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Full Text: State Treasurers' Testimony At May 1 W&M Tax Reform Hearing.

MAY 1, 1996

Full Text: State Treasurers' Testimony At May 1 W&M Tax Reform Hearing.

DATED MAY 1, 1996
DOCUMENT ATTRIBUTES
  • Authors
    Holden, Bob
  • Institutional Authors
    State of Missouri
    National Association of State Treasurers
  • Cross-Reference
    For related text and news coverage, see the Tax Notes Today Table of

    Contents for May 2, 1996.
  • Subject Area/Tax Topics
  • Index Terms
    intergovernmental relations, fiscal federalism
    state taxation
    rates, flat
    exempt organizations, public charities
    sales tax
    income tax
    charitable deduction
    exempt bonds
    unrelated business income
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 96-13118 (8 pages)
  • Tax Analysts Electronic Citation
    96 TNT 87-60
====== FULL TEXT ======

TESTIMONY

 

of the

 

NATIONAL ASSOCIATION OF STATE TREASURERS

presented by

 

Bob Holden

 

State Treasurer of Missouri

regarding

 

The Impact of Federal Tax Reform on State and Local Government

before the

 

Committee on Ways and Means

 

U.S. House of Representatives

May 1, 1996

[1] Mr. Chairman and members of the Committee, I am Bob Holden, the State Treasurer of Missouri and the Legislative Committee Chairman of the National Association of State Treasurers (NAST), which represents the state treasurers in all fifty states and the territories.

[2] As I am sure you know, State Treasurers are the chief financial officers of the states. Within our respective states, State Treasurers exercise a broad range of essential fiscal responsibilities, including cash management, debt management, the investment of public funds, and the investment and management of public pension funds. Accordingly, because State Treasurers recognize the challenges and complexities involved in shaping and implementing fiscal policy, NAST appreciates this opportunity to begin what we hope will be an ongoing dialogue about tax reform and tax policy and its impact on our shared enterprise -- the federal, state and local government partnership -- and the citizens we jointly serve.

[3] Let me make clear at the outset that the State Treasurers share your concerns about the problems, impediments and inefficiencies in our existing tax structure, and that we wholeheartedly support your efforts to simplify the tax structure, to enhance its fairness, to improve its administration, to increase incentives to work, save and invest, and to stimulate economic growth.

[4] In short, the State Treasurers are not here to say "nay" to tax reform in general, or any reform proposal in particular. To the contrary, NAST wants you to know that we are eager to work with you to explore ways in which tax reform can provide an overall benefit to the taxpayer and the economy, and enhance the ability of government at all levels to deliver appropriate services.

[5] In offering this support, however, we must also convey an important precautionary message: The operation of federal, state and local government is inextricably linked and limited by a fundamental fact -- we draw our resources from the same taxpayer. Accordingly, your decisions on matters of federal tax policy will flow "downstream" from Capitol Hill and have a dramatic and widespread effect on state and local fiscal management, the tax policy choices available to state and local governments, and the ability of state and local government to fulfill program responsibilities, including those that Congress is contemplating transferring to the state and local level as part of "devolution."

[6] Thus, your decisions on federal tax policy will have a tremendous effect on the vitality of the "new" federalism -- a concept that we welcome -- and we are here today to bring the cautionary reminder that as Congress pursues the laudable goals of tax reform, you do not inadvertently impair state and local sovereignty and increase fiscal dependence on the federal government at a time when state and local government is striving to achieve greater autonomy.

[7] In sending this message of caution, we also want to reiterate that NAST does not come before you merely as a "special interest" trying to protect favorable treatment under the tax laws. Instead, as I suggested previously, we are here today because under our Constitution, we are partners in the enterprise of governing. Federal tax reform WILL generate a significant ripple effect on tax policy through all levels of government, and NAST believes that the fundamental linkage between federal, state and local government must stay foremost in your consideration if this important dialogue on tax reform is to yield an overall benefit to the taxpayer, and not simply shift the source of the tax burden from one level of government to another.

[8] In this regard, I would like to draw your attention to several areas where NAST has serious concerns about the potential impact of federal tax reform on state and local fiscal management, the tax policy choices available to state and local governments, and the ability of state and local government to fulfill program responsibilities.

THE ABILITY OF STATE AND LOCAL GOVERNMENT TO

 

FINANCE INFRASTRUCTURE AND OTHER CAPITAL NEEDS

[9] Since the 16th Amendment ratified a federal tax system in 1913, state and local governments have utilized tax-exempt governmental bonds as an important source of funding to finance infrastructure, capital-intensive public projects and vital programs needs. It does not overstate the case to say that bonds issued by state and local government have played a major role in building this nation: The proceeds of governmental bonds have built schools, hospitals, roads, bridges, subways, tunnels, airports, housing and numerous other facilities used daily by the American people. In so doing, tax-exempt governmental bonds have provided the lifeblood for economic development and growth in our states and in our local communities.

[10] Some of the current tax reform proposals would directly or indirectly affect the federal tax treatment of state and local government securities. The primary effect of these proposals would be to remove the unique tax-exempt treatment for income generated by such governmental bonds. This longstanding tax exemption has allowed investors to accept a lower interest rate on governmental debt, which in turn, has lowered the cost of borrowing for state and local governments.

[11] Some experts believe that removing the favorable tax treatment for state and local bonds will cause the yield on such bonds to rise and the value of outstanding bonds to fall, with the overall effect of increasing the cost of borrowing by state and local government. Other experts argue, however, that interest rates will fall after tax reform, and state and local borrowing costs will remain the same or be reduced, even without the current preferential tax treatment. Still other experts contend that increased interest rates on state and local bonds will increase the demand for such securities by pension funds and other tax-exempt buyers, thereby expanding the pool of capital available to state and local government.

[12] While the experts may differ on the likely short-term and long-term effects which will result from a change in the tax treatment of state and local government bonds, there is no question that tax considerations alone will not determine the demand for and value of governmental securities and the cost of borrowing to the governmental issuer. Instead, cost and value will be determined by the market based on a combination of tax considerations and broader economic factors. Such factors (e.g., Federal Reserve policies, the size of the federal budget deficit, the rate of inflation, foreign interest rates and the business cycle) could impede any potential benefits of tax reform for the issuers of state and local securities. Moreover, even the slightest increase in the interest rate paid on a governmental bond will result in significantly higher costs of borrowing to the state or local issuer.

[13] NAST believes that this uncertainty regarding the economic effect of removing the preferential tax treatment of state and local bonds must be placed alongside the incontrovertible fact that state and local governments face a backlog of infrastructure needs and a shortage of capital. For example, close to 235,000 miles of American roads are rated poor or mediocre; one out of three bridges in the United States is rated structurally deficient or functionally obsolete; and the cost of repair for aging public schools is estimated at $100 billion. When you add to this the responsibilities which will flow to the states under "devolution" and the "new" federalism, it is clear that state and local governments will need more -- not less -- capacity to finance governmental projects and services.

[14] Accordingly, NAST strongly recommends that Congress exercise great caution when considering any tax reform measures which could potentially jeopardize the ability of state and local government to access low cost financing, or which hamstring the flexibility of state and local governments to generate capital investment.

STATE TAX SYSTEMS, STATE TAX POLICY; AND STATE SOVEREIGNTY

[15] To simplify the administration of state tax law and policy, most states presently conform a significant portion of their tax law to the existing federal tax law and system. By so doing, the states make it easier for taxpayers to comply with state tax laws because taxpayers are not required to deal with two separate sets of tax laws, rules and definitions. For example, nearly every state with a personal or corporate income tax begins the calculation of state tax from a federal "starting point" -- often the federal measures of adjusted gross income or taxable income. In addition, state tax laws often conform to numerous other federal definitions and provisions such as personal exemptions, standard allowances, itemized deductions, depreciation schedules, treatment of capital gains, and Individual Retirement Arrangements (IRA).

[16] The states have also found that conformance to federal tax law facilitates the administration of state tax law by allowing states to rely extensively on federal enforcement and compliance programs and federal information reporting and withholding mechanisms.

[17] Of the states which conform state tax law to the federal tax law, twenty states conform automatically, so that changes in the federal law are incorporated into state law without further state action. Seventeen other states are tied to the federal law in effect on a particular date, and thus state legislation would be necessary to update the reference point and incorporate new changes in federal law into state law.

[18] Given this linkage between state tax systems and the existing federal tax law and system, it is clear that fundamental federal tax reform, with nothing more, will also trigger fundamental changes in state tax law and policy, in that federal tax reform will compel the states to choose between continued conformity with the federal law or the creation and maintenance of an independent tax infrastructure. Moreover, it is also clear that economic, administrative, legal and political considerations will generate tremendous pressure on the states to remain in conformity with any new federal tax law since the greater the degree of nonconformity, the more complex the state tax law will be for taxpayers. This also increases the likelihood of noncompliance and the difficulty in enforcing the state tax.

[19] In particular, it should be noted that tax reform proposals which call for the repeal of the federal income tax will also effectively require the repeal of state income tax laws since current state income tax systems rely heavily on the infrastructure of the existing federal income tax system, and most states will have a great difficulty maintaining and administering a personal or corporate income tax without a federal counterpart.

[20] The fundamental principles of federalism mandate that such federal constraints on the tax policy choices of state and local government should occur only after a complete analysis of the issues, an effort which goes beyond the proceedings of today's hearing.

[21] Under the Constitution states are sovereign entities, entitled to maximum flexibility to determine tax policy and design revenue systems which meet the needs and reflect the desires of our taxpayers. The autonomy of the states in determining tax policy is a core element of sovereignty in that the power to generate revenue carries with it the independence to set expenditures, and to establish priorities among those expenditures.

[22] Fundamental federal tax reform will force the states to choose between simplicity -- continuing to conform to federal tax law, whatever its form -- or autonomy -- with all its attendant costs and burdens. Simplicity will effectively cede control of state tax policy and the ability to generate state revenue to the Congress. Autonomy will result in the need to go to state legislatures to obtain legal authority to employ a non-federal taxing mechanism, will generate enormous costs and compliance problems, and will challenge the willingness of the taxpayer to give state and local government additional tax headroom.

[23] If there is to be any real "choice" in this matter, Congress and state and local government must work together to fashion changes in tax policy which recognize both the effective reach and the inherent limits in our intergovernmental relationship with America's taxpayers.

[24] In this regard, such a dialogue should also include consideration of the impact on state and local revenue streams of the proposed changes in the mortgage interest deduction, and the deduction for property taxes and state and local income taxes.

[25] Most local governments rely heavily on property taxes for the generation of revenue to fund operating costs and to repay debt. Many analysts believe that if the mortgage interest deduction and the property tax deduction are eliminated, property values will fall, and local property tax revenue will be negatively affected. At the very least, such an environment would make it very difficult to increase property taxes, especially those requiring voter approval.

[26] A comparable conclusion has been reached regarding the proposed elimination of the deduction for state and local income taxes. These taxes are a significant source of revenue for state and local governments, and assuming such taxes survive the press for conformity with federal taxes, the loss of the deduction would increase the pressure on state and local government to lower existing rates. Again, at a minimum, it would be very difficult to increase such taxes in the future.

[27] Once again, therefore, NAST strongly recommends that before the Congress embarks on the path of tax reform, you seriously consider the ramifications for federalism, the sources and limits of state and local revenue, and the fiscal and tax policy ripple effect which tax reform will have on state and local government.

STATE AND LOCAL GOVERNMENT RESPONSIBILITIES TO

 

PROVIDE RETIREMENT BENEFITS AND HEALTH CARE COVERAGE

[28] State and local governments not only must provide for the retirement income and health care of public employees, but state and local governments are the front line providers of public services and the fall back for public benefit support. As such, changes in the federal tax treatment of retirement benefits and health care coverage will have a potential fiscal impact on state and local governments, both as an employer, and as a provider of governmental services.

[29] Many experts contend that incentives under the current tax law have served as the impetus for the formation of retirement and health plans. Under current law, private sector employers receive favorable tax treatment for providing compensation in the form of such benefits, and the worker receives the tax benefit of an up-front exclusion from income taxation, coupled with the deferral of taxation on accrued investment income until distribution.

[30] Under the principal tax reform proposals, however, employee benefits would receive less favorable tax treatment than under the current law. For example, many proposals would place all savings on a par with amounts deferred under qualified pension plans. Accordingly, under such reforms workers will weigh the relative advantages of continuing to receive compensation in the form of employer-sponsored retirement benefits (deferring income to savings, but with restrictions on access) or receiving compensation directly as income and then controlling the savings themselves. Other tax reform proposals call for including pension or health care contributions in the worker's current taxable income, and removing pension and health care contributions as a deduction by the employer.

[31] Although it is unclear which reforms will ultimately find their way into law, it is reasonable to conclude that the overall effect of the current proposed reforms will be to reduce the incentive to maintain employer-sponsored retirement and health care plans and to create a preference for current income (wages) over deferred income (pension contributions).

[32] While the primary effect of these changes will be experienced in the private sector, there is likely to be spillover to state and local government. First, to attract and retain qualified employees, state and local government may have to adjust benefit packages to provide greater wage compensation. Second, if the value of health care premiums is included in taxable income, the cost of coverage would increase for all employers, who would, in turn, pass such costs on to employees in the form of lower wages or reduced coverage.

[33] Finally, if individuals fail to take advantage of the changes in the tax law to save sufficient amounts for retirement and/or health care, or if employers have less incentive to provide retirement and health care benefits, then there will be increased demands on and increased cost borne by the public benefit programs run by state and local government.

THE RESPONSIBILITIES OF STATE AND LOCAL GOVERNMENTS IN

 

CARRYING OUT TAX REFORM

[34] As reflected by the foregoing discussion, the impact of federal tax reform on state and local government is not merely a theoretical conundrum to be debated on college campuses or in think tanks in Washington, D.C. It is a serious question involving the fundamental relationship between federal, state and local government. It involves issues which are at the core of sovereignty -- the power to set tax policy, and to design revenue and expenditure systems which meet the needs and reflect the desires of our taxpayers. It is a debate which will have far reaching and significant economic impact in every state and every community in this country.

[35] We must not forget, however, that the parties most affected by this debate have a very human face -- they are the taxpayers of this country. When you push beyond the constitutional theory and political rhetoric, we are talking about shaping the tax burden which will be imposed on real people, who are trying to earn a living, feed and care for their families, and put a roof over their heads. As public officials, it is our responsibility to honor this public trust by working together to fashion an intergovernmental tax structure that is not only simple and fair, but also enhances opportunity and the quality of life for the people who pay the bill.

[36] Accordingly, NAST calls upon the national organizations of state and local officials to join with us in conducting a coordinated national analysis of the impact of the federal tax reform on state and local government. The goal of this effort should be to generate a state-by-state analysis of the impact of the major tax reform proposals which can then be presented to Congress for use in this debate. If we are asking you to heed the concerns of state and local government, then we should be prepared to step forward and give Congress the information it needs to address those concerns.

[37] Finally, NAST wants to convey in the strongest terms, that whatever decisions you might reach about the specific components of tax reform, it is imperative that Congress build in a reasonable transition period for state and local governments to coordinate with any new federal tax provisions. As we have illustrated today, fundamental federal tax reform will have a significant impact on critical aspects of the fiscal operation of state and local government. Adjustments will have to be made in tax policy and revenue systems, debt management, and program priorities. In many cases, changes will have to be made in state law to accommodate such adjustments. Retooling an intergovernmental tax structure is a project on a par with balancing the budget, and should not be given short shrift.

[38] Mr. Chairman, a famous Missourian, Mark Twain, has been credited with saying, "Everybody complains about the weather, but nobody does anything about it." I think he would be pleased that you ARE doing something about an issue which concerns millions of Americans. I want to commend you and the members of this committee for your resolve to scrutinize and reform our federal tax process. It will not be an easy job, and I hope that through my remarks today, you can see that NAST wants to work with you to meet the goal of a simpler, more equitable, more efficient system. Thank you.

DOCUMENT ATTRIBUTES
  • Authors
    Holden, Bob
  • Institutional Authors
    State of Missouri
    National Association of State Treasurers
  • Cross-Reference
    For related text and news coverage, see the Tax Notes Today Table of

    Contents for May 2, 1996.
  • Subject Area/Tax Topics
  • Index Terms
    intergovernmental relations, fiscal federalism
    state taxation
    rates, flat
    exempt organizations, public charities
    sales tax
    income tax
    charitable deduction
    exempt bonds
    unrelated business income
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 96-13118 (8 pages)
  • Tax Analysts Electronic Citation
    96 TNT 87-60
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