State and Local Tax Policy Issues

This document reviews several notable tax proposals in President Obama’s Fiscal Year 2014 Budget. These include a 28 percent limit on certain tax expenditures, a cap on tax preferences for retirement savers with high balances, a minimum tax ("Buffett Rule") on high-income taxpayers, alternative incentives for infrastructure investment, and a new measure of inflation ("chained CPI") for indexing tax parameters.

Examining state and local finances in recent economic recoveries, we find that state and local government activity exhibited an unprecedented decline during the most recent recovery. Never before had state and local contribution to GDP been negative three years after a recession passed its low point. This decreased activity caused a contraction in state and local government payrolls. While many factors affect these trends, it is likely that the unusually low growth in property tax revenue heavily impacted this decline.

New York's Strengthening Families Through Stronger Fathers Initiative is an innovative approach to helping low-income fathers find work and pay child support. Enacted in 2006, the initiative offered a state earned income tax credit and job-oriented programs to noncustodial parents. Our evaluation shows that the approach worked-the tax credit increased work and child support compliance among those with low child support orders and the job-oriented programs increased participants' earnings and child support payments. These positive results suggest that further investments in this approach are worthy of consideration.

Their Fair Share: Taxing the Rich in the Age of FDR, by historian Joseph Thorndike, explores the emergence of the modern tax regime, focusing especially on 1934 to 1943. It follows the evolution of the excess profits tax (enacted to fund World War I), the estate tax, excise taxes, the sales tax, and the income tax from the 1920s through the Great Depression, until after World War II.

Joseph J. Thorndike's history of the U.S. federal tax system from the 1920s until the end of World War II might feel familiar: the president with a progressive reputation who proves more pragmatic than his ardent supporters hoped, the legislators who serve the media apoplectic rhetoric, the magnates who pay no income tax and defend themselves with the perfectly true argument that doing so is 100 percent legal, and the public interested seeing everyone pay their fair share. Thorndike mines governmental and popular media archives to explore both the scholarship of taxes and the way we feel about paying them.

The 2001 tax cuts temporarily phased out a credit for state estate and inheritance taxes and replaced it in 2005 with a deduction. Responding to the repeal, some states simply repealed their estate taxes. Others decoupled from the federal law, either establishing a stand-alone tax or explicitly linking their taxes to the 2001 law. But most states did nothing, leaving dormant legislation in place linked to the repealed federal credit. The uncertain future of the credit highlights the inter-relationship between federal and state tax systems and the uncertainty federal temporary actions create for taxpayers and other levels of government.

Federal tax reform may put added pressure on state and local governments that already face severe fiscal challenges. Tax-exempt bonds and the deduction for state and local taxes are among the major preferences likely to come under scrutiny in any rewrite of the Revenue Code. In addition, lower income tax rates themselves would limit the market for tax-exempt debt. As a result, tax reform is likely to have significant policy and revenue implications for state and local governments and will raise important questions about federalism.

Driven by increasing pressure on local budgets, some municipalities have sought a reexamination of the property-tax exemption for nonprofit organizations provided by state law. The property tax is a major source of revenue for many municipalities, and large nonprofits such as universities and hospitals may own significant portions of land within a given city. Some cities have begun asking nonprofits for voluntary PILOTs, or Payments in Lieu of Taxes—an attempt to collect a portion of the property tax revenue which would be owed if nonprofits were not tax-exempt. However, concerns from nonprofit organizations have arisen regarding PILOTs.