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149 IRET Congressional Advisory 1 (2003)

handle is hein.taxfoundation/iretcgadv0146 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies thait will promote growth and efficient operation of the market economy. March 7, 2003 Advisory No. 149 PRESIDENT BUSH'S SAVING PROPOSALS AND THE STATES Many state governments are confronting a difficult budget situation. According to the National Association of State Budget Officers, States are facing a perfect storm: deteriorating tax bases, an explosion in health care costs, and a virtual collapse of capital gains and corporate profits tax revenues. Currently, states face budget shortfalls of $29 billion in fiscal 2003 and $82 billion in fiscal 2004. (NASBO web site, www.nasbo.or2.) Because of their financial difficulties, state and local officials are nervous about President Bush's proposals to eliminate double taxation of dividends at the shareholder level and to reduce the capital gains tax on retained earnings. They also fear his plans to create Lifetime Saving Accounts, Retirement Saving Accounts, and Employer Retirement Saving Accounts with expanded contribution limits and simplified eligibility rules. The President's saving proposals would give most State and local officials are also upset that removing dividends and a portion of capital gains from the federal definition of taxable income would cut into state and local income tax revenues, because many states use the federal definition of taxable income as taxes. The President's saing proposals would give most saving inviested in stocks, corporate bonds, and governent bonds the samne federal tax treatment ais is now accorded to tax exempt bonds issued by state and local governments. Many state and local officials are worried that if their bonds lost their current tax advantage relative to other (non- pension) assets, state and local governents wtould hav~e to pay a higher rate of interest wvhen they borrowv. saving invested in stocks, corporate bonds, and government bonds the same federal tax treatment as is now accorded to tax exempt bonds issued by state and local governments. Many state and local officials are worried that if their bonds lost their current tax advantage relative to other (non-pension) assets, state and local governments would have to pay a higher rate of interest when they borrow. the basis for their state income These concerns are unfounded. The President's tax proposals would be good for state and local governments. In particular, they would help to remedy the specific revenue losses the states have suffered from the reduction in corporate profits and the slump in the stock market. The President's saving initiatives would not make tax exempt bonds less attractive. Savers base their decisions about what assets to buy by looking at the expected real, after-tax returns. They begin with that, and then factor in risk differentials, expected inflation, and the tax treatment of the interest or dividends, and demand a high enough gross nominal return to give them the inflation and risk adjusted after-tax reward they seek. After-tax returns are made equal by the market. Taxable and non-taxable assets are priced to yield the same returns to the holders. A * * ~ 3 ~gg

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