By Gail Perry

Legislation currently wending its way through Congress would add a new twist to an old tax law that has been dormant for 18 years.

The House recently passed H.R. 4520, the American Jobs Creation Act, a massive piece of legislation designed to address a plethora of tax-related issues including international trade disputes and business tax issues such as lower corporate tax rates, treatment of fixed asset purchases, taxation of alcohol fuel products, a buyout program in conjunction with the dissolution of price supports for tobacco farmers, collection of unpaid taxes, and deductibility of certain charitable contributions.

The bill passed with a vote of 251-178.

Attached to this bill was a provision that would allow taxpayers to make a choice between taking an itemized tax deduction for sales tax or state income tax. Seemingly out of place with the corporate issues contained in the legislation, the sales tax deduction is seen by some as bait to draw support to the overall bill. Supporters of the tax deduction line up behind Rep. Kevin Brady, R-Texas, who introduced the measure last year as a stand-alone bill and who is also responsible for proposing that the deduction be added to the current legislation.

Brady claims that passage of the bill is an issue of fairness for residents of seven states, including those in his home state of Texas, who are denied a tax deduction for state income tax because they live in states where there is no income tax. “You have 55 million Americans who at tax time don’t have an opportunity to take a deduction that citizens in 43 other states can,” stated Brady’s press secretary, Sarah Stephens.

The seven states whose residents would be directly affected by passage of this measure are Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming. None of these states has an income tax. Alaska and New Hampshire don’t have a state income tax either, but there is no state sales tax in these states, so this issue doesn’t affect their residents.

Opponents of the measure, including the Heritage Foundation, a Washington-based think tank, claim that a deduction for sales tax gives governors and state legislatures an incentive to increase sales taxes because the true cost of the sales tax increase would be partially absorbed by the benefit of reduced federal income taxes.

“Deductibility shields taxpayers from the full burden of tax increases,” said Daniel J. Mitchell, the Heritage Foundation’s chief expert on tax policy and the economy, in a recent memo. “This makes it easier to increase the size of government.”

The details of the new tax provision are as follows:

  • All taxpayers who itemize would be eligible for the deduction.
  • Eligible taxpayers could choose between deducting state income tax or sales tax.
  • Instructions for the sales tax deduction would include a formula for calculating the deduction.
  • Taxpayers would be required to use the formula as opposed to saving receipts to support their deduction.
  • The provision would be available for tax years 2004 and 2005 only.

Another try
Last year, Brady sponsored a stand-alone bill to add an optional sales tax deduction, H.R. 720. The main difference between Brady’s stand-alone bill and the provision that appears in the American Jobs Creation Act is that H.R. 720 would permanently reinstate the optional sales tax deduction, while the current legislation would reinstate the deduction for only 2004 and 2005.“After 18 years of having no deductibility, it was a major victory to even have a two-year provision,” said Stephens. “Proponents of the legislation see this as a great opportunity to restore a provision of the law that hasn’t seen the light of day in 18 years,” she continued.

Pete Sepp, vice president for communications at the National Taxpayers Union, said that the NTU agrees. The 350,000-member, nonprofit citizens’ organization is dedicated to working for lower taxes and smaller government, and sees the sales tax deduction as a matter of fairness. “We support the concept out of fairness to the taxpayers living in states that have shown the wisdom not to enact income tax on their citizens,” Sepp said.

Prior to 1986, all itemizing taxpayers were allowed a general sales tax deduction. Taxpayers had the option of calculating their own sales tax deduction by saving receipts during the year, or using tables to calculate the deduction based on their state, their total amount of income including non-taxable income, and the size of their family. Sales tax paid on big-ticket items, including automobiles, airplanes, boats, mobile homes and building materials used for the construction of a new home could be added to the amount calculated with the tables to come up to a total deduction for sales tax paid during the year.

While passage of a corporate tax relief bill appears to be a priority in both chambers of Congress, the inclusion of the sales tax legislation is not such a certainty. The Senate has passed its own version of a bill that does not include the sales tax deduction.

Natural supporters
Tennessee’s Republican senators, Bill Frist and Lamar Alexander, are lobbying Senate colleagues to add the sales tax provision to the Senate legislation. “I strongly support giving Tennesseans the right to deduct their sales tax payments from their federal income tax bill,” Alexander said. “This is a matter of simple fairness, since citizens in other states are allowed to deduct their state income tax payments.” Tennessee is one of the states that would be directly affected by the legislation.

The future of the sales tax deduction is now in the hands of a conference committee charged with working out a bill upon which both the Senate and House can agree.

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