This report focuses on the interplay between federal and state and local tax systems through the federal deductibility of state and local taxes. Generally, individual taxpayers who itemize deductions are allowed to deduct real and personal property taxes and state and local income taxes paid from federal taxable income. In 2004, the 108 th Congress modified the deductibility of state and local taxes to include sales tax for the 2004 and 2005 tax years. This provision was extended by each Congress up through the 113 th , and was made permanent by Division Q of the Consolidated Appropriations Act, 2016 ( P.L. 114-113 ). In addition to the sales tax deduction option, Congress previously enacted a provision that allowed non-itemizers to deduct up to $500 ($1,000 for joint filers) of property taxes paid. The special deduction was available for the 2008 and 2009 tax years and was in response to the housing crisis. Unlike the sales tax deduction option, the special property tax deduction was not extended beyond 2009. The tax savings from the special property tax deduction likely benefited taxpayers that did not have other potentially deductible expenses that were high enough to merit itemizing. Taxpayers with no mortgage (or low mortgage debt) in states with relatively low state and local tax burdens were the most likely to have benefited the most from this expired tax provision. Previously, the American Recovery and Reinvestment Act ( P.L. 111-5 ) provided for an above-the-line deduction for sales and excise taxes paid on new vehicle purchases for non-itemizers. This deduction also expired after the 2009 tax year. The deduction from federal income for state and local taxes paid originates from the Revenue Act of 1913. A provision in that act allowed the deduction for "all national, State, county, school and municipal taxes paid within the year, not including those assessed against local benefits." State sales taxes, however, were not introduced until 1932 (Mississippi was the first) and a deduction for those taxes for individuals was not explicitly stated in the tax code until passage of the Revenue Act of 1942 (P.L. 77-753). The deductibility provision was frequently modified over the years, including the introduction of the standard deduction in lieu of itemizing deductions in 1944, but significant revision did not occur until 1964 with enactment of the Revenue Act of 1964 (P.L. 88-272). Before the 1964 act, a deduction was allowed for all state and local taxes paid or incurred within the taxable year except those taxes explicitly excluded. After the 1964 act, only taxes explicitly mentioned were deductible. Included in the list of deductible taxes were state and local taxes on real and personal property; income; general sales; and the sale of gasoline, diesel fuel, and other motor fuels. A new subsection in the 1964 act spelled out the test for deductibility of general sales taxes. First, the tax must be a sales tax (a tax on retail sales) and second, it must be general, that is, imposed at one rate on the sales of a wide range of classes of items. "Items" could refer either to commodities or services. The deductibility provision remained largely unchanged until the deduction for sales taxes was repealed by the Tax Reform Act of 1986 (TRA 1986, P.L. 99-514 ). One of the primary goals of TRA 1986 was to broaden the base of the federal income tax. Eliminating the deduction for all state and local taxes paid was one of the policy options considered to broaden the tax base. The final version of TRA 1986 repealed the deduction for general sales taxes but preserved the deduction for ad valorem property taxes and income taxes. The Joint Committee on Taxation (JCT) summary of TRA 1986 suggested that Congress chose to repeal the sales tax deduction and not income or property taxes, because: only general sales taxes were deductible and not selective sales taxes (e.g., tobacco and alcohol taxes), which created economic inefficiencies arising from individuals changing consumption patterns in response to differential taxation; the deduction was not allowed for taxes paid at the wholesale level (and passed forward to the consumer), thus creating additional inequities and inefficiencies; the sales tax deduction was administratively burdensome for taxpayers who chose to collect receipts to justify sales tax deduction claims; and the alternative sales tax deduction tables generated by the Internal Revenue Service (IRS) did not accurately reflect individual consumption patterns, thereby diminishing the equitability of the tax policy. The American Jobs Creation Act of 2004 (AJCA 2004, P.L. 108-357 ) reinstated deductible sales tax in lieu of income taxes. The in lieu of treatment in AJCA 2004 is in contrast to the "in addition to" treatment in pre-TRA 1986 tax law. The concerns noted above would still hold. A secondary concern—presented during the debate before repeal in 1986—that states would alter their tax structures in response to the elimination of sales tax deductibility, would not arise. The AJCA 2004 sales tax deductibility provision expired after the 2005 tax year, but was extended on multiple occasions: through 2007 by the Tax Relief and Health Care Act of 2006 ( P.L. 109-432 ); through the 2009 tax year by the Emergency Economic Stabilization Act of 2008 ( P.L. 110-343 ); through the 2011 tax year by The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ( P.L. 111-312 ); through the 2013 tax year by The American Taxpayer Relief Act ( P.L. 112-240 ); and through the 2014 tax year by the Tax Increase Prevention Act of 2014 ( P.L. 113-295 ). The Consolidated Appropriations Act, 2016 ( P.L. 114-113 ) permanently incorporated the deduction of state and local sales taxes in lieu of state and local income taxes into the tax code. The remainder of this report will describe and analyze the deduction for the following state and local taxes: (1) real estate property taxes; (2) personal property taxes; (3) income taxes; and (4) sales and use taxes. As Congress considers possible modifications to the deductibility of state and local taxes as part of fundamental tax reform, a better understanding of the existing policy may be useful. Generally, taxpayers may deduct state and local taxes paid from income. Individual taxpayers must itemize deductions (rather than use the standard deduction) on their income tax return to claim the deduction for state and local taxes paid. Business taxpayers, in contrast, may deduct state and local taxes as a cost of doing business. The federal tax savings from the deduction is equal to the taxpayer's marginal tax rate multiplied by the size of the deduction. Because the federal income tax rate regime is progressive, a deduction for itemizers, in contrast to a tax credit for all taxpayers, favors taxpayers in higher income tax brackets. For example, in 2010, 88% of all benefits from the deduction of state and local taxes paid went to individuals with adjusted gross incomes greater than $100,000. Table 1 reports the number and percentage of returns with itemized deductions for the four state and local taxes described and analyzed in this report. The 1986 tax year is included in Table 1 to exhibit the utilization of the deduction for sales taxes paid, which was repealed by TRA 1986. In 1986, before repeal, the sales tax deduction was the most common itemized deduction for taxes paid. More taxpayers would claim a sales tax deduction because all but five states imposed a sales tax and, in contrast to property taxes, paying the tax is not conditioned on owning property, real or personal. The current sales tax deduction is not as common because it is in lieu of income taxes. In 2014, 9.8 million (or 6.6%) of taxpayers claimed a deduction for sales taxes paid, and the percentage of taxpayers who claimed a deduction for income taxes paid dropped from 25.8% in 2006 to 21.8% in 2014. The percentage of itemizers has remained relatively stable since 2003 (see Table 1 ). The decline in 2003 likely is in response to the lower marginal tax rates and more generous standard deduction for married taxpayers filing joint returns. The percentage of itemizers increased from 33.7% in 2003 to 35.0% in 2004, likely reflecting the introduction of the sales tax deduction option. The decline in 2009 may be related to the economic downturn that began in 2008. Generally, the percentage of itemizers and the taxes they deduct has been consistent since 2003. Under the federal income tax, taxpayers can deduct ad valorem property taxes (taxes levied as a percentage of assessed value) from taxable income. For example, an itemizing individual owning a home with an assessed value of $100,000 and who pays a 1% property tax can deduct the $1,000 in taxes paid from his or her adjusted gross income. If this taxpayer is in the 28% marginal tax bracket, taking $1,000 out of taxable income reduces taxes by $280 ($1,000 multiplied by 28%). In most cases, both the taxpayer's tax bracket and home value increase with income. Thus, higher-income taxpayers in higher tax brackets receive a greater tax savings than low-income taxpayers because of the typically progressive state income tax. The effect is even greater because of the assumed positive relationship between home value (and property tax bill) and income. In the 110 th Congress, P.L. 110-289 included a provision that allowed non-itemizers to deduct up to $500 ($1,000 for joint filers) of property taxes paid. The special deduction was first available for the 2008 tax year and was extended through 2009 by P.L. 110-343 . This special deduction has since expired. The real estate property tax deduction was claimed on approximately 25.1% of all tax returns, and of those returns that itemized, approximately 85% claimed a real estate property tax deduction in 2014.