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Summary

Under current law, taxpayers who itemize deductions can deduct state and local real and personal property taxes, and either income or sales taxes from federal income when calculating taxable income. The temporary deduction for sales taxes in lieu of income taxes expires after December 31, 2007. The federal deduction for state and local taxes results in the federal government paying part of these 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 the deduction. 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 low-tax states to high-tax states. Maintaining the current deductibility would continue the indirect federal subsidy for state/local spending. On December 20, 2006, the Tax Relief and Health Care Act of 2006 (P.L. 109432) was enacted, extending the sales tax deduction option for the 2006 and 2007 tax years. In the 110th Congress, H.R. 3996 would extend the sales tax deduction option through the 2008 tax year. This report will be updated as legislative events warrant.

Related Legislation:
• H.R.3996

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