Debate on deduction for state sales tax continues

WASHINGTON – Each year, about a million Washington residents itemize their sales tax receipts and ease their federal tax burden by hundreds of dollars.

For Dishman Dodge Chrysler manager Todd Tuflija, the ability of Washington residents to deduct what they pay in state sales taxes each year from their federal income tax bill also means more business.

“When you have a buyer who’s wanting to purchase a new vehicle, you can show the tax benefit will help them buy down their monthly payments,” Tuflija said.

That’s why Tuflija welcomed U.S. Sen. Maria Cantwell to the Spokane Valley dealership in August as part of a bipartisan push to enable Washington residents to keep claiming the sales tax deduction on their federal returns. Four months later, with help from U.S. Rep. Cathy McMorris Rodgers and other members of the state’s congressional delegation, a temporary deal was struck to keep the deduction in place through 2013.

The January compromise came just a few months before Washington residents, and those of eight other states lacking state income taxes, would have to file returns without claiming state tax credits. Cantwell said the issue comes down to fairness and promoting business in Washington state.

While the state income tax deduction is a permanent part of the federal tax code, Congress continues to extend the sales tax break for just a year or two at a time. It’s enjoyed by more than 1 million Washington taxpayers to the tune of $2 billion annually. The “fiscal cliff” deal marked the fourth time since 2004 that the sales tax deduction was extended on a temporary basis.

With each new Congress, Cantwell seeks to change that.

“It’s time for the administration and people to just put this into the tax code,” Cantwell said in a recent interview at the Capitol. In January, she introduced for the fourth time a measure that would extend the sales tax deduction permanently.

The legislation has become something of a New Year’s tradition for Cantwell, who has powerful allies in both parties in the Senate. But the fate of the deduction is likely tied to the success of larger-scale tax reform, said state and local tax expert Kim Rueben, a senior fellow at the Urban Institute in Washington, D.C.

“I think it’s more of a political argument than an economic argument,” Rueben said. “I also feel like it’s going to be almost impossible to get it passed permanently.”

A permanent deduction carries a hefty price tag, which makes extending the deduction for longer than a year or two at a time politically unattractive, Rueben said.

Cantwell remains committed to a permanent deduction, despite the difficulties it has faced in the past.

Former Oregon senator was key

Before the Tax Reform Act of 1986, taxpayers were able to deduct both state income and sales taxes when filling out their federal returns. President Ronald Reagan and the Treasury Department tried to change that.

“There were a number of people who actually thought they were going to get the deduction for state and local taxes eliminated,” Rueben said.

Slade Gorton, a longtime Republican senator from Washington state, was among those following Reagan’s lead in 1986, arguing a simpler tax code would make for a more sound fiscal policy and fewer confused taxpayers. But when Oregon’s Republican senator at the time, Bob Packwood, chairman of the Finance Committee, introduced a bill that cut the sales tax deduction and kept the income tax deduction, Gorton cried foul. Oregon has an income tax but no sales tax.

“Allowing one tax to be deducted and not another is utterly and completely unfair,” Gorton said recently. But Packwood’s plan ultimately became law.

Gorton called the 1986 law one of the great tax reforms in American history. But he had to swallow the defeat of the sales tax deduction for the greater good in simplifying the code, he said.

He said Packwood used his position to unfairly gain an advantage for Oregon taxpayers, and the resulting code that left one deduction in place and the other obliterated was “one of the unhappy elements in my Senate career.”

Tide turned in 2004

Throughout the early 1990s, bills were introduced to reinstate the deduction, but none made it to the House or Senate floor.

In 2004 the tide turned, and Congress and the White House came to an agreement reinstating the deduction for two years.

“We were at a point where a number of people who were in very powerful positions were from states with no income tax,” Rueben said. “There was a lot of lobbying for this not being fair, and people were given the option.”

Since then, Cantwell has argued extending the tax deduction is not only an issue of fairness, but one that impacts business in Washington and especially large-goods sellers like auto dealers. Extending the deduction permanently would stimulate economic growth in Washington by removing doubt from shoppers’ minds, she said.

“We get right up to that last six or seven months, and people are always asking, is that going to stay? Am I going to be able to deduct that?” Cantwell said.

Deduction spurred buying

Keith Schmidt is a principal at the accounting firm McDirmid, Mikkelsen and Secrest in Spokane. The itemized deduction allows taxpayers to opt out of what he called a “very conservative” estimated deduction offered by the IRS as an alternative to keeping receipts, he said.

The deduction spurred large-item purchases in the state immediately after its reintroduction, Schmidt said. Credits for cars, boats, recreational vehicles and building supplies remain on the books as items taxpayers can claim on top of standard deductions outlined by the IRS.

Sales figures along the borders of Oregon and Idaho indicate shoppers are keenly aware of tax discrepancies that would be sharpened if the sales tax deduction expired. A 2010 study published in the Journal of Contemporary Economic Policy found border counties lost $21 million annually in sales to Oregon, which has no state or local sales taxes.

Permanent break unlikely

Gorton and Rueben, of the Urban Institute, are skeptical a long-term deal will get done without comprehensive changes to the tax code.

The dominance of revenue-neutral spending plans in Washington will likely spoil efforts to extend the break beyond a year or two, Rueben said. Republicans in the House and Senate have voiced opposition to recent spending bills that don’t incorporate dollar-for-dollar cuts.

The Congressional Budget Office estimated in January 2012 that extending the deduction through 2013, the current sunset date, would cost the federal government $1.4 billion in lost tax revenue. Through 2022, that figure grows to $18.1 billion.

Rueben said the more likely scenario is the loss of both sales and income tax deductions, as Reagan envisioned.

“At some point, we’ll have conversations about more fundamental tax reform,” Rueben said. “And I’m guessing it will either survive or die with the income tax deduction.”