Tax Reform Ideas Loom Large over Capitol Hill

By Shafroth, Frank | Nation's Cities Weekly, April 24, 1995 | Go to article overview

Tax Reform Ideas Loom Large over Capitol Hill


Shafroth, Frank, Nation's Cities Weekly


Radical changes to our nation's tax system would have serious implications for cities and towns. This article is the first in a series of stories The Weekly will publish this year to examine tax reform proposals from the municipal government perspective. We will invite key proponents of various tax reform initiatives to use these pages to explain the specifics of their proposals, including details on how their plans would affect local governments.

Flat tax--national sales tax-consumption tax. Suddenly, proposals to substantially change or eliminate the federal income tax are being discussed seriously by members of Congress and Presidential candidates.

No one talking about income tax reform has yet discussed the impact of tax code changes on state and local governments. That's not surprising, because at the state and local level, the disruption of "simplification" would be great--not only for local governments, but also for taxpayers.

The Existing System

Over the years, the federal tax system has become inextricably interwoven with state income tax systems, and both have operated within a framework of reciprocal federalism.

The federal government has generally left the field of sales taxes to state and local governments; Congress has chosen not to intrude upon a key revenue source traditionally reserved to state and local governments. Similarly, states have modeled their individual and corporate income tax codes on the federal system, making it simpler for taxpayers and easier to catch cheaters.

Most significantly, reciprocal federalism--or immunity--has meant that states and local governments do not tax the debt or borrowing of the federal government, and the federal government does not tax the debt or bonds of cities and towns.

For local governments, this means that some $2.1 trillion dollars in outstanding capital borrowing is exempt today from federal taxation. A loss or significant modification of that exemption, as proposed in every leading tax change option, could have profound effects on the ability and cost of borrowing to meet capital and infrastructure needs of all cities and towns in the future.

Why Tax Reform Now?

Talk of tax "simplification" often springs to life in mid-April. It's also driven by a perception among members of Congress, widely shared throughout the country, that the existing tax code has become far too complex.

That concern about complexity did not prevent the House of Representatives from voting last month to make the federal income tax code substantially more complicated, and from adding a whole host of new deductions and tax subsidies to it. But talk of tax reform and tax simplicity in Congress has caught the attention of many voters.

Other experts on the federal tax code are concerned about savings and investment. The current decline in the dollar, especially compared to the Japanese yen, is viewed by some as evidence of the lack of public and private savings in the U.S. compared to our economic competitors in Europe and Asia. These individuals believe the current federal income tax encourages borrowing and consumption, and penalizes savings and investment. They believe the federal tax code should be fundamentally altered to encourage savings and investment, and to tax consumption.

The Proposals, The Players

Presidential candidates and Congressional leaders have offered three basic alternatives to the current federal income tax: a flat tax, a national sales tax, and a consumption tax. …

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