# Presentation: 224399

## Federal Tax Reform and State Taxes

- President’s Advisory Panel on Federal Tax Reform
- Harley T. Duncan
- Federation of Tax Administrators
- April 18, 2005

## Purpose

- Overview of the state tax impacts of various federal tax reform/change proposals
- Framework for analysis
- Overview of key proposals
- Not advocating for or against any particular proposal
- Discussion of the issues marks an important first step

## Punchline

- Fundamental reform could substantially alter state tax bases and state tax authority
- Certain proposals also present opportunities for improving state tax structures
- Need for structured dialogue
- Develop context for dealing with issues
- Take advantage of opportunities for improvement

## Operating Premise

- State base must necessarily follow federal base
- Taxpayer compliance and burden
- Required for reliance on federal compliance systems
- No 3rd party reporting systems
- With no federal income tax, there can be no state income tax [broad-based]
- Possibility of wage-based tax

## Analytic Framework

- Conformity Impacts
- What are structural impacts on state tax base?
- “Crowding Out” Impacts
- To what degree does federal taxation move into traditional state tax base and limit flexibility?
- Sovereignty Impacts
- What is the effect on tax authority/prerogatives and what range of options does it leave states?
- Opportunity Impacts
- Does it create avenues for improving state tax structures?

## Reform  Options

- Broadened income tax
- Broaden base, lower rates
- Consumed income tax
- Exclude capital income
- National retail sales tax
- Retail tax on all goods and services
- Value-added tax
- Transaction, European style
- “Flat” tax
- Integrated personal/business income tax

## Reform Current Income Tax

- Conformity
- Broadening of the base is likely
- Crowding
- Standing alone would be neutral [See caveat.]
- Sovereignty
- Broader base retains or increases state options for rate reductions and comprehensive income base
- Opportunities
- Base broadening would improve horizontal equity and affect compliance positively

## Caveat : State/Local Deduction

- Repeal of deduction has crowding out effect
- Increases “price” of state and local government
- Impact is more severe if it is only deduction repealed since relative “price” of other services are not affected
- Some offset with AMT reform
- One of primary determinants of AMT liability

## National Sales Tax and VAT

- Conformity
- Opportunities for improvement/coordination are maximized with conformity
- Differing federal/state bases (and type of tax) would be complex for businesses
- Crowding
- Would move federal government into traditional state/local area
- Question is one of degree

## NST and VAT [Cont.]

- Sovereignty
- Design must accommodate state/local rate flexibility
- Requires recognition that base is being shared
- Opportunities
- Improved consumption tax -- services, business inputs and interstate sales
- Issues of rates, compliance, coordinated administration require examination
- If the federal income tax is replaced (and states are required to abandon income taxes), the combined federal and state revenue-neutral rate would need to be at least 50 percent higher than the federal revenue-neutral rate to replace state and local income and sales taxes

## Consumed Income Tax

- Conformity
- Narrowing of base; decoupling,if possible, dependent on type of federal change and information reporting systems
- Constrains choices and complicates administration
- Crowding
- Shifts federal taxation to traditional state base, albeit not as directly as an RST or VAT
- Sovereignty
- Effectively precludes comprehensive income tax if reporting/compliance system is eliminated
- Opportunities
- From intergovernmental perspective, improvements are minimal

## Flat Income Tax

- Conformity
- Some potential broadening of base even with integration
- Crowding
- Neutral relative to current system
- Sovereignty
- State ability to retain current approach is dependent on information reporting system
- Opportunities
- Some base broadening
- Improved business tax base

## Conclusion

- Federal changes likely to occasion similar state-level changes
- Certain reforms pose difficult conformity issues, but offer opportunity to improve tax systems as well
- Repeal of state and local deductibility raises fiscal federalism issues
- Eliminating federal income tax is problematic
- Need a structured dialogue to assess impacts and maximize opportunities for improvement

## Slide 14

| Appendix:  Summary Evaluation of Federal Reform Proposals |  |  |  |  |
| --- | --- | --- | --- | --- |
|  | Reform Income Tax | RST or VAT | Consumed Income Tax | Flat (Integrated) Tax |
| Conformity | Broader base creates rate flexibility

Reduced preferences improve compliance | Significant taxpayer burden unless state conforms to federal

Conformity improves compliance and creates opportunities for improvement

VAT, as new tax, creates greater challenges | Narrowing of income tax base compared to current

State options to decouple constrained dependent on type of federal change and reporting systems

Decoupling adds complexity and reduces compliance | Some potential broadening of base is possible even with integration

Pressure to conform, but options would exist with retention of information reporting systems |
| Crowding | By itself has neutral impact

Repealing state/local tax deduction increases “price” of services and constrains options | Shifts some portion of federal financing to traditional state tax base

Question of degree dependent on retention (or not) of income tax | Shifts federal financing to base used by state

Less direct than with RST or VAT | Neutral relative to the current system |
| Sovereignty | Broader base improves state flexibility

Repeal of state/local tax deduction reduces flexibility | State control of base is likely diminished

Design must accommodate  rate flexibility

Need recognition that tax base is being shared

Repeal of income tax would constrain state choices | Ability to retain comprehensive state income tax is dependent on information reporting

State choices likely restricted | Retention of comprehensive income tax base is dependent on information reporting systems

State choices potentially constrained |
| Opportunities | Broader base improves horizontal equity

Reduced preferences improves compliance | Could improve design and administration of state consumption taxes

Improvements maximized if state base conforms to federal | From intergovernmental perspective, improvements are minimal | Potential for broader base with fewer preferences

Potentially improved business income tax base

Compliance improvements and burden reduction possible |
| SOURCE:  Federation of Tax Administrators |  |  |  |  |