Tax Analysts Blog

Time To Get Rid of the Deduction for State And Local Taxes

Posted on Dec 12, 2012

Since the federal government needs money, here is a quick way to pick up about $70 billion -- eliminate the deduction for state and local taxes. My friends in blue states won't like that. But it is the right thing to do. Here are a few reasons why. First, eliminating these expenditures is consistent with good tax policy. A good tax system is based on a broad base and low rates. Anyone who says otherwise is misinformed. Second, like most tax benefits, state and local deductions inure to the wealthy. In 2009, 73 percent of the deduction's benefits went to taxpayers with annual incomes above $100,000, according to the Congressional Budget Office. And an astonishing 20 percent went to taxpayers with annual incomes above $1 million. If the liberals want to hit the rich here is their chance. Third, the deductions are essentially a subsidy to state and local governments. They allow states and cities to raise taxes and have some of the burdens borne by taxpayers in other states. Why should I, a resident of Virginia, be subsidizing higher taxes in New York? If New Yorkers want more government let them pay for it. Fourth, this break is hardly universal. As noted, the rich make out like bandits. Seven states account for 90 percent of the state and local tax deductions -- New York, New Jersey, California, Pennsylvania, Maryland, Illinois and Massachusetts. It is hardly a break enjoyed by most Americans. The folks in the rest of the country won't be crying so much.

Now it's true that some states -- well seven actually -- will face some tough decisions if the deductions are eliminated. Their citizens may demand lower taxes and resign themselves to fewer government services. But that would square with honest and efficient government. If you want a lot of government, you should be willing to pay for it. If you are not willing to pay for it, you should not enjoy the benefits. Some people will make the argument that state and local taxes are not voluntary payments and thus reduce disposable income. Let's test that flawed argument. I suspect if people in New Jersey actually had to pay the full cost of government they would demand less. Their taxes would be reduced. I would say that the level of taxes they pay is well within their control.

Read Comments (6)

West Coast OffenseDec 11, 2012

I thought SALT people loved this deduction. Guess I was mistaken. As I
understand it, eliminating this deduction would help shrink the tax-base
differential between the conventional income tax and the AMT. Is that correct?
Also, is there some sort of master plan afoot to gradually bring the income tax
base closer to the AMT base via a series of incremental measures such as this?
And if there isn't such a plot, should there be? How low could they get our
marginal rates if we put the whole darn country on AMT?

Vivian DarkbloomDec 12, 2012

Good article, Mr Bruni.

You wrote:

"In 2009, 73 percent of the deduction's benefits went to taxpayers with annual
incomes above $100,000, according to the Congressional Budget Office. And an
astonishing 20 percent went to taxpayers with annual incomes above $1 million.
If the liberals want to hit the rich here is their chance."

Just to be clear, the deduction for state and local income taxes (much like the
exemption for interest on certain state and local debt instruments) does not
*solely* inure to the wealthy. As you point out, it is also a subsidy to state
and local governments. Thus, the benefit inures indirectly to other citizens
and well.

Also, as West Coast alludes to, state and local taxes are not deductible for
purposes of the AMT. This reduces somewhat the benefit of that deduction to
wealthier (not solely rich) taxpayers. Finally, if the Pease phase-out rules
are re-introduced, those rules would eliminate 80 percent of the deduction for
the highest income taxpayers (and the combined effect of AMT and Pease would be
even more dramatic). Note that in 2009, the year cited above for the
distribution of the deduction benefit, the Pease rules where 2/3 phased out (a
phase-out of phase-out!!)

How much the current deduction benefits the "non-rich" is not entirely clear.
If the response to the loss of the deduction would be a taxpayer revolt
against effectively higher state taxes (primarily by itemizers) then *their
state and local taxes* would need to be lowered in response and spending along
with it. Given our unique federal/state/local tax system, it's not clear who
taxpayers would choose to revolt against. Against state and local governments
whose taxes are effectively higher due to the loss of a*federal* deduction? Or
against the federal government for eliminating a deduction that has a very long
history? (the deduction for state and local taxes has existed since 1913,
scaled back in minor fashion in 1964 and only in 1986 was the deduction scaled
back to include only state and local income and real property taxes).
Recently, with the re-introduction of limited deductibility for sales taxes, we
seem to be going in the opposite direction.

But, I'm with Bruni. Eliminate this deduction for everyone (and also eliminate
the tax preference for interest on certain state and local obligations) rather
than re-introduce complicated phase-out rules. Federal tax policy should not
be dictated by what state and local governments decide to do with policies at
that level.

Better yet, let's simplify things even more and have a combined federal/state
income tax system. States should decide which rates to tax and simply have
this as a surcharge on federal income tax return (this is now done in some
states but with duplicative bureaucracies). Enforcement and collection can
then be combined in a federal/state partnership located geographically at the
state level. Only one return and one combined enforcement and collection
agency closer to to where taxpayers reside. That's much cheaper and more
efficient for everyone. But, that probably makes too much sense.

Vivian DarkbloomDec 12, 2012

Sorry, in the prior post mis-spelled your name, Mr. Brunori. I must have been thinking of Carla Bruni who does not resemble you one bit.

David BrunoriDec 12, 2012

Vivian Darkbloom, That is funny because I am often mistaken for Carla Bruni.

David BrunoriDec 12, 2012

Vivian and West Coast, Excellent points made. I would support an AMT only system with a big exemption and no deductions. Michael Graetz proposed such a plan (I think with a $100k exemption). But he ruined it for me with a call for a VAT. Still good tax policy dictates broad bases and low rates. Keeping the salt deduction makes it harder to get there.

Heard But Not SeenDec 13, 2012

If GOP insists on limiting new revenue sources to 'base broadeners' (rather
than Obama's rate increases) then maybe they should throw their party's weight
behind a mass expansion of AMT to the middle class.

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