**SUBMISSION TO**

**[THE PRESIDENT'S ADVISORY PANEL ON FEDERAL TAX REFORM]{.underline}**

**Kathryn S. Wylde, President and CEO**

**Partnership for New York City**

**April 28, 2005**

This submission is from the category of Organization and Associations
and is filed under the category of General Comments. The submission
urges retention of the deductibility of state and local taxes and reform
of the alternative minimum tax.

For further information, please contact Peter Faber, chairman of the
Partnership's Tax Committee, at 212-547-5585 or pfaber@mwe.com.

**[TESTIMONY OF THE PARTNERSHIP FOR NEW YORK CITY]{.underline}**

 

The Partnership for New York City, Inc. (\"Partnership\") submits this
testimony under General Comments to the President\'s Advisory Panel on
Federal Tax Reform. The Partnership represents New York City's business
leaders and is focused on economic development and job creation. The
Partnership thanks you for this opportunity to make its views known to
you.

**[State and Local Tax Deductibility]{.underline}**

 

The Partnership believes that among the panel's goals should be
simplifying the tax code, rationalizing it, and preserving the fiscal
balance between the federal government and the states. An important
element of this balance is the deductibility for federal income tax
purposes of certain state and local taxes. Deductibility of state and
local taxes is a long-standing federal policy that has endured because
it is sound tax policy. Its elimination would introduce an element of
unfairness into the system, create anomalies in the tax law, lead to
unintended consequences that are difficult to foresee, and undermine
state and local government financing.

Our federal income tax is based on the concept that tax liabilities
should be based on taxpayers\' ability to pay. To achieve this, gross
income is reduced by deductions for outlays that are viewed as reducing
taxpayers\' ability to pay, such as dependency exemptions and
extraordinary medical expenses. Taxes paid to state and local
governments, which are involuntary payments, reduce a taxpayer\'s
ability to pay just like these other deductible expenses. Repealing
deductibility of state and local taxes would move the federal system
away from the ability-to-pay concept.

 

Under our federal system, governments at all levels must raise money to
finance their different responsibilities. Historically, each level of
government accommodates the needs of the others. When governments share
the same tax base, as is the case with the personal income tax, this
accommodation is necessary to protect taxpayers from a piling-on of tax
burdens that would lead to onerous cumulative tax rates.

Over the last few decades, the federal government has reduced its
support of programs that have historically helped states and localities.
At the same time, the federal government has imposed functions and
mandates on states and localities without providing funding. This has
put an enormous burden on local governments and increased substantially
the tension between them and the

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federal government. State and local governments all over the country are
straining under the burden. It is easy to say that if a state wants a
program, it should pay for it. In fact, the states are paying for
federal programs over which they have limited say. This has contributed
to the states' fiscal difficulties. Eliminating state and local tax
deductibility and imposing double taxation is not the answer. It would
make a difficult situation worse.

 

Because state and local deductibility is a long-standing federal policy,
local governments have built it into their fiscal assumptions, not only
in how they craft their tax laws, but also in how they deliver services.
These links are sometimes not obvious, and we urge the panel to
carefully consider these unintended consequences before any major
reforms are proposed. For example, education is one of the costliest
programs in state and local budgets. Governments around the country are
struggling to find the resources to educate every child to the skill
levels required by our economy and now mandated by federal law. A fully
educated work force is critical to meeting worldwide competition and
maintaining the strength of our economy in a high-tech world. Public
education is funded almost entirely by state and local taxes that are
deductible for federal income tax purposes. If we are to meet the
challenge of a global market, where investments and labor are mobile, we
cannot afford to undermine local school funding this seriously.

Repeal of state-local tax deductibility would also create an anomaly in
our federal tax law that could ultimately threaten the charitable
deduction. State and local governments and tax-exempt nonprofit
organizations perform many of the same services, including health care
and education.  How can one justify a system under which taxes to state
and local governments that fund these services are not deductible, but
charitable contributions for these same purposes are deductible? If
taxes are non-deductible, questions will be raised about charitable
deductions as well.

 

A repeal of the deductibility of state and local taxes would fall
particularly hard on New York. New York City, as a global headquarters
location and world financial center, provides services to the rest of
the nation, many of which are financed by income and property taxes paid
by New Yorkers. For example, New York City has greatly increased its
spending on security in response to the 9/11 attacks. We are grateful
for the federal assistance we have received to help with recovery and
prevention, but New York taxpayers are still paying a disproportionate
part of the national anti-terrorism bill. In another example, New
York\'s educational institutions and teaching hospitals, which are
funded to a significant extent by New York taxes, educate students from
all over the country,

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most of whom go elsewhere when they graduate. Overall, New York
taxpayers pay \$13.1 billion more to the federal government then they
get back in services. This imbalance would be compounded if deductions
for state and local taxes were eliminated.

 

The Partnership wants to make clear that state and local tax
deductibility is not a New York issue or even a regional issue. It is a
*national* issue. In 2002, the last year for which IRS data are
available, 35% of U.S. households itemized deductions. Almost all
deducted state and local taxes. Also, 40 million households deducted
local property taxes, and 38 million deducted state and local income
taxes. At the time, sales taxes were not deductible. Starting in 2005,
Congress permitted taxpayers to elect to deduct local sales taxes. As a
result, the number and geographic distribution of people claiming local
tax deductions will go up significantly when the 2005 returns are filed.

 

The American middle class depends on these deductions. More than
three-quarters (77%) of taxpayers claiming the deduction for local
income taxes, and the same proportion for local property taxes, have
incomes of under \$100,000.

Although deductibility is not *only* a New York issue, its elimination
would have a severe impact on New York. About 700,000 households in New
York City take the deduction. Its elimination would cost them an average
\$4,700 a year. More than half of those households have incomes below
\$75,000.

About 170,000 households in New York City with incomes less of than
\$40,000 a year take the deduction. Their federal taxes would go up by
an average of \$468, or more than 20 percent, without deductibility.

In New York State, about 2.5 million households with incomes under
\$100,000 take the deduction. These households would lose the ability to
deduct \$5,600 a year. For a two-earner family in the 25 percent tax
bracket, that\'s a tax increase of \$1,400. In other words, eliminating
this deduction would cost the average middle-class family in New York
State 1.4 percent of its income.

As New York City's leading voice for business leaders, the Partnership
understands that any discussion of elimination of state and local
deductibility will take place in the context of other tax reforms, and
any calculation of burdens will have to take into account the effect of
the combined changes. Nevertheless, eliminating deductibility would
result in a shifting of burdens that would result in New Yorkers paying
more. Reducing all government taxes and spending is a priority for the
Partnership. New York's business leaders invest a tremendous

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amount of capital toward that end by working with New York State and New
York City to find better and less costly ways to deliver necessary
services. At the same time, we understand that certain basic services
must be maintained if our businesses are to flourish. New York's taxes
are high because it has an aged infrastructure, a disproportionately
large population with special needs, and a special role in global
finance that is important for American security and financial interests.
New York taxpayers not only bear those burdens, but also subsidize the
rest of the country through the imbalance of payments to Washington. It
would be unfair to shift any more of the burden to New York.

**[Alternative Minimum Tax]{.underline}**

The Partnership also urges the commission to address the alternative
minimum tax. Unless its problems are remedied, the AMT would result in
an unintended and creeping unfairness in the tax law and also do damage
to the fiscal balance among the states.

The AMT was initially created in 1969 as a fiscal safety measure to make
sure that the very wealthy do not avoid their fair share of taxes
through the use of excessive tax preferences. But the thresholds in the
law were never indexed for inflation, and slowly over the years more
middle class taxpayers, for whom the alternative minimum was never
intended, have been paying this tax. This year, 2.9 million households
that file their 2004 returns will have paid an average \$6,000 in
additional tax, more than double the number of households in 2000.
Because the income exemptions are scheduled to decline in 2006, the AMT
is expected to apply to 18 million households by then or 1,400% more
than the beginning of the decade.

Each year, the inequity gets worse. Within five years, as many as a
quarter of all taxpayers nationwide could be paying the alternative
minimum tax. These are not the super-wealthy, nor even the upper middle
class. This unintended bracket creep will soon apply to every married
taxpayer who has children and a mortgage. Unless the federal government
indexes the thresholds for inflation, the alternative minimum tax will
become a permanent and substantial tax increase on the working middle
class.

This is especially important for New York. States that rely most heavily
on income taxes are the hardest hit by the AMT. In two-thirds of the
states in 2003, the last year for which statistics are available, fewer
than 2% of the taxpayers paid the AMT. In New York, it was 6%, or
300,000 taxpayers. That is because New York has high state and local
taxes for the reasons stated earlier. Unless

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something is done to control the expansion of the AMT, half of all
households, or 3 million taxpayers in New York State, will be subject to
the tax within five years. That would raise a working family's cost of
living in New York by thousands of dollars a year. It would undermine
New York's ability to stay competitive and drive working and middle
class families out of the state. It would seriously damage the ability
of New York's businesses, on which much of the U.S. economy depends, to
attract and maintain a workforce.

For these reasons, we urge you to maintain state and local deductibility
in federal taxes and restore the alternative minimum tax to its intended
purpose.

Thank you for your consideration.