The Impact of Federal Tax Reform on State and Local Governments

President Trump and Congress are committed to undertaking comprehensive federal tax reform this year in order to create jobs and spur domestic investments in manufacturing and other industries. These federal tax reform efforts should not overshadow the potential fiscal repercussions at the state and local levels. State and local officials are increasingly concerned that federal tax reform will dramatically impact revenues and shift the fiscal burden for providing public services and other government programs to states, cities and counties.

Two suggested tax reform proposals with significant state and local implications are the elimination of tax-free public financing (bonds) and the federal deduction on state and local taxes. These proposals would constrain public financing and make it harder for government entities outside of Washington to raise the capital for transportation, infrastructure and other public works projects.

The importance to local officials of tax-exempt financing for public projects was reflected in a meeting at the U.S. Conference of Mayors of the “Don’t Mess with our Bonds” coalition, and the group plans to execute a national grassroots campaign to preserve the current tax-exempt status for public financing. Many states also link or conform their tax structure to the Internal Revenue Code, so federal efforts to adjust the corporate income tax rate, eliminate the estate tax or redefine the expensing of investments will have significant budgetary implications.

Because of the intergovernmental relationship between the federal tax code and state and local tax structures, governors, state legislators, mayors and county officials will remain actively engaged in the federal debate on tax reform. They will seek to protect their interests and ensure their constitutional and statutory control over revenues and expenditures while avoiding unfunded mandates. State and local governments will be affected by federal tax reform, but the extent will not be known until a final tax bill is signed into law and the economic growth that is expected to result from such tax reform materializes.

While federal tax reform is expected later this year or early next year, its implementation is expected to be gradual over the next several years. Because of this, state and local governments will not initially feel the budgetary impact of federal reforms and are currently putting together their budgets based on the current federal tax structure. They will make adjustments during the transition period as federal tax reform measures take effect. When this occurs, the fiscal challenges for state and local governments will be felt and may include addressing fiscal gaps through additional taxes and fees on commercial real estate and the private sector.

Comprehensive federal tax reform means that everything is on the table for consideration, including tax provisions important to both commercial real estate and state and local governments. It will entail the balancing of interests that may require interested parties to give a little in one area for the benefit in another area.

NAIOP is engaged in the federal debate on tax reform. Our engagement includes NAIOP members contacting their federal representatives to support the interests of commercial real estate. However, following federal action, the tax debate will then shift to state and local governments to address its fiscal impact.

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