Most members of the Senate Finance Committee returned from their weekend tax retreat willing to consider a partial limitation on the deduction for state and local taxes as a means of raising revenue to preserve other deductions.
Senate Finance Committee Chairman Bob Packwood (R-Ore.) said there was support for eliminating the deduction for state sales taxes and personal property taxes, while retaining the deduction for real estate taxes and, perhaps, for state income taxes.
"I personally was very surprised that there was an overwhelming majority for some compromise in that area," said Sen. Charles E. Grassley (R-Iowa), who opposes limiting the deduction for any state and local taxes.
Senate tax writers may find, however, that state sales taxes are a more politically potent issue than they seem at this early stage in the tax deliberations.
Repealing the deduction for those taxes would have widely differing regional impacts, and well could raise far less revenue than the $17 billion to $20 billion estimated over the next five years, because states would restructure their tax systems to rely more heavily on deductible taxes.
"We feel that, in some ways, this would be the worst of all possible worlds," said Earl Mackey, executive director of the National Conference of State Legislatures. "States are facing substantial reductions in federal funds. . . . When it comes to financing these reductions, the federal government is going to dictate to us how we would raise the revenue." The NCSL and other state-government organizations are preparing to lobby against the proposal.
State and local officials also see ending sales-tax deductibility as the first step in ending deductions for other state and local taxes.
John Shannon, executive director of the Advisory Commission on Intergovernmental Relations, which has no official position on ending tax deductibility, said, "I would imagine most of the folks manning the ramparts would have that fear, that it's just a question of time before somebody else looking for more revenue would move in and say, 'Let's do away with the real estate or the personal income tax' " deduction.
Eliminating the deduction for personal property taxes, which are levied in relatively few states, including Virginia, is seen as a less significant precedent.
The Senate Finance Committee begins hearings on the House bill today, with economists expected to testify for and against the legislation.
Curtailing the sales-tax deductions would have virtually no impact in the four states that do not have sales taxes. Among them: Packwood's home state of Oregon, where candidates for state office have been defeated for advocating sales taxes. Oregon municipalities also do not impose sales taxes. Income taxes in Oregon are relatively high.
On the other hand, almost 69 percent of the revenue that Louisiana -- the home state of ranking committee Democrat Russell B. Long -- receives from the deductible sales, income and property taxes comes from sales taxes.
Texas, the state of second-ranking Democrat Lloyd Bentsen, gets 44.3 percent of its federally deductible revenue from sales taxes and has no income tax.
Long is expected to have a large say in the writing of the tax plan, which the committee will use as a starting point for its deliberations, and he prefers an overall cap on state and local tax deductions to terminating the sales tax write-off. Other committee members such as Grassley, Daniel Patrick Moynihan (D-N.Y.) and David Durenberger (R-Minn.) oppose any change.
The House Ways and Means Committee flirted with partial restrictions on the deduction for state and local taxes, but left all taxes alone in the measure that was approved by the House in December.
The deduction for sales taxes has been around since the income tax was enacted in 1913. But tax experts point out that not every state tax is deductible from federal taxes. The deduction for gasoline taxes was terminated a few years ago, for example. Moreover, the 65 percent of taxpayers who do not itemize their deductions get no advantage from any of the deductions for state and local taxes.
President Reagan's own tax-overhaul proposal, which was sent to Congress last spring, said "elimination of any one tax deduction would have an uneven effect on taxpayers among the states. In addition, because state and local governments would be likely to increase reliance on the remaining deductible taxes, disallowing deductions for particular taxes is likely to lead to sizable distortions in state and local revenue mixes."
Administration officials now say they are willing to accept ending the deductibility of only some state and local taxes. Their goal is to bring in more tax revenue to "pay" for the business investment write-offs, higher personal exemption and lower rates that Reagan wants.
But the cost of those tax changes -- at least $50 billion over five years and probably more -- far exceeds the revenue gained from ending the sales tax deduction. Aides pointed out yesterday that ending the sales tax deduction would just about cover the cost of retaining current tax treatment of the timber and oil and gas industries, favorites of Packwood and Long.