revenue loss for the federal government.
As a result of the higher tax rates, taxpayers will shift from being subject to the AMT to being subject to the regular income tax “and will therefore be able to claim the deduction for state and local taxes paid.”
If certain tax policies that have recently been in effect were extended rather than being allowed to expire, as under current law, the revenue effects of the taxes-paid deduction would be different. If all tax provisions were extended at the end of the year and the AMT exemption levels were increased for a number of years, there would be two opposing effects on the taxes-paid deduction: 1) The lower regular income tax rates would reduce the tax savings and associated revenue loss for the federal government for taxpayers claiming the deduction; and 2) The higher AMT exemption levels would reduce the number of taxpayers subject to AMT, thereby increasing the number of taxpayers who would claim the deduction.
In her opening testimony, Kim Rueben, Senior Fellow at the Urban-Brookings Tax Policy Center, identified four points to the committee: 1) Federal tax policy and reform can help or hurt states; 2) Unstable federal tax policy trickles down to the states, and uncertainty is especially problematic; 3) Transition relief may be important for state and local governments if fundamental tax reform is undertaken; and 4) Congress can play a role in helping to coordinate or protect existing state and local tax base.
Elaborating further on her points, Rueben said the elimination of the state and local tax deduction could increase the costs to state and local governments in providing services. In addition, temporary extensions to certain tax provisions by the federal government complicates state and local budget forecasting. “Especially problematic has been uncertainty about future federal estate taxes and tax rates on dividends and income. Dividends and capital gains source as a volatile income for state governments.”
Rueben also said transition relief “might be important” for state and local governments. Understanding the short run effects of tax changes “may require slower adoption of certain policies or some fiscal relief.”
In his opening statement, Walter Hellerstein, Professor of Taxation Law at the University of Georgia School of Law, focused his remarks on horizontal tax coordination. In his testimony, Hellerstein also discusses vertical tax coordination.
Hellerstein said Congress should be guided by three objectives: 1) Congress should remove the unreasonable burdens that state taxes impose on interstate commerce; 2) Congress should not unreasonably restrict states from exercising their essential taxing powers to fulfill their constitutional obligations within the federal system; 3) Congress should strive to achieve both objectives at once.
Hellerstein also said the Mobile Telecommunications Act “is the poster child” for horizontal coordination and serves as a model for federal-state coordination.
In his opening testimony, Joseph Henchman, Vice President of Legal & State Projects at the Tax Foundation, said “states will put their own interest ahead of the federal interest every time. They have an incentive to shift tax burdens from physically present individuals and businesses to those who are beyond their borders.” Henchman noted his support behind a uniform apportionment standard.
In his testimony, Sanford Zinman, Owner of Zinman Accounting, discussed multi state residency issues, problems faced by individuals related to the AMT, employment taxes and sales and use taxes.
Question & Answer
In thinking about lower rates and a broadened the tax base, Baucus asked the panel to identify areas to cut tax expenditures.
Sammartino said the CBO has looked at various options in the past to limit the state and local tax deduction. “We found that various options from eliminating it completely to placing a cap on it, or converting it to a 15 percent credit, all would raise significant revenue over a ten year period.”
Sammartino said the CBO considered the same options with the AMT and found that “for all the options we looked at… except the option for the 15 percent credit, that if you both restricted or eliminated the taxes-paid deduction and eliminated the AMT, you would still raise revenues through that combination.”
He added that if the taxes-paid deduction and the AMT were eliminated “it would still be a net revenue increase for the federal government.” For the states “it is a problem because you’re reducing some of the subsidy to state and local governments.” Sammartino told the Committee that the CBO did not examine the impact of AMT elimination on the states.
Rueben added that if “you actually had consistent tax policy with reform of the AMT, it would be incredibly helpful for states.”
Hatch focused on itemized deductions to state and local municipalities, which the JCT estimated the revenue loss to the federal government to be $247 billion between 2011 and 2015. He asked Zinman how aware his clients are of the dynamics of the deductions.
Zinman said ten years ago “we did not talk about AMT at all,” but it has now become a typical conversation. If nothing happens to AMT, Zinman said it is projected that by 2013, 50 percent of Americans will be calculating taxes using AMT calculations. He said the number of individuals who are paying a higher amount of state and local real estate taxes, income taxes, and “they’re not getting the federal tax deduction they were hoping to get.” He added, “the federal income tax is not offset by what’s happening, and this is starting to trouble a lot of people.”
Hatch then focused on President Obama’s FY 2013 budget which reduces charitable deduction by proposing to take away up to 29 percent of itemized deductions from families that are either in the top two income tax brackets. “Charity should be the last thing the President should be attacking, in my opinion,” Hatch said. He added that the President is also going after individual’s ability to exclude interest on tax-exempt bonds from their income. Hatch asked the panel whether the President’s proposal would increase borrowing costs for state and local governments.
Sammartino said the CBO believes it will have a minor affect on borrowing costs. When state and local governments set an interest rate on the number of bonds they want to issue, “to clear the market they have to target that rate to taxpayers with lower marginal tax rates.”
He added that the rate “is something at or below 28 percent.” The President’s proposal to limit itemized deductions to 28 percent “would not affect taxpayers whose marginal tax rate is at or below 28 percent.” For those taxpayers above that percent, their alternative to buying tax-exempt bonds is to buy a taxable bond, and they “would still be better off buying the tax-exempt bonds at current rates, than buying a taxable bond and paying the tax.”
Cantwell asked the panel about tax-exempt bonds used to finance public power projects for capital investment and what impact eliminating tax-exempt bonds status would have on utility rates.
Rueben said she was unsure of what the precise rates would be, but added that whatever Congress does going forward, “if there is some switch in how we treat tax-exempt debt, it will be important to think about how specific localities will fare under these arrangements.” Having a transition period “will be pivotal,” she added.
If there were to be a transition, “having both systems in place… would be important, to see whether revenue bonds can be approved at minimal costs to investors and issuers,” she said.
At the end of the hearing, Hatch addressed Build America Bonds (BAB) in the President’s FY 2013 budget proposal. He noted that, according to the JCT, the administration’s proposal would increase outlays by $70 billion and taxes by $63 billion. He asked Sammartino whether the President’s proposal increases spending by $70 billion and increases revenues by $63 billion, and whether he agreed that outlays were spending.
Sammartino said CBO agrees that outlays are spending, but recognizes that “it’s not clear whether higher revenues from a reduction in the tax expenditure for state and local interest is really a tax increase or a spending reduction.”
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