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The Cost of Unstable Federal Tax Law

2 min readBy: Gerald Prante

The federal tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. for state and local taxes was amended two years ago by adding an option for taxpayers to claim the deduction based upon the sales taxes they paid that year in lieu of the income taxes they paid that year. But this provision was only temporary and is set to expire at the end of the year, creating uncertainty for some and a rush to buy big-ticket items for others. From the Tacoma News-Tribune:

Rep. Brian Baird (D-Vancouver) has some advice for Washington shoppers in the market for big-ticket items like a car or boat: buy now, before a federal taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. break expires Dec. 31.

Congress has put off until next year consideration of a bill that includes an extension of the current break that allows Washington residents to deduct sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. payments from their federal tax bills.

Baird said he expects Congress will extend the sales tax deduction eventually, possibly in February.

“But there are no guarantees,” he warned. “If you buy a car or a boat by the end of the year, you might end up saving some money.”

When Washington residents file federal income tax returns in April, they may deduct state sales taxes paid during 2005. Unless Congress acts, the deduction might not be available in 2006. (Full Story)

Stability is a key feature of any good tax system. As we’ve noted before in our report, “The Cost of Unstable Tax Laws”:

Two different types of costs are imposed on the U.S. economy when taxpayers face uncertainty about tax laws. First, uncertain tax laws (or the uncertainty of pending tax legislation) interrupt, distort, or stifle economic activity. Second, uncertainty adds to tax law complexity, which forces the private economy to expend valuable resources on the economically sterile exercise of tax research and planning, as well as tax compliance and litigation.

In 1988, Professor Jonathan Skinner of the University of Virginia, using data from 1929 through 1975, calculated that uncertainty with regard to the federal taxation of wage and investment income costs the U .S. economy 0.4 percent of national income per year. For example, applying Professor Skinner’s cost figure to 1993 national income, the widespread taxpayer uncertainty that accompanied the tax changes embodied in the Revenue Reconciliation Act of 1993 cost the U .S. economy an estimated $20.5 billion.

Download the full study here.