The state and local implications of federal tax reform: it is imperative that Congress understand the negative impact some of the Panel's proposals would have on state and local governments, particularly the elimination of the state and local tax deductions.

• Author: Gaffney, Susan
• Position: Federal Focus

On November 1, the President's Advisory Panel on Federal Tax Reform delivered its much-anticipated report to Treasury Secretary John Snow. President Bush created the Panel in January to recommend options for making the tax code simpler, fairer, and more conducive to economic growth. While the cornerstone of the Panel's report is the repeal of the Alternative Minimum Tax, it also includes many provisions that would be harmful to state and local governments if the recommendations were to become law. The Panel reached consensus on two tax reform platforms--the Simplified Income Tax Plan and the Growth and Investment Tax Plan. Both plans recommend repeal of the AMT, a measure that will cost the U.S. Treasury more than $600 billion over a 10-year period; however, this lost revenue is fully offset by other recommendations. The difference between the plans lies mainly in the tax treatment of business and capital income. This article examines the Panel's recommendations as they relate to state and local governments.

DEDUCTIBILITY OF STATE AND LOCAL TAXES

The most important element of the Panel's report to state and local governments is the recommendation to eliminate the deductibility of state and local income, sales, and property taxes. The report states that "the deduction provides a federal subsidy for public services provided by state and local governments. Taxpayers who claim the state and local tax deduction pay for these services with tax-free dollars. These services, which are determined through the political process, represent a substantial personal benefit to the state or local residents who receive them--either by delivering the service directly or by supporting a better quality of life in their community. The Panel concluded that these expenditures should be treated like any other nondeductible personal expense, such as goods or clothing, and that the costs of those services should be borne by those who want them--not by every taxpayer in the country" (page 83).

GFOA and other state and local government organizations have long fought against the elimination of federal deductibility of state and local taxes. This was a long-fought battle in the 1986 tax reform bill, and came forward again in the 1990s. State and local governments have argued against this provision for many reasons, including the fact that it constitutes federally mandated double taxation of income, property, and purchased goods. But just as importantly, eliminating the...