	Introduction

This report focuses on the interplay between federal and state and local tax systems through the federal deductibility of state and local taxes. Generally, individual taxpayers who itemize deductions are allowed to deduct real and personal property taxes and state and local income taxes paid from federal taxable income. 111-5 ) provided for an above-the-line deduction for sales and excise taxes paid on new vehicle purchases for non-itemizers. The Joint Committee on Taxation (JCT) summary of TRA 1986 suggested that Congress chose to repeal the sales tax deduction and not income or property taxes, because:
only general sales taxes were deductible and not selective sales taxes (e.g., tobacco and alcohol taxes), which created economic inefficiencies arising from individuals changing consumption patterns in response to differential taxation; the deduction was not allowed for taxes paid at the wholesale level (and passed forward to the consumer), thus creating additional inequities and inefficiencies; the sales tax deduction was administratively burdensome for taxpayers who chose to collect receipts to justify sales tax deduction claims; and the alternative sales tax deduction tables generated by the Internal Revenue Service (IRS) did not accurately reflect individual consumption patterns, thereby diminishing the equitability of the tax policy. 108-357 ) reinstated deductible sales tax in lieu of income taxes. 112-240 ); and through the 2014 tax year by the Tax Increase Prevention Act of 2014 ( P.L. 113-295 ). The Consolidated Appropriations Act, 2016 ( P.L. Deductible State and Local Taxes

Generally, taxpayers may deduct state and local taxes paid from income. This special deduction has since expired. Deduction for Income Taxes

As with local property taxes, the federal deduction for state and local income taxes is equal to the taxpayer's individual tax rate multiplied by the amount of state and local income tax paid. 114-113 ) permanently extended the deduction of state and local sales taxes in lieu of state and local income taxes. Analysis

The deduction for state and local income taxes affects the distributional burden of both state and federal taxes. Due to the expiration of the alternative sales tax deduction, taxpayers in states without an income tax are more likely to be non-itemizers; thus, taxpayers in these states bear a relatively higher tax burden than taxpayers in states with an income tax. The American Recovery and Reinvestment Act (ARRA, P.L. In contrast, in states that levy an income tax, state and local governments rely on income and property taxes for 51% of total tax revenue. Policy Alternatives and Current Legislation

President Obama's FY2016 budget plan proposed limiting the tax rate at which itemized deductions would reduce tax liability. Assuming that other federal taxes were maintained after the elimination of the federal deduction for state and local taxes, the tax burden would shift toward high-tax states from low-tax states. Quantifying the magnitude of the state and local spending response is difficult, however, because many other factors influence state and local spending decisions, such as state and local political considerations and overall economic conditions. Nevertheless, most research has found that state spending declines or would decline, but by how much? Some recent tax reform plans have proposed an expansion of the standard deduction, including the "A Better Way" tax plan published by the House Budget Committee in June 2016 and H.R. For some state and local taxes and taxpayers, the fee-for-specific-services view is more accurate.
Under current law, taxpayers who itemize can deduct state and local real estate taxes, personal property taxes, and income taxes from federal income when calculating taxable income. A deduction for sales taxes in lieu of income taxes is also available. The federal deduction for state and local taxes results in the federal government paying part of these state and local taxes through lower federal tax collections. Theory would suggest that taxpayers are willing to accept higher state and local tax rates and greater state and local public spending because of lower federal income taxes arising from these deductions. In addition, there is some evidence that state and local governments rely more on these deductible taxes than on nondeductible taxes and fees for services.
Repealing the deductibility of state and local taxes would affect state and local government fiscal decisions, albeit indirectly. Generally, state and local public spending would decline, although the magnitude of the decline is uncertain. And, repealing the deduction for state and local taxes would shift the federal tax burden away from taxpayers in low-tax states to taxpayers in high-tax states. Maintaining the current deductibility would continue the indirect federal subsidy for state and local spending.
Expanding deductibility, such as reinstating the sales tax deduction option or allowing non-itemizers to deduct taxes paid, would likely increase the subsidy for state and local spending. The sales tax deduction option would primarily benefit taxpayers in states without an income tax that are already itemizing. The effect of allowing non-itemizers to deduct taxes paid would depend on the type of deductible tax. For example, property taxes are only paid (directly) by property owners whereas all consumers pay sales taxes in states that levy a sales tax. The Tax Increase Prevention Act of 2014 (P.L. 113-295) extended the sales tax deduction option through the 2014 tax year, but it has since been allowed to expire.
Recent tax reform proposals have included changes to state and local tax deductibility. The "A Better Way" tax reform proposal published by the House Budget Committee in June 2016 included a repeal of the deductions for state and local taxes. In April 2017, Treasury Secretary Steven Mnuchin and National Economic Director Gary Cohn also indicated an interest in repealing state and local tax deductions as part of a larger tax reform proposal.
The Obama Administration's FY2016 budget proposed a limit on the tax rate (generally a 28% marginal tax rate) at which itemized deductions would reduce tax liability, but did not specifically address deductions related to state and local taxes. In the 114th Congress, the Consolidated Appropriations Act, 2016 (P.L. 114-113) permanently extended the deduction of state and local sales taxes in lieu of state and local income taxes. In the 111th Congress, the American Recovery and Reinvestment Act provided for an above-the-line deduction for sales and excise taxes paid on new vehicle purchases for non-itemizers, which has since expired.
This report will be updated as legislative events warrant.