# Presentation: 549180

## How the Tax Code Interacts with 
State and Local Tax Systems

Submitted to the 
President’s Advisory Panel on Federal Tax Reform
April 18, 2005 

Bruce Johnson

Multistate Tax Commission
444 North Capitol St., NW, #425
Washington, D.C.
Ph. 202/624-8699
mtc@mtc.gov

**State and Local Tax Systems**
- Submitted to the
**President’s Advisory Panel on Federal Tax Reform**
- April 18, 2005
**Bruce Johnson**
**Multistate Tax Commission**
- 444 North Capitol St., NW, #425
- Washington, D.C.
- Ph. 202/624-8699
- mtc@mtc.gov

## Purpose

Provide an overview of state and local retail sales and use taxes and income taxes in the U.S. and their administration.

Examine such issues as the use of these taxes among states and localities, general characteristics of the state tax base, tax rates, and the interaction between federal taxes and these state taxes. 

**Purpose**
- Provide an overview of state and local retail sales and use taxes and income taxes in the U.S. and their administration.
- Examine such issues as the use of these taxes among states and localities, general characteristics of the state tax base, tax rates, and the interaction between federal taxes and these state taxes.

**General Sales Tax **
**Prevalence of the Tax at the State Level**
- Forty-five states and the District of Columbia impose a broad-based general retail sales and use tax at the state level.1
- In FY 2003, states collected about $185 billion in general retail sales taxes, about one-third of total state general tax collections of roughly $552 billion.2
- ________________
- 1 Those states not levying the tax include Alaska, Delaware, Montana, New Hampshire, and Oregon.  Local governments in Alaska may impose sales taxes.
- 2 U.S. Bureau of the Census.

## General Sales Tax

Prevalence of the Tax at the Local Level 

Approximately 7,500 separate local jurisdictions in 34 states impose a sales tax. 

Local governments in ten states do not impose sales taxes.3

In all but four states, local taxes are imposed as an add-on to the state tax and are collected and administered by the state tax administration agency. 

In AL, AZ, CO and LA, some local governments are authorized to administer their own sales tax. In these states, there is also somewhat more divergence between the state and local tax base.
_______________
3 Hawaii, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Jersey, Rhode Island, and West Virginia.

**Prevalence of the Tax at the Local Level**
- Approximately 7,500 separate local jurisdictions in 34 states impose a sales tax.
- Local governments in ten states do not impose sales taxes.3
- In all but four states, local taxes are imposed as an add-on to the state tax and are collected and administered by the state tax administration agency.
- In AL, AZ, CO and LA, some local governments are authorized to administer their own sales tax. In these states, there is also somewhat more divergence between the state and local tax base.
- _______________
- 3 Hawaii, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Jersey, Rhode Island, and West Virginia.

## State and Local Sales Taxes

- State-Level Only

- State and Local

- No State or Local

- Local Only

## Components of Sales Taxes 

Rates

Among states that impose sales taxes, rates range from 3.5% in VA to 7.0% in Mississippi, Rhode Island, and Tennessee

When combined with local sales taxes, highest rates are found in Alabama (11.0%), Arkansas (10.625%), Oklahoma (10.5%), and Louisiana (10.5%)

Base

States tax wide range of goods (tangibles)

**Components of Sales Taxes**** **
**Rates**
- Among states that impose sales taxes, rates range from 3.5% in VA to 7.0% in Mississippi, Rhode Island, and Tennessee
- When combined with local sales taxes, highest rates are found in Alabama (11.0%), Arkansas (10.625%), Oklahoma (10.5%), and Louisiana (10.5%)
**Base**
- States tax wide range of goods (tangibles)

## Components of Sales Taxes

Exemptions

Common exemptions are food and prescription drugs

Some states also exempt clothing

Wholesalers - states also impose tax on a wide range of purchases by businesses with exemptions of goods for resale and often exemptions for goods used directly in manufacturing

Services widely exempt from tax, with the exception of a few states

Other exemptions include purchases by specific users (governments, charities, educational institutions)

**Exemptions**
- Common exemptions are food and prescription drugs
- Some states also exempt clothing
- Wholesalers - states also impose tax on a wide range of purchases by businesses with exemptions of goods for resale and often exemptions for goods used directly in manufacturing
- Services widely exempt from tax, with the exception of a few states
- Other exemptions include purchases by specific users (governments, charities, educational institutions)

## Sales Tax Issues in Federal Tax Reform

If Federal government were to adopt a Value Added Tax (VAT) or a National Retail Sales Tax (NRST), simplification of the federal tax system may be achieved at the expense of greater overall complexity.

Federal and state tax bases may differ significantly.

Administrative rules may differ.

Would adoption of either a federal VAT or NRST undo the work done by states through the Streamlined Sales Tax Project?

**Sales Tax Issues in Federal Tax Reform**
- If Federal government were to adopt a Value Added Tax (VAT) or a National Retail Sales Tax (NRST), simplification of the federal tax system may be achieved at the expense of greater overall complexity.
- Federal and state tax bases may differ significantly.
- Administrative rules may differ.
- Would adoption of either a federal VAT or NRST undo the work done by states through the Streamlined Sales Tax Project?

## Personal Income Taxes

In 2003, state governments collected $182.9 billion in personal income taxes – about one-third of total tax collections 

42 states impose broad based personal income tax

2 states tax only interest and dividends

7 states do impose a personal income tax

Marginal rates range from 0.36% in IA to over 9% in CA and VT

Most states use federal adjusted gross income (AGI) as the starting point in determining the state individual income tax base

Many states allow federal deductions, with some adjustments, in determining taxable income

**Personal Income Taxes**
- In 2003, state governments collected $182.9 billion in personal income taxes – about one-third of total tax collections
- 42 states impose broad based personal income tax
- 2 states tax only interest and dividends
- 7 states do impose a personal income tax
- Marginal rates range from 0.36% in IA to over 9% in CA and VT
- Most states use federal adjusted gross income (AGI) as the starting point in determining the state individual income tax base
- Many states allow federal deductions, with some adjustments, in determining taxable income

## State Personal Income Taxes

- Use Federal Taxable Income

- No state income tax

- Use Federal AGI

- Interest and Dividends

- Other

## Corporate Income Taxes

Corporate income taxes are imposed in 46 states 

Collections totaled $28.6 billion – about 5% of total tax collections.

Most states use taxable income (line 28) of Form 1120 as the tax base for apportionable (among the states) corporate net income

- Corporate income taxes are imposed in 46 states
- Collections totaled $28.6 billion – about 5% of total tax collections.
- Most states use taxable income (line 28) of Form 1120 as the tax base for apportionable (among the states) corporate net income

## Income Tax Issues in Federal Tax Reform

In recent years, changes in Federal tax policy have led to increasing complexity for state tax agencies and for taxpayers.

“Bonus depreciation” – a number of states decoupled from federal depreciation allowances because of negative impact on state tax bases.

Qualified Domestic Production Activities deduction in Jobs Creation Act --  again some states will decouple from Federal tax system because of negative impact on state tax base. 

Decoupling leads to greater administrative costs for state agencies and greater compliance costs for taxpayers.

**Income Tax Issues in Federal Tax Reform**
- In recent years, changes in Federal tax policy have led to increasing complexity for state tax agencies and for taxpayers.
- “Bonus depreciation” – a number of states decoupled from federal depreciation allowances because of negative impact on state tax bases.
- Qualified Domestic Production Activities deduction in Jobs Creation Act --  again some states will decouple from Federal tax system because of negative impact on state tax base.
- Decoupling leads to greater administrative costs for state agencies and greater compliance costs for taxpayers.

## Income Tax Issues in Federal Tax Reform

Greater simplification of federal tax code would probably reduce the current “tax gap” of $358 billion reported by the IRS.

Reducing the federal tax gap would have positive impact on state income tax revenues as well.  This is especially true in case of reporting of business income.

Any restructuring or simplification of federal tax system must take potential impact on state taxes into account.  If restructuring does not take state taxes into account, state policy actions may negate any benefits of federal reform. 

- Greater simplification of federal tax code would probably reduce the current “tax gap” of $358 billion reported by the IRS.
- Reducing the federal tax gap would have positive impact on state income tax revenues as well.  This is especially true in case of reporting of business income.
- Any restructuring or simplification of federal tax system must take potential impact on state taxes into account.  If restructuring does not take state taxes into account, state policy actions may negate any benefits of federal reform.