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Cities urge caution on tax reform: look before you leap, witnesses warn Congress.

The subject was federal tax reform. The message to Congress from state and local governments was, "First, do no harm."

At a House Ways and Means committee hearing convened last week by chairman Bill Archer (R-Tex.), a parade of speakers warned Congress to carefully consider the negative impacts of proposed tax reform plans on state and local governments and their taxpayers.

"Federal tax reform could do significant damage to state and local governments and wreak havoc with state and local services. said Harley Dullcan of the Federation of State Tax Administrators. "Moreover, by shifting major power away from states and cities to the federal government, Congress would achieve the exact opposite of its repeated commitments to turn over power, authority, and responsibility to the levels of government closest to the people," Duncan added.

Peter Powers, deputy mayor of New York City, said, "New federal tax policies should not create problems for cities or reduce their attractiveness as places to do business for national and international firms, as well as local businesses. ,

Frank Shafroth, NLC director of policy and federal relations. expressed similar concerns. "Because of the interrelated nature of federal, state, and local tax systems, any changes at the federal level are certain to have major impacts at the local level," Shafroth said.

Shafroth urged Congress to take a hard look at the impact of tax reform on local revenues, local capital budgets, and local economies, stressing the potentially negative effects of tax reform on the municipal bond market. "Outside of defense, the main source of public capital investment today is municipal bonds," he said. "Any proposal to disrupt or eliminate the incentives for this $1.2 trillion market could have severe and long-lasting adverse impacts on the nation's economy, and it could increase the cost of borrowing to states and local governments by as much as 30 percent."

"With the General Accounting Office projecting that states and local governments currently need to spend in excess of $100 billion just on the rehabilitation and construction of public schools," Shafroth continued, "an abrupt Congressional change affecting state and local borrowing authority could cost state and local taxpayers $30 billion-but result in no net additional benefit in an investment critical to the future of the nation." Archer acknowledged the witnesses, points, saying, "We need and want input from state and local governments, because we understand changes could have substantial impacts on state and local governments and the citizens they serve. I assure you we will be sensitive to your concerns. Whatever we do, it will represent a major change in the federal system. And major change should not be taken lightly."

The hearing marked the first effort by Congress to consider the potential impact of federal tax reform on local revenues and economies.

NLC's Board of Directors voted last month to make federal tax reform one of the organization's five highest federal legislative priorities for 1996, and NLC's Election '96 Task Force selected federal tax reform as one of the highest priority issues for the 1996 Congressional and Presidential election campaigns as well.

NLC policy supports the continued use of personal and corporate income as the primary federal tax base and a progressive rate structure that reflects a taxpayer's ability to pay. NLC opposes tax reform proposals that exacerbate the federal deficit, increase the cost of municipal public capital investment, interfere with traditional state and local tax systems, or preempt the deductibility of state and local taxes.

NLC supports reform of those provisions in the current internal revenue code that encourage consumption and borrowing over savings and investment. NLC supports tax code modifications that would discourage the growth of existing federal tax expenditures and the creation of new ones.

Flats, VATs, and Consumption Taxes

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

A flat tax would replace the current, graduated income tax on families and businesses with a 20 percent flat tax, eliminating almost all personal deductions (state and local taxes, mortgage interest, charitable contributions) and city revitalization deductions (targeted jobs, low income housing, and earned income tax credits,) while scrapping or reducing the tax preference for municipal bonds.

A flat tax, Powers noted, would raise federal taxes on middle income families in the city by $1,736 annually, and on low income families with children by an average of $800 annually. "This must not be the result of reform,"he said.

Powers said a federal flat tax could result in a net reduction in New York City's personal income tax revenues of hundreds of millions of dollars annually. "While on the federal level this loss is expected to be completely offset by an increase in business taxes, this may not occur at the local level," Powers added.

Congress also is considering an alternative, most recently proposed by Reps. Dan Schaefer (R-Colo.) and Billy Tanzin (D La.,) that would replace the individual and corporate income tax with a national sales tax--to be collected by states--on goods and services.

As with the flat tax proposals, a national sales tax--and its cousin, the Value Added Tax (VAT)--would eliminate virtually all tax deductions and preferences. It would be inequitable in its effects, depending whether cities currently collect sales taxes or not, and it would pose severe administrative problems--requiring a sorting out of what goods and services purchased by cities, and provided by cities to their citizens, could be taxed.

Shafroth warned, "A national sales tax would have a more disruptive impact on cities than any other tax reform alternative.

A consumption tax--little discussed by Congress to date--would, after deductions, impose a graduated tax only on income that is spent, thus encouraging savings and investment. While it would preserve the federal income tax, a consumption tax would be extremely complicated to administer, would modify the tax-exempt preference for municipal bonds, and would eliminate tax preferences for private sector investment in cities.

Over the next few weeks, The Weekly will examine each of the major federal tax restructuring alternatives Congress is considering from the perspective of cities and towns. The main alternatives cited by the Committee are: a National Retail Sales Tax, a Value Added or VAT tax, a Consumption-Based Flat Tax, a Cash Flow Tax, and a Pure Income Tax.
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Title Annotation:includes related article on state and federal tax areas
Author:Fletcher, Jeff
Publication:Nation's Cities Weekly
Date:May 6, 1996
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