Federal Tax Reform and State and Local Governments

Transcription

1 Federal Tax Reform and State and Local Governments Materials to Accompany Remarks Robert Ebel and Kim Rueben The Urban-Brookings New Mexico Tax Policy Conference April 19 and 20, 2005 Source: Kim Rueben, March 2005

2 Federal Tax Policy Affects Subnational Governments Tax Panel Background AMT Deductibility of S&L Taxes Other Tax Reform Possibilities Current Federal Policy Concerns Summary

3 Purpose of Forming Tax Reform Panel Listed purposes include: 1. Simplify law, reduce costs and complexity 2. Share burdens and benefits in progressive way recognizing importance of home-ownership and charity 3. Promote long term economic growth All in a revenue neutral way

4 Translation Need to broaden the base and reduce complexity Fix the AMT Need alternative source of revenues State and local tax deductibility largest deduction not specifically listed as needing protection Effects on state and local governments not considered

5 Outline Tax Panel Background AMT Deductibility of S&L Taxes Other Tax Reform Possibilities Current Federal Policy Concerns Summary

6 AMT Original target: high-income tax shirkers By 2010: AMT will affect 30 million taxpayers,especially in high-tax states Virtually all upper middle class families with 2 or more kids Impetus for tax reform For a discussion of the AMT, see Len Burman, William Gale, and Jeff Rohaly, The AMT: Projections and Problems, Tax Notes. July 7, (Numbers updated for this presentation.)

7 Causes of AMT Growth Number of AMT Taxp a y ers ( M illio n s ) Current Law (extended) Pre-EGTRRA Law Pre-EGTRRA Law, with indexing Effect of 2001 and 2003 tax cuts Effect of failure to index for inflation Year Urban-Brookings Microsimulation Model, 2005

8 AMT Projections Under current law, AMT will raise $670 billion from If tax cuts extended, AMT revenue = $1.2 trillion About 4% of taxpayers on AMT in % in 06 and 30% in 10

9 AMT Demographics (2010) AMT inflicts large marriage/child penalties 48% of married couples v. 3% of single on AMT 94% of marrieds with 2+ kids and AGI between 75&100K Residents of high-tax states 5 percentage points more likely to be on AMT than those in low-tax states

10 Outline Tax Panel Background AMT Deductibility of S&L Taxes Other Tax Reform Possibilities Current Federal Policy Concerns Summary

11 State and Local Tax Deductibility Largest Unprotected Area 2002 itemizers (millions) Amount ($billions) % of HHs % of deductions Total 46.0 $ % 100% S&L deductions 45.4 $303 99% 33.5% Interest 38.0 $361 83% 39.2% Charitable Giving 40.2 $139 88% 15.1% Source:

12 State and Local Tax Deductibility Most itemizers deduct state and/local taxes (99%) Benefit accrues to taxpayers with Higher incomes High/Progressive Income Taxes High Property Values or Property Taxes NY and CA residents alone take 29% of listed deductions, 60% in just 10 states Source:

13 Federal Savings From Eliminating Deductibility Cost savings to federal government $70 billion in 2005 $ billion (depends on if tax cuts are extended) Would mostly offset repeal of the AMT (aggregate revenues loss of $113 billion or gain of $300 billion) Static estimates assumes no behavioral response

14 Effects of Repeal on S&L Governments Removing deductibility means price of raising money local rises Average tax price increase from $.84 to $.91 (8.5% change Varies across states WY <1% change MD > 10% change Source:Robert Tannenwald (1998), The Subsidy From State and Local Tax Deductibility Federal Reserve Bank of Boston Working Paper

15 Effects of Repeal on S&L Governments Will there be a race to the bottom? Mixed evidence from 86 Cost of business taxes become relatively lower Offset by lower rates Makes taxes less regressive Over time current value of deductibility would have eroded due to AMT

16 Outline Tax Panel Background AMT Deductibility of S&L Taxes Other Tax Reform Possibilities Current Federal Policy Concerns Summary

17 Tax Exempt Status of Municipal Debt Not on Table If exempt status changed more direct effect on S&L governments However, no evidence being considered (court ruling) Market is large $262 billion debt issued Over $1 trillion outstanding Interest rates needed would increase by tax rate difference

18 Is State Income Tax Viable Under Flat Tax? Admin/compliance costs of state income tax magnified without fed tax Large relative to revenue Difficult, if not impossible, to collect 1099s for outof-state entities Voters would want states to conform to feds State taxes very regressive overall* Undermining state income and estate taxes would further increase burdens on low/middle income people And federal government is also limiting states ability to raise revenue from other sources Internet (explicitly) and sales tax (through neglect) * (see McIntyre et al., Who Pays? A Distributional Analysis of the Tax Systems in All 50 States, Second Edition)

19 Outline Tax Panel Background AMT Deductibility of S&L Taxes Tax Exempt Municipal Debt Other Tax Reform Policies Current Federal Policy Concerns Summary

20 Repeal of Estate Tax Estate tax dies out by 2010, resurrected in 2011 State death tax credit phased out by 2006 Credit made state taxes essentially free source of revenue Many states tie their estate taxes to federal credit, so major loss of revenue for states

21 State Estate Taxes Pre- and Post-EGTRRA Update of Pickup Tax Automatic Legislated Total Pickup Tax No estate tax in 2005 No estate tax by Stand-alone + pickup tax Inheritance Estate Total Sources: Harley T. Duncan, "State Responses to Estate Tax Changes Enacted as Part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)," Federation of Tax Administrators, October 24, 2002; Joel Michael, "State Responses to EGTRRA Estate Tax Changes," Tax Notes, April 1, 2004.

22 Effects of Repeal Will cost states almost $5 billion in lost revenues in 2007 (Duncan) Makes tax system more regressive Helps few farmers/small businesses

23 Other Current Fed Tax Changes Affecting States Many states used federal definition of tax depreciation before 2002 JGTRRA allows 50% bonus depreciation through states have decoupled Rest stand to lose $4 billion (Lav and Brecher, CBPP, May 12, 2004) Several states used to base their tax on federal income tax or taxable income They have all had to decouple to maintain their tax base, but that contributes to complexity

24 Federal Deficits Limit Spending Options Revenue - Outlays Unified Baseline Extend Bush Tax Cuts Extend Other Provisions Fix AMT

25 Deficits Reduction Focuses on Cuts to Domestic Programs Goal of cutting the deficit by half by budget contains proposals to: Cut Federal Medicaid by $45 billion over 10 years Cut domestic discretionary programs by $214 billion in 5 years $18 billion in 2006 $6 billion in cuts for grants-in-aid Source: CBPP analysis of 2005 budget

26 Summary Tax reform panel likely not to consider effect on S&L governments Elimination of state and local tax deductibility likely on the table Raise price of S&L services Elimination mitigated if AMT reform part of package Municipal Debt Tax Exemption Direct cost to S&L higher Not being discussed

27 Summary (2) Broader reform could directly affect state revenue options Not clear state income tax viable under consumption tax Sales tax rates high for pure flat tax Prior reforms costly to S&L Proposed cuts in federal aid to S&Ls are high and likely