Federal tax restructuring: experts consider impacts on states and localities.

• Author: Markoe, Jeannine C.
• Position: Federal Focus

The United States Congress is considering several proposals to restructure the federal income tax system. These initiatives consist of eliminating the income tax and replacing it with a new federal retail sales tax; a value added tax; or a flat, single-rate income tax. Congressional hearings, conferences, and economic analyses are being conducted to provide federal lawmakers with information they will need to assess the various proposals. State and local government finance officials will likewise need to analyze the key issues surrounding federal tax reform proposals, particularly those affecting their ability to finance projects, provide services, and raise revenues.

To begin developing a better understanding of the leading congressional proposals and their impacts on state and local governments, GFOA organized a panel discussion at its annual winter meeting of its standing committees, January 30-31, 1996. Speakers from Congress, Wall Street, and research/consulting groups explored some of the potential effects the tax proposals would have on state and local government finances, including how borrowing costs might be affected, what could happen to state and local revenue systems, whether states and localities would be subject to federal taxation themselves, how employee benefit plans might change, and what impact there might be on retirement savings. This article summarizes the views of the panelists: Paul Auster, majority tax counsel, House Ways and Means Committee; Steven D. Gold, senior fellow, The Urban Institute; Jane G. Gravelle, senior specialist for economic policy, Congressional Research Service; and Peter Shapiro, senior vice president, EuroBrokers.

Evaluating the Overall Benefits

Panelists generally agreed that the goals of the current tax restructuring proposals were to address broad policy objectives, such as simplifying tax preparation and administration, making the tax burden more equitable, and stimulating economic growth by increasing the incentives for taxpayers to work, save, and invest. While it was noted that each proposal supported one or more of these goals to some degree, there was great skepticism on the part of some of the speakers regarding whether many of the purported benefits of the proposals would be realized. In addition, the presenters cautioned that the potential benefits of alternative tax structures would need to be weighed against the costs. In other words, Congress would have to assess the possible impacts on specific market segments, such as state and local governments, before taking any action. In a wide-ranging discussion of economic impacts of the various plans, the topics described below were highlighted.

Distributional Effects. Nearly all of the alternative proposals result in a tax system that is considerably less progressive than the current one. Accordingly, one would expect a redistribution of the tax burden across income classes, with lower income groups paying a greater portion of the tax burden after reform than they do now. In addition, the different tax treatment afforded various types of income would raise important equity issues. Under some proposals, earned income would be subject to income taxation, but unearned income (interest on all investments) would not be taxed. Since different types of income are usually associated with younger and older populations, the tax burden would be spread differently within income groups and across generations. Distributional effects among asset classes also would arise: under most of the tax reform proposals...