Delegating Up: State Conformity with the Federal Tax Base
Mason, Ruth, Duke Law Journal
Congress uses the income tax to achieve policy goals. States import federal tax policies into their own tax systems when they incorporate by reference the federal income tax base as the starting point for assessment of state income taxes. But federal tax policies reflect national, not state, political choices. This Article calls attention to the practice of tax-base conformity and to its advantages and disadvantages. Conformity conserves legislative, administrative, and judicial resources, and it reduces taxpayers' compliance burdens. At the same time, however, conforming states cede tax autonomy to the federal government, thereby jeopardizing federalism values, such as regulatory diversity and diffusion of power. Conforming states also expose themselves to revenue volatility stemming from the ever-changing federal tax law. Despite these concerns, the administrative and compliance advantages of federal-state tax-base conformity are so significant that states are unlikely to abandon it. Thus, this Article makes only limited recommendations for reducing the adverse impacts of tax-base conformity.
TABLE OF CONTENTS Introduction I. Federal-State Tax-Base Conformity II. Advantages of Tax-Base Conformity A. Vertical Harmonization Benefits B. Horizontal Harmonization Benefits 1. Facilitates Interstate Commerce 2. Reduces Double Taxation 3. Prevents Tax Arbitrage 4. Encourages Cross-Border Spillovers 5. Discourages Tax Exportation and Protectionist Taxation 6. Helps Identify Unconstitutional Tax Discrimination III. Disadvantages of Tax-Base Conformity A. State Tax Autonomy 1. Structure and Definition of Income 2. Incentives 3. Agenda-Setting and Other Authority B. Harmonization Costs 1. Voter Preferences 2. Political Accountability 3. Tailoring Tax Incentives 4. Policy Experimentation C. Fiscal Stability IV. Tax-Base Conformity and State Tax Competition V. Decoupling State and Federal Tax Bases A. Full and Partial Decoupling B. Mitigating Role of Decoupling 1. State Autonomy and Regulatory Diversity 2. Accountability 3. Targeting Tax Incentives 4. Fiscal Stability C. Entrenchment 1. Stickiness of the Federal Tax Base 2. Nonseverable Default Rules VI. Evaluation and Recommendations A. Policy Recommendations 1. State Governments 2. Federal Government B. Implications for Perennial Tax Policy Debates 1. Tax Expenditures Generally 2. The SALT Deduction in Particular 3. Legislative Sunsets 4. Consumption Taxes C. Avenues for Future Research Conclusion
Congress uses tax incentives to regulate by rewarding socially useful behavior with lower taxes and penalizing undesirable activities with higher taxes. Deductions, exemptions, and tax credits reward favored activities, such as charitable giving. Higher tax rates, acceleration of tax liability, and denials of deductions, exemptions, and tax credits penalize disfavored activities, such as early withdrawal of retirement savings. Thus, Congress uses its taxing power to influence behavior.
Whereas Congress uses tax incentives to affect the behavior of private taxpayers, this Article argues that federal tax incentives also affect the states because most states incorporate federal definitions of income into their own tax laws. For example, the starting point for calculating individual income taxes in almost all states is the taxpayer's federal "adjusted gross income" or "taxable income." As this Article explains, these federal income definitions reflect a variety of controversial tax policy decisions made at the federal level. When states incorporate by reference federal income definitions, states automatically import federal tax policies into state law. …