With the 2016 Presidential election around the corner, tax policy is sure to remain a prime topic for debate. Candidates have already begun releasing details of their federal tax reform proposals.
A few GOP candidates have expressed support for a flat tax; a seemingly simple idea but a system that can have many variations. It is argued that a flat tax, although resulting in less revenue for the government, produces stronger economic growth. One candidate’s detailed proposal is estimated to result in 1.4 million full-time jobs according to the Tax Foundation. Prior consistency, however, is not part of the flat tax argument, as both successful and poor performance has been associated with the flat tax in other countries.
Suffice it to say, the particulars of all the candidates’ proposals, both proportional and progressive, will vary greatly, just as their politics. But amidst the differences, all have one thing in common: an impact on the states.
States are far more intertwined with federal tax law than many may realize. A majority of states closely conform to the federal tax code, and although federal coupling scales back intricacy with regard to administrative burdens and taxpayer compliance, it leaves states susceptible to federal changes.
For example, states that impose an individual income tax begin their computation of state taxable income either entirely with federal adjusted gross income or federal taxable income, or at least by use of various items of federal income to develop a tax base. By choosing to follow federal definitions, states introduce federal tax policy into state tax structure, thus allowing for state revenue volatility.
Such conformity, however, is seen as beneficial primarily for the ease with which state tax administrations may encourage and enforce taxpayer compliance, according to analysis by Ruth Mason. Furthermore, states are still able to choose specific provisions to decouple from federal tax law.
In addition to the effect of federal conformity on state tax law and revenues, other possible impactful changes with federal tax reform could include reducing the allowable deductions for state and local taxes paid, cautions The Pew Charitable Trusts. Limiting or eliminating this deduction, for instance, would directly affect taxpayers by potentially creating, in essence, more expensive state and local taxes. Sometimes the bargain that flat tax proposals strike is a lower tax rate in exchange for fewer deductions.
States, as well as taxpayers, might want to consider state implications of all federal tax reform proposals when weighing the debates this election season.
Continue the discussion on LinkedIn: How else might states feel the impact of federal tax reform?
For more information regarding federal conformity, see the Individual Income Tax Navigator.
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