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An overhaul of the federal tax code could include changes to the treatment of municipal bonds, according to testimony during an April 25 Senate committee hearing.

Impact of Federal Tax Reform on State and Local Taxes

  • 5/2/2012

Impact of Federal Tax Reform on State and Local Taxes

An overhaul of the federal tax code could include changes to the treatment of municipal bonds, according to Senate Finance Committee Chairman Max Baucus, D-Mont. He warned witnesses during an April 25 committee hearing that they would all need to work together to avoid future economic hardship.

Baucus said that lawmakers could consider making the interest on bonds tax-exempt, which would reduce the interest rate state and local governments pay to finance roads, schools, hospitals, and other construction projects. They might also consider providing a uniform subsidy for bondholders. Currently, the value of this subsidy varies based on a taxpayer’s marginal income tax rates.

"For every dollar we spend on infrastructure through a tax-exempt bond, 20 cents goes to tax breaks for higher income taxpayers," stated Baucus. "A uniform subsidy would mean each taxpayer receives the same subsidy regardless of tax bracket."

Witnesses expressed differing opinions on the effectiveness of changing the tax treatment of municipal bonds, but they were unanimous in their call for federal legislation to coordinate the taxation of internet sales.

"Federal-state tax coordination should authorize the states to require remote vendors to collect sales and use taxes on sales to in-state purchasers, regardless of their physical presence in the state, under specified conditions generally requiring harmonization and simplification of their sales and use tax regimes," said Walter Hellerstein, a Francis Shackelford Professor of Taxation at the University of Georgia law school.

Kim Rueben, a senior fellow at the Urban-Brookings Tax Policy Center, said Congress can take specific actions to help coordinate and protect existing state and local tax systems. He said their ability to raise revenue can be hobbled by limitations that Congress can remove.

"Most notably, Congress could enact legislation that would enable state and local governments to collect taxes on internet and mail-order sales," said Rueben. "Doing so could help stop the erosion of sales tax receipts as more and more commerce takes place online."

In a written statement, the National Retail Federation (NRF) urged lawmakers to support legislation that would require internet retailers to collect sales tax, just like local merchants must do.

"As retailing evolves and internet sales become a more prominent portion of total retail sales, it is critical that Congress address the sales tax collection discrimination that exists between brick-and-mortar and remote retailers," said NRF Senior Vice President for Government Relations David French.

The NRF argued that sales tax fairness legislation would level the playing field between retailers and ease the burden on cash-strapped states that are currently losing an estimated $24 billion a year to untaxed purchases their residents make from out-of-state sellers.

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