The Senate Finance Committee held a hearing Wednesday on tax reform and its impact on state and local tax and fiscal policy.

Among the topics covered were sales taxes on Internet purchases and downloads, and the interplay between federal, state and local taxes, including property taxes and tax-exempt bonds.

“We need to make sure our federal, state and local tax systems are working together,” said Senate Finance Committee Chairman Max Baucus, D-Mont. “As part of tax reform, we should ask how we can help states collect taxes owed and how we can encourage standard rules to protect taxpayers from multiple taxes and needless complexity.”

The hearing was the latest in a series held by the committee examining various aspects of tax reform. “As we reform the Tax Code to encourage growth and make our country more competitive, we need to ask whether the current exemptions and deductions make sense,” said Baucus. “State and local taxes could potentially be allowed as above-the-line deductions, allowing all taxpayers to benefit.”

Accountant Sanford Zinman, the owner of Zinman Accounting in White Plains, N.Y., was among the tax experts testifying. He is the national tax chair of the National Conference of CPA Practitioners and president of ncCPAp’s Westchester/Rockland New York Chapter. He noted that in his area, taxpayers are paying high levels of state and local income taxes and real estate taxes, and many of them are not receiving the federal deduction for those payments because of the alternative minimum tax. “This is troubling to many people,” he said.

Zinman also noted that many people who maintain residences in different states, such as New York and Florida, get taxed by New York on their full-year’s earnings and then it’s up to their accountant to determine how much of the wages is taxable. “Whether you’re a full-year resident or a part-time resident, you have to report your full-year revenue and the tax preparer has to break it out,” he said.

He noted that many New York residents have moved out west or to low-tax states like Florida because of estate tax issues.

“People move to states that are tax friendly, especially with estate tax issues, one because of the quality of life and, two, so they can leave more of their assets to their children,” Zinman noted. “But if you don’t do it right, the previous state where you resided will try and grab some of your assets anyway.”

He noted a recent Tax Court case in which a couple were audited by the IRS and needed to pay deficiencies, penalties and interest because of the way their interest income was allocated.
Senator Orrin Hatch, R-Utah, the ranking Republican member of the committee, quipped, “The more I listen to you, I’m glad I’m just a humble lawyer instead of a CPA.”

In his opening statement, Hatch noted, “The rush for new tax dollars that too often characterizes the federal legislative process, oftentimes leaves issues involving federal-state tax coordination by the wayside. But we cannot forget that the policies being discussed today touch-on fundamental constitutional principles of federalism and separation of powers.”

He cited the testimony of another witness at the hearing, Walter Hellerstein, a professor of taxation law at the University of Georgia’s School of Law, in which Hellerstein invoked the Hippocratic oath of do no harm. “Too often, Congress forgets this sensible advice,” said Hatch.

Taxing Digital Downloads
Hellerstein cited that rule during questioning by Sen. John Thune, R-S.D., who asked about legislation he had introduced last year with Sen. Ron Wyden, D-Ore., the Digital Goods and Services Tax Fairness Act. The bill would clarify which state could tax digital downloads, such as apps and music, based on where the purchaser resides so multiple states would not be able to impose taxes on a single download. “As the digital economy grows, we have to make sure we set some digital rules of the road,” said Thune. He noted that the bill would not take any taxing authority away from the states.

Hellerstein countered that such legislation would provide a “field day for lawyers” who would seek to exempt certain goods from taxation, and urged the committee to be careful in crafting the provisions, some of which he did not regard as ideal.

Thune argued that the legislation did not dictate which digital goods should be taxed. “Wouldn’t all stakeholders be better served to have some framework to provide some certainty in the taxes collected for digital commerce?” he asked. “I guess the question is how do we do it? We have a proposal out there. We refine that and make it more effective. With all the advances we’re seeing in technology and the way people are purchasing things these days, that’s an issue we will have to deal with.”

Taxing Internet Purchases
Sen. Benjamin Cardin, D-Md., asked about another piece of legislation aimed at collecting taxes on Internet purchases, the Marketplace Fairness Act, which the governor of Maryland said would have allowed the state to balance its budget. One of the witnesses, Kim Rueben, a senior fellow at the Urban-Brookings Tax Policy Center in Washington, D.C., approved of the legislation. “Congressional action to coordinate this would be a no-brainer,” she said.

Zinman pointed out that New York State has a line on its tax return asking taxpayers to include the value of their Internet purchases, but Florida does not. “Many people ignore the taxes they have to pay,” he noted.

Joseph Henchman, vice president of legal and state projects at the Tax Foundation, in Washington, D.C., noted that retailers would have to keep track of 9,600 different state and local sales rates. Cardin asked why they couldn’t use software to compute the different tax rates.

“I’m not saying there isn’t software,” Henchman responded. “It’s not a question of a computer program. It’s a question of tracking changes in state laws. I work with the Tax Foundation and we track changes in state and local tax laws, and it’s hard for us.”

Taxes on Wireless Services
Wyden asked about a different piece of legislation, the Wireless Tax Fairness Act, which he and Sen. Olympia Snowe, R-Maine, introduced last year. The bill would restrict any state or local jurisdiction from imposing a new discriminatory tax on cell phone services, providers or property.
“We have smart phones on the market and dumb tax policies,” said Wyden. “What Senator Snowe and I want to do is to make sure these smart phones are not subject to multiple and discriminatory taxes on these smart phones.”

He noted that the taxes in some cases could total over 20 percent on wireless service. “The bill would be prospective, laying out the rules of the road for the digital future,” said Wyden.

According to the Congressional Budget Office, there would be no additional net cost to the federal government or to state, local and tribal governments, he pointed out. Frank Sammartino, assistant director for tax policy at the CBO, who was one of the witnesses at the hearing, concurred.

Wyden asked Henchman of the Tax Foundation about how to come to grips with handling the taxation of new, emerging technologies. “Isn’t the heart of it trying to have the federal government do no harm?” he asked. “You have multiple, discriminatory policies that come about from these [state and local tax] laws I looked at. One would treat a chocolate bar one way and a cookie another way.” Henchman agreed that the goal should be tax simplification.

Tax Extenders and Tax Reform
Snowe said that Congress needs to move beyond the debate over tax reform and make it a concrete goal rather than a theoretical goal. “This is the worst post-recession recovery in the history of our country,” she said. “We need to provide certainty to businesses and state and local governments. Think about the issues that keep state and local governments in turmoil. We have an uncertainty with respect to the Tax Code and the changes from state to state. If Congress could deal with it, how should it happen? If we start piecemealing our approach, it would pre-empt the necessity of overhauling the Tax Code.”

Henchman suggested that the 1986 tax reforms should be the template to follow. He pointed out that with a piecemeal approach, industries lobby to be exempted from tax increases until the only group that is taxed is the one that didn’t lobby lawmakers, and then it lobbies to have the tax increase eliminated.

Baucus agreed with Snowe that Congress has to find a way to handle all the various tax extender items. “We need to deal with these provisions, either make them permanent or repeal them,” he said. “I agree with you, Senator, the uncertainty is one of the greatest impediments to growth in this country. If we have certainty, we’ll have to make some tough choices. Interest groups will have to subsume their interests and come up with alternatives for the greater good. With all the special interest politics, it will be difficult to reach the goal. We have to come up with constructive alternatives.”

Hatch asked about the complexities of taxing professional athletes and umpires who spend much of their time on the road, and how different states receive the revenue on their taxes. Hellerstein noted that Zinman would probably have some colorful examples among his clients.

Sammartino presented a report from the CBO on federal support for state and local governments through the Tax Code. He noted that if the federal government eliminated the deductibility of state and local taxes, along with the alternative minimum tax, there would still be a net revenue increase to the federal government, but that would eliminate some of the subsidies to state and local governments.

Hatch asked about the Obama administration’s proposal to limit charitable deductions and for high-income taxpayers and tax breaks on tax-exempt bonds, and wondered if that would hurt the subsidies on bonds to state and local governments.

Sammartino contended that the President’s proposal to limit the tax breaks for high-income taxpayers to 28 percent would not have a big effect on most taxpayers, although he acknowledged it might prompt some taxpayers to shift their investments portfolios a bit.

Tax-Exempt Bonds
Sen. Maria Cantwell, D-Wash., asked about tax-exempt bond issues and how they are used to finance public power projects for capital investments, and what impact that would have on utility rates if Congress got rid of the tax-exempt bond status.

“Part of it is going to depend on how the transition is done,” responded Rueben. There would need to be a transition period before eliminating tax-exempt debt. Lowering the tax-exempt status would need to depend upon factors such as whether it’s newly issued debt or existing debt, and who is holding the debt right now.