INTRODUCTION
States rely heavily on the federal income tax regime; however, they
also reflect their own preferences, for example, by legislating
deviations from federal taxable income. These differences in taxing
systems have created a compliance and administrative burden that is
exacerbated by the mobility of modern businesses and individuals and by
the growth in businesses that operate across many state lines. Taxpayers
have to deal with both state and federal tax systems, and the burden is
even greater for multi-jurisdictional businesses as they deal with
several states" tax regimes. Furthermore, economic inefficiencies
can arise when changes in the federal law affect states (e.g., vertical
externalities) or when changes in one jurisdiction have consequences on
others (e.g., horizontal externalities). (1)
The simplest way to deal with the complexity and inefficiencies is
to work towards a harmonized tax system, but political and practical
problems with abandoning our federalist system make that difficult and
unlikely. (2) An alternative is for the federal and state governments to
cooperate in a way that maintains the essential desirable elements of
tax autonomy but minimizes the compliance problems and economic
distortions. Little research has been done on the appropriate level of
cooperative interaction between federal and state governments in setting
tax policy, but improvements to the current state of affairs are
possible. For example, economic savings may be achieved on the
compliance side, particularly with more uniformity (Fox and Swain,
forthcoming), and technology improvements open up a vast array of
possibilities for cooperative tax administration efforts.
The federal government has extensive interactions with state
governments and provides various types of direct and indirect assistance
across a wide spectrum of tax-related activities. For purposes of this
paper, these interactions can be broadly characterized in three
categories--fiscal assistance, de facto cooperation, and active
cooperation. We begin with a description of the goals of effective
federal and state cooperation, followed by a description of existing and
planned cooperative efforts in each of the broad categories of
federal/state interactions, (3) discuss some promising ongoing and
planned efforts, and conclude with an evaluation of the existing state
of affairs and where we might go from here.
GOALS OF A FEDERAL/STATE COOPERATIVE RELATIONSHIP
An ideal cooperative relationship should strive for the following
goals: provide a policy framework for decision making, preserve tax
autonomy at all levels of government, seek economies of scale, minimize
compliance and administrative costs, and identify and promote mutually
beneficial cooperative efforts. The starting point to improving the
current system is to develop an effective framework for making tax
policy decisions. At a minimum, the federal government should consider
the impact of any federal tax changes on the entire tax system. Changes
made at the federal level are particularly important as most states use
the federal tax base as their own starting point. The federal government
should quantify the impact of proposed legislation on state revenues and
consider alternatives when the impact is expected to be significant. For
issues that affect the efficiency of the tax system as a whole, the
federal government should determine under what circumstances
intervention in state tax matters should take place (promote horizontal
equity, prevent tax planning abuses, etc.). Furthermore, states should
also consider how their tax policies could affect other states--for
example by directing taxable activity to domestic "tax havens"
or by facilitating other types of tax competition.
Important benefits exist for allowing states to independently levy
taxes, limited only by constitutional restrictions. Therefore, steps
towards a more cooperative relationship, including more uniformity,
should not sacrifice the essential desirable elements of autonomy
regarding the tax base and rates. Independent tax autonomy allows for
decentralized government operations and can result in greater efficiency
gains for service delivery. Furthermore, subnational governments are
often better equipped to respond to their citizens' demands.
State and federal governments should work together to streamline
the tax assessment and collection process. The ease of transmitting
information around the world opens up possibilities of developing
economies of scale and minimizing compliance and administration costs.
Data collection and sorting requires a significant up-front investment,
but once collected, the data can be shared among all interested parties
quickly and accurately. Several data-sharing initiatives are ongoing,
but opportunities exist for new programs.
The federal and state governments can differ on taxable bases and
tax rates; however, governments at all levels share common interests in
identifying non-filers, uncovering illegal tax evasion schemes,
streamlining the audit process, and collecting taxes owed. Identifying
these and other common interests where working together can be mutually
beneficial to all parties is a key underlying goal of intergovernmental
cooperation. Plans are already under way to increase joint electronic
filing efforts and to streamline the audit and collection processes.
CATEGORIES OF FEDERAL/STATE INTERACTIONS
Fiscal Assistance
The federal government provides an indirect financial subsidy to
the states by allowing a federal deduction for state and local taxes
paid. This fiscal assistance effectively subsidizes about one-third of
the state taxes paid by taxpayers in the highest federal brackets. For
businesses, almost all state and local taxes are deductible by
businesses as taxes or as a cost of acquiring business inputs. Currently
at the individual level, income, property, and sales taxes are
deductible at the federal level, but only for taxpayers that are able to
itemize. (4)
The deduction / subsidy is an important benefit to subnational
governments, but not without a cost. Federal tax deductibility reduces
the amount of income redistribution because it decreases the
progressivity of the federal income tax system. (5) Itemizers
effectively pay only a portion of their state tax, with the portion
decreasing as the taxpayer's marginal rate increases. Therefore,
the deduction helps high-income itemizers but provides little or no
assistance to taxpayers in the lowest brackets or individuals who do not
itemize. (6)
The deduction also potentially creates behavioral responses. First,
if deductibility does not apply uniformly to all state and local taxes,
governments will have an incentive to finance public goods and services
with taxes that are deductible and have a lower real cost to state and
local taxpayers. (7) For example, elimination of the deductibility of
state and local sales taxes with the Tax Reform Act of 19868 may have
given state and local governments an incentive to raise revenues from
the still--deductible income and property taxes and decrease their
relative reliance on the sales and use tax. The actual experience did
not follow predictions as the sales tax continued to grow (Fox, 1998).
Second, prior research shows that federal deductibility of state and
local taxes increases the size of state and local governments because
the deduction subsidizes the net cost of financing additional state and
local spending (Gramlich, 1985). The federal policy makers should
consider whether favoring some taxes over others and/or subsidizing
local governments is a desirable side effect of the federal tax
deduction. Feldstein and Metcalf (1987) suggest that the deduction may
stimulate additional spending by governments with artificially low
levels of public services and may be more cost effective than federal
grants.
De Facto Cooperation--The Common Tax Base
In the U.S., the de facto adoption by most states of the federal
income tax base is a key element of the federal/state policy framework.
The agreement on the essential elements of what constitutes taxable
income makes many other cooperative efforts possible. There are
important differences between the federal and state tax regimes, but all
but two corporate income taxing states (Arkansas and Mississippi) and
the District of Columbia use federal income as starting point for their
taxable base. A similar percentage of states use the federal individual
income tax base as a starting point. On most broad measures, the
percentage of states following the federal lead has increased over time.
For example, in 2005, 93.4 percent of states used federal corporate
income as a starting point versus only 56.1 percent in 1967 (Hildreth et
al., 2005).
The essential agreement on most tax-base issues allows states to
rely on federal codes, regulations, cases and rulings to resolve
questions of law or interpretation. Relief from the heavy lifting of
legislating and interpreting the detail necessary for a modern tax on
income leaves state and local tax authorities free to focus on other
matters. Even those states that have a starting point other than federal
taxable income utilize the federal statutory scheme to resolve important
questions of law. Joint audits and cooperation between audit
departments, shared professional education, bilateral data exchange, and
cooperation on tax shelter reporting are all possible because the
fundamentals of taxing income rely on the same basic starting point.
To illustrate how this agreed-upon starting point simplifies tax
compliance and administration, consider a simple matter such as wages,
reported on W-2 forms to millions of workers every year. Wages include
cash payments but exclude an array of employer-provided benefits such as
health and life insurance, working condition fringe benefits,
educational benefits, and employers' contributions to the various
payroll and unemployment taxes. In fact, dozens of codes on the back of
recent W-2s explain exactly what is included or excluded from the line
"wages."
States that adopt the federal wage definition greatly simplify
taxpayer compliance efforts since preparers of W-2 forms only need to
calculate wages under one definition. If states independently determine
what constitutes "wages," each of the millions of employers
has to be familiar with and account for state differences for each state
in which the employer has employees. Federal and state differences also
introduce the possibility of inadvertent errors on the part of taxpayers
who must first become aware of the differences and then keep track of
year to year changes across perhaps many states. Administration is
simplified since state auditors can use the results of a federal
adjustment to the wages line without performing their own calculations
of the amount of under/overstatement. With a uniform wage definition,
the state adjustment will be the same as the federal adjustment.
The presumption is that coordination of the federal and state
taxable base minimizes compliance and administration costs. Studies of
individual income tax and business income tax compliance costs have been
done, (9) but none attempts to estimate the cost savings of federal and
state coordination. Prior research, however, finds that disconformity
between states increases state tax compliance burdens and that greater
uniformity could generate substantial compliance cost savings (Gupta and
Mills, 2003; Hildreth et al., 2005).
Policy Challenges of Conformity
The states' dependence on the federal base introduces tension
between levels of government, particularly when changes in the federal
tax law occur. Tax policy decisions at the federal level most often
ignore potential impacts on state revenues. (10) States have the option
of accepting the federal changes and the impact on their own budgets or
decoupling from the federal provision and, therefore, increasing
complexity. For example, the federal response to the recession in the
early 2000s was to reduce tax on many business activities and provide
major investment incentives, largely funded with a federal budget
deficit. Because states require a balanced budget, and the federal
changes were estimated to cost states as much as $14.7 billion over
three years (Dennen, Nakamura, Hogroian, and Weinreb, 2002), many states
chose to decouple from the most generous federal changes, such as bonus
depreciation and IRC Section 179 asset expensing. Furthermore, when
states need additional revenues, they may find it politically easier to
decouple from selected federal provisions (rather than increasing
marginal rates) without considering the increase in complexity and,
therefore, increased administration and compliance costs.
The estate tax at the federal and state level is informative, both
as an example of a perfectly conforming state tax and how federal action
can have dramatic but perhaps unintended impacts on state revenues.
Prior to the Economic Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA), the federal estate tax allowed taxpayers a credit (subject to
limits) for state death taxes paid. States had no desire to tackle
difficult estate tax audits for the relatively small incremental revenue
(11) and 38 states simply assessed a "pick-up" tax equal to
the maximum allowed federal credit. This approach vastly simplified the
estate tax compliance and administrative burdens as taxpayers
essentially had a single return to complete (Form 706), which determined
both the federal and state death tax owed. State auditors relied almost
entirely on the federal return and audit results and were tasked only to
ensure that the proper amount was actually remitted to the state.
Taxpayers were indifferent to the state estate "pick-up" tax
since any amount not paid to the state would reduce the federal credit
allowed and increase the amount, dollar for dollar, due to the federal
government. Effectively, this arrangement was equivalent to a national
estate tax and a federally determined grant to the states.
This simple and effective situation changed dramatically with
EGTRRA. The Act phased out the credit over time and replaced it with a
simple deduction. This change literally gutted the estate tax system of
the "pick-up" states because when the maximum federal credit
allowed for state taxes paid went to zero, so did the state estate tax
for the 38 states with a pick-up tax. Some states passed legislation
establishing a new estate tax, often based on what the credit was at
some point in prior law, but most have not legislated a replacement
estate tax.
Furthermore, the federal change significantly increased the
compliance and administration burdens for taxpayers and state
governments. Since the state death tax is now in addition to the federal
tax (whereas before it was an offsetting credit) taxpayers have, for the
first time in many states, an incentive not to file a state return.
State auditors now must first ensure that each estate properly files a
return and must audit the return, at a minimum for mathematical
accuracy, and to account for differences between the federal and state
exemption equivalents. For taxpayers and tax professionals, the estate
tax regimes that replaced the "pick-up" tax vary from state to
state, with different exemption amounts and rates. In addition to filing
a separate state tax return, tax and estate planning strategies that
assumed a uniform state and federal death tax are no longer valid and
must include provisions that allow for different strategies and
post-death actions on the part of executors depending on the particular
state estate tax in effect at death. Taxpayers also have, for the first
time, an incentive to locate in states with lower estate taxes, or to
plan their estates to take advantage of state rate differences.
The policy challenge facing federal and state governments is to
allow for the desirable differences in the tax rate and tax base, but in
a manner that minimizes the compliance burdens and economic distortions.
The "pick-up" estate tax may have been popular because the
state revenues raised by the tax were minor and legislative tinkering
would unacceptably increase the compliance and administrative burden
without an offsetting beneficial impact on state revenues or other
policy goals. With corporate income taxes only comprising approximately
ten percent of state revenues, weighing disadvantages of decoupling from
federal rules with the benefits would likely reveal a greater preference
for conformity than currently exists. States should reserve decoupling
for the most significant items that are critical to accomplishing their
economic development goals.
Active Cooperation
Federal-State Exchange of Information
Despite the many significant hurdles presented by tax-regime
differences, states and the federal government have found a number of
areas where cooperation is possible and increasingly efficient. The
cornerstone of cooperative tax administration in the United States is an
active exchange of information between federal and state tax authorities
to support enforcement of the personal and corporate income tax. The
recent increases in information exchange (discussed below) are likely
due to several factors. First, the visibility of tax-planning abuses,
particularly by large corporations, makes enforcement strategies more
politically important. Second, advances in technology make information
sharing easier and more cost effective. State and local revenue
departments constantly face limited resources, and the political climate
and competition for business has made raising tax rates or implementing
new taxes more difficult. Finally, continually changing business
practices have also contributed to the increase in information sharing.
As businesses develop more complicated structures, tax administrators
are forced to specialize in certain areas and certain industries.
Federal law authorizes the IRS to provide federal tax return
information to state tax agencies, provided it is used solely for tax
administration purposes and is properly safeguarded against unauthorized
disclosure or release. (12) All states have entered into an exchange of
information agreement with the IRS through which they routinely receive
an abundance of tax information. Information exchanged includes copies
of all federal audits or other adjustments to a taxpayer's return,
identification of taxpayers filing a federal income tax return with an
address in the receiving state, extracts of items of income and expense
reported on the federal tax return, information reports filed by
third-party payers (e.g., banks, brokerage firms, and employers) with
respect to taxpayers in a particular state, address and location
information for taxpayers, and information on possible taxpayer assets
available for levy.
Given the basic level of conformity between state and federal
income tax bases (see earlier discussion), this information is often
used to assess additional state tax directly. For example, one of the
most effective information exchanges is an IRS program that matches
third-party reports of income to entries on taxpayer returns. The IRS
assesses additional federal tax where income has been omitted and
provides information on the adjustment to the state tax authority in
which the taxpayer resides. The state customarily issues an automated
assessment of additional state tax, unless the income is exempted by the
state. States also compare the exchanged data with state files to insure
consistency in amounts reported to federal and state tax authorities and
to identify potentially non-filing taxpayers. With the massive amounts
of information involved, all information is exchanged on
computer-readable or electronic media instead of paper. States and the
IRS are now in the process of migrating the means of delivering the
information from a physical transportation to secure electronic
delivery.
Federal data and federal audit reports are the predominant means of
independently auditing state individual income tax returns in many
states. The rates of state individual income taxes (generally five to
eight percent of taxable income) are such that it is not cost-effective
(particularly compared to the yield on audits of state corporate income
taxes and retail sales taxes) to maintain a substantial cadre of state
revenue agents to conduct on-site audits of individual income tax
returns.
States also use the results of federal corporate tax audits for
enforcement. Since the computation of state tax generally begins with
federal taxable income, states rely extensively on federal examination
activities for verification of the tax base and the proper treatment of
various transactions, particularly those involving international
operations. State agencies devote their audit activities primarily to
verifying the apportionment of income across states, examining the
taxpayer's treatment of certain types of transactions, and
determining the membership of the unitary group if the state employs
combined reporting. The sharing of information on multistate
corporations is not as seamless as many believe it should be. Current
interpretations of federal law require that states must make a special
request for information on a corporation that is not headquartered in
the state. The information is available to the requesting state,
presuming it can provide a valid tax administration reason as to why it
needs the information.
States have recently gained access to data from other federal
agencies to aid in tax enforcement activities. They receive regular
reports from the U.S. Customs Service on imported goods, which they use
to identify goods to which the retail sales and use tax may apply or to
identify potential taxpayers who may not be registered.
Historically, the flow of information was largely from the federal
government to the states. In recent years, however, states have begun
providing more information to federal tax administrators, and the IRS
has begun more systematically using the information it receives. In
particular, federal administrators use state lists of registered sales
taxpayers to identify potential non-fliers of federal employment and
corporation taxes and to cross-check reported receipts. They also
periodically use files maintained by other state agencies that license
individuals engaged in various trades and professions as a source of
leads (e.g., on non-fliers). Finally, state driver license files provide
a good source of address information and potential assets in a seizure
situation. Here again, the data are exchanged under legal agreements
regarding the use and safeguarding of the data, and most information is
exchanged in computer-useable form.
Two relatively nascent efforts that are primarily of benefit to the
IRS are also worthy of mention because they indicate how the IRS is
beginning to make more systematic use of the state data. The first is a
program called the State Reverse File Match Initiative
(SRFMI--pronounced Surf Me), where states will be extracting various
items of return information from their individual income tax files and
providing them to the IRS who will match them against the IRS Master
File. The effort is two-fold: (1) Identify people who may have filed at
the state level but not at the federal level; and (2) Compare certain
items of income and expense that are reported on the state return to
those entries on the federal return. Once institutionalized at the IRS
and state levels, this can be a cost-effective match program. IRS has
identified the information they want and the format they want it in. It
will take some work by states to participate, but all have expressed a
willingness to do so as long as they can fold implementation into their
regular work plans.
The second "new" effort is the "State RAR (Revenue
Agent Report) Program." Here, the states are doing what the IRS has
done for some time, i.e., sending information on adjustments made during
a state audit to the IRS so it can follow up with any appropriate
federal adjustments. Once again, the IRS is finalizing the information
it wants and the format in which it wants it. The program is being
piloted and an implementation plan is being developed.
The tax shelter area is an excellent example of where exchanging
information between the IRS and states can and has improved compliance
at both levels. Through some extraordinary efforts at the state and
federal levels, a regular, two-way flow of information between states
and the IRS was developed on who was participating in shelters, the
types of shelters, who was coming forward in the Voluntary Compliance
Inititatives (VCIs), who the promoters were, and the like. This enabled
both the IRS and the states to leverage their resources and achieve
better coverage than they could have individually. Forty-eight states,
the City of New York, and the District of Columbia entered into a
Memorandum of Understanding (MoU) with the IRS to exchange information
on shelter participants and promoters, and states and the IRS regularly
exchanged information on adjustments made during tax shelter audits.
According to the IRS, the Abusive Tax Avoidance Transaction (ATAT)
partnership resulted in the sharing of over 28,000 leads between the
states and the federal government, leading to the discovery of tens of
millions of dollars in previously unknown fraudulent tax avoidance
schemes. In one "infamous" case, one state was able to provide
IRS with information necessary to make a $6 million assessment just
hours before the federal statute of limitations would have run out
because of the active program of information exchange.
About 40 states also signed MoUs among themselves to share
information on tax shelter promoters and participants. States have
developed a data base of information on promoters and participants in
various tax shelters. The data base contains identifying information on
the participants and promoters so that users of the data base can then
examine their files for information on the taxpayer and the returns that
have been filed. The IRS is considering participation in the data base,
but there are some disclosure issues that need to be addressed.
Another initiative in the data exchange area is that states and the
IRS are now exploring the possibility of establishing a
"relationships data base" that would enable users to identify
the ownership/ income relationships among various levels of pass-through
entities. The intent would be to enable an auditor or agent to inquire
against the data base and identify the various types and levels of
pass-through entities in which an individual or corporation or other
pass-through entity may be involved. The data base would be built using
information already gathered by the IRS, maintained by the IRS, and
governed by IRS disclosure and safeguard standards.
There are relatively few instances in which the states and federal
government conduct joint audits of individual taxpayers. An exception is
in the motor fuel excise tax area in cases where earlier investigative
work by either the federal or state tax authority has revealed evidence
of criminal tax evasion.
There is little in the way of cooperative efforts between state and
federal agencies in the administration of excise taxes on alcoholic
beverages or tobacco products, except for occasional working
arrangements between individual agencies at the local level. (13)
Federal law, however, does require that manufacturers of tobacco
products and alcoholic beverages provide reports to state tax
authorities on all products shipped to wholesalers in the state. This is
a great aid in insuring that tax is paid on all products entering the
distribution chain in a particular state.
There has been increasing cooperation between the federal
government and states in the collection of delinquent tax obligations.
Delinquent taxpayers may often owe money to both state and federal
authorities. In fact, this is often a source of friction between tax
authorities, with one level attempting to assert priority over the other
where there are insufficient resources to satisfy both obligations. (14)
However, the two sides have agreed to cooperate when the taxpayer is due
a refund from one jurisdiction but has unpaid obligations to another.
Since 2000, states have been participating in the federal Tax
Refund Offset Program where a certified delinquent state income tax debt
is offset against a federal tax refund. This produces about $200 million
per year for the states. The program is limited, however, to resident
taxpayers. States are seeking federal legislation to expand the program
to nonresident taxpayers. Likewise, the IRS participates in state offset
programs through the State Income Tax Levy Program (SITLP) in something
over half of the states, and this produces upwards of $100 million per
year for the IRS. The IRS may levy income tax refunds by matching
federal delinquent accounts against a database of states participating
in the SITLP. (15) State participation is just now beginning to pick up
after the program was suspended to bring it into compliance with the
revised delinquency procedures of the IRS Restructuring Act of 1998. In
addition, three states are now piloting a program with the federal
government in which the federal tax debt files are matched to all vendor
payments made by states in order to recover tax delinquencies. Presuming
success, this sort of program could pay some substantial benefits to
closing the federal tax gap. If successful, the federal government
should consider offsetting other types of federal payments for state tax
debts.
Cooperative Taxpayer Assistance
Beyond the audit and enforcement efforts, state and federal tax
authorities have undertaken a wide range of cooperative taxpayer service
and education activities. Of particular note are cooperative or joint
programs for providing training and education to tax practitioners and
preparers as well as providing cooperative registration and filing
assistance to new businesses. It is also not uncommon for state and
federal authorities to offer onsite taxpayer assistance at a single
site.
The most ambitious effort has been in the area of cooperative or
coordinated electronic filing. Each of the 42 states (including D.C.)
with an individual income tax has a program for electronic filing of the
returns. All but four of these states participate in the FedState E-file
program in which the taxpayer (using a participating tax preparer or
approved third-party software) may file his/her federal and state tax
return in a single electronic transmission. (16) The return is
transmitted to the IRS, which performs limited validity checks and then
makes the state return information available for download by the states.
(17) This close program coordination facilitates the use of common
formats, data definitions, etc., all of which eases any burden of
electronic filing on taxpayers and tax preparers and promotes
participation in electronic filing. Electronic filing is generally seen
as improving tax compliance by eliminating mathematical and data-entry
errors and improving overall service to taxpayers. In 2006, about 54
percent of all state income tax returns were filed electronically, the
vast majority through the cooperative FedState program. (18)
Cooperative electronic filing efforts are also being extended to
areas beyond the individual income tax. As the IRS has moved into
electronic filing of corporation income and other types of returns,
states have worked closely with the Service to fashion counterpart
state-level programs. In 2007, about one-half of the states will
implement electronic filing programs for the corporate income tax.
Nearly all of them will be "FedState programs" that will
operate like the individual tax program with the returns being filed
using common formats, definitions, protocols, etc. with the IRS and then
being made available to the states. Likewise, a number of states will be
developing similar programs for the electronic filing of partnership
returns over the next few years.
The IRS and states have entered into some other, more minor,
cooperative programs to take advantage of online convenience. As of this
writing, two states (Georgia and New York) will take online applications
for business registrations and transmit that information to the IRS. The
IRS will use that information to immediately issue an employee
identification number (EIN), and will follow up with the traditional
letter confirming the federal EIN in about two weeks. The hope is that
this one-stop paperless application will be convenient to both taxpayers
and tax administrators.
According to the IRS, several other programs are in development or
in the initial operational stages. Under the Fed/State Offshore Payment
Card Matching Initiative, the IRS is expanding the use of state
databases to identify and locate taxpayers who have participated in
offshore credit-card abuse. The Title 31 Money Servicing Businesses
Memorandum of Understanding (MOU) is a federal-state information
exchange program targeted at increasing compliance by money services.
The initiative includes personnel from the IRS, the Financial Crimes
Enforcement Network (FinCEN), and state regulatory agencies.
Collaborative Training Efforts
A final area of collaboration between state and federal tax
authorities is in training personnel. This cooperation takes three
forms: First, state tax agency personnel are able to take part in all
IRS-sponsored training sessions if space is available. This includes
access to a wide range of courses from short-term, specialized courses
to more basic courses, which might be several weeks in length (e.g.,
basic criminal investigation). This enables states to leverage the
resources of the IRS to meet certain training needs for which it would
be impractical to develop their own offerings.
Second, state and federal tax authorities have on occasion jointly
developed specialized training programs. Most recently, they cooperated
in developing basic and advanced courses in motor fuel audit and
investigation; over 1,200 state and federal agents attended the course
over the last three years.
Finally, IRS personnel regularly participate, both as instructors
and students, in training sessions conducted by state agencies or their
representatives. For example, the Federation of Tax Administrators (FTA)
(19) regularly sponsors training workshops and conferences on current
topics and techniques in tax administration for state agency personnel.
IRS personnel regularly participate in such events.
Procedures for Cooperation
The process by which these cooperative tax administration
activities are initiated, developed, and implemented is diverse and
somewhat dependent on the nature of the initiative. Outside the
information and data exchange area, the cooperative efforts are
generated largely by individual state tax authorities and their
counterpart IRS district office. Representatives from the IRS and state
tax agency regularly meet to examine ways to cooperate, and it is out of
such liaisons that many individual initiatives grow. Once developed and
tested, they are likely to be replicated in other states. But the
implementation of many efforts may not occur in all areas of the
country.
There is a similar coordinative mechanism at the national level for
efforts affecting all states. The leadership of the FTA, as
representatives of state tax authorities, holds regular liaison sessions
with the executive leadership of the IRS to discuss and coordinate
cooperative activities. The IRS maintains a small National Office staff
(about 15 persons) dedicated to assisting states in working with the IRS
and in providing information on the types of cooperative activities
being conducted across the country. Numerous IRS staff throughout the
country and in various functions devote at least part-time to working
with states. Leadership and staff of the IRS and FTA play a lead role in
designing and implementing efforts that are nation-wide in
implementation, e.g., the joint electronic filing program and the
information exchange program. They are also active in facilitating the
adoption of initiatives generated at the state-district level to other
regions of the country.
PROMISING CURRENT INITIATIVES
The discussion above highlights a number of good examples of the
federal and state governments working together, particularly in the
areas of information sharing and taxpayer assistance. Many of theses
initiatives simplify and improve compliance with routine requirements
and are mutually beneficial to both the federal and state taxing
authorities. Although those programs are very helpful to the governments
administering taxes, there has been little reduction in overall taxpayer
compliance costs and no true economies of scale. For example, the
cost-savings benefits from coordinated electronic filing should be
substantial as paperless returns become the norm, but the overall
taxpayer burden of dealing with multiple taxing jurisdictions is
relatively unaffected by such measures. The programs discussed below
could potentially have a real beneficial impact on the overall
complexity of the U.S. tax system.
The Streamlined Sales Tax Project
The states have long recognized that the sales tax base is eroding
due to increases in remote commerce and sales not subject to sales/use
tax in any state. The Streamlined Sales Tax Project (SSTP) was created
to reverse the decline and to prod Congress to change the law to reverse
the base erosion. The project itself seeks to simplify and modernize the
collection and administration of sales and use taxes, and it is a
current example of where cooperation between federal and state
governments could have a significant impact on tax collections and tax
efficiency. Its key features include rate simplification, uniform
definitions of sourcing rules and audit procedures, uniform definitions
of key categories such as "food" and "drugs," and
state-level administration of taxes and funding of the system.
Vendors without nexus are not required to collect and remit sales
and use taxes on remote sales. The current sales and use tax landscape
includes thousands of taxing jurisdiction with dozens of different
definitions of sales taxable items and hundreds of different rates.
Without very advanced software and streamlined reporting and tax
remittance procedures, the compliance burden for small and large
businesses alike would be overwhelming and cost prohibitive. The hope is
that simpler and more efficient administrative procedures would reduce
the compliance burden on businesses, and businesses would voluntarily
comply with the sales and use tax systems of participating states.
When the SSTP was first formed in 2000, most businesses and policy
makers were skeptical that states could ever agree on a comprehensive
simplification package and pass conforming legislation. Today, 22
states, including 15 full members and 7 associate members, have passed
all or most of the required Streamlined Sales and Use Tax Agreement
(SSUTA) simplification recommendations. (20) Since October 2006,
voluntary vendor participants in the SSTP have remitted sales/use tax
collections of approximately $66.5 million to the states.
The long-run goal of the SSTP is to convince Congress to give
states the authority to collect sales and use taxes from remote vendors.
Several bills have been introduced in Congress to get its consent to the
SSUTA. (21) In June 2006, the Streamline Sales Tax Simplification Act
(S.2153) authorized member states of the SSUTA to require remote sellers
to collect and remit the sales and use taxes on sales to the member
states. All bills have been rejected primarily due to concern for small
businesses, Internet businesses, and impacts on local governments. There
is also significant concern that the costs to implement the rules will
outweigh the increase in revenues.
Federal legislation to adopt the SSUTA would have many advantages.
First, the legislation would shift the compliance burden from consumers
(who are obligated under current law to pay use taxes) to sellers and,
therefore, reduce the number of taxpayers. It would also simplify the
compliance burden for businesses currently complying with the sales and
use tax system. (22) This in turn would reduce the administrative and
audit burden on states and businesses. In addition, proposed legislation
would significantly reduce complexity in dealing with multiple
jurisdictions in the 50 states. Finally, the legislation would also
close a growing loophole that encourages tax avoidance. Adoption of the
SSUTA would collect taxes equally from all retailers, reducing the
inequity between Internet firms and brick-and-mortar firms. (23)
Probably the biggest disadvantage of the SSUTA is loss of autonomy
at the local level. (24) Local governments generally support federal
legislation allowing states and localities to collect taxes on remote
sales, but prior bills have been perceived as harmful by the local
governments. For example, the Agreement requires local governments to
simplify telecommunication taxes, a major source of revenue for local
governments. The SSUTA also requires state-level administration and
uniform sourcing rules, which require destination sourcing. The
destination-sourcing rules result in winners and losers.
There is much work still needed as the SSTP continues to address
thorny issues; however, the SSTP is a move in the right direction. The
SSTP is a good example of how states and the federal government might be
able to come together to improve the sales tax system while maintaining
the essential autonomy states require. The SSUTA forced states to accept
common definitions of broad categories of tangible products but still
allowed them the option to include or exclude each category from the
sales tax base as well as flexibility on the rate of tax. Essentially,
the participating states agree on where and how to disagree. The federal
government's role is to require consistent sales/use tax treatment
of all retail sales when such treatment is administratively feasible.
Business Nexus Standards
Businesses have become more adept in recent years at planning
strategies that take advantage of currently accepted nexus standards to
lower their overall state tax liabilities. Partly in response to these
effective planning techniques, states have begun to assert various
expanded nexus standards, including "doing business" standards
and asserting nexus based merely on the presence of intangible property.
The various nexus interpretations cause uncertainties for multi-state
corporations and exert a significant compliance burden. Businesses have
responded to the uncertainty by asking Congress to establish bright-line
standards based on physical presence that sharply limit states'
ability to assert nexus. These proposals extend the protection of P.L.
86-272 to services and other types of activity and have been highly
criticized because they narrow the base further and encourage tax
planning and economic inefficiencies. (25)
The alternative for states might be a cooperative effort similar in
concept to the SSUTA, although on a much smaller scale. The goal would
be simplified, bright-line standards that broadly satisfy state demands
to assert nexus on businesses with a substantial economic presence, but
standards that are not as encompassing as the most aggressive state
positions. Developing such standards would give Congress a reasonable
alternative that satisfies the businesses' desire for a workable
and fair nexus standard, but also preserves the states' authority
to levy tax on businesses from a state's public infrastructure.
A similar policy framework for other income tax issues may also be
needed to bring about substantial further improvements in the
cooperative relationships between the federal and state governments and
a more efficient system. There is a current disagreement on