The continued existence of a deduction for state and local taxes is shaping up to be the most contentious issue in the drive to enact tax reform and reduction.
According to the Tax Policy Center:
Taxpayers who itemize deductions on their federal income tax returns can deduct state and local real estate and personal property taxes as well as either income taxes or general sales taxes … State and local income and real estate taxes make up the bulk of total state and local taxes deducted (about 60 percent and 35 percent, respectively), while sales taxes and personal property taxes account for the remainder. The state and local tax (SALT) deduction is one of the largest federal tax expenditures, with an estimated revenue cost of $96 billion in 2017 and $1.3 trillion over the 10-year period from 2017 to 2026. (Tax expenditures are defined as “those revenue losses attributable to provisions of the federal tax laws which allow a special exclusion, exemption, or deduction from gross income, or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.”) … about one-third of tax filers opt to itemize deductions on their federal income tax returns (figure 1), and virtually all who do itemize claim a deduction for state and local taxes paid.
High-income households are more likely than low- or moderate-income households to benefit from the SALT deduction. The amount of state and local taxes paid, the probability that taxpayers itemize their deductions, and the reduction in federal income taxes for each dollar of state and local taxes deducted all increase with income. About 10 percent of tax filers with incomes less than $50,000 claimed the SALT deduction in 2014, compared with about 81 percent of tax filers with incomes exceeding $100,000. The latter group, which made up about 16 percent of tax filers, accounted for about 75 percent of the total dollar amount of SALT deductions claimed. The average claim in this affluent group was about $12,300.
There are widely diverse views on the wisdom of eliminating the deduction.
The American Legislative Exchange Council (ALEC) notes that:
more than 100 American Legislative Exchange Council (ALEC) state legislators signed a letter to Congress urging the elimination of state and local tax (SALT) deduction … Eliminating the state and local tax (SALT) deduction would provide upwards of $1.5 trillion over the next decade to implement broad-based tax cuts nationally. This overhaul would spur the growth in economic output needed to jolt business investment, personal income growth, and job growth.
The Tax Foundation notes that:
The state and local tax deduction disproportionately benefits high-income taxpayers, with more than 88 percent of the benefit flowing to those with incomes in excess of $100,000. The deduction favors high-income, high-tax states like California and New York, which together receive nearly one-third of the deduction’s total value nationwide. Six states—California, New York, New Jersey, Illinois, Texas, and Pennsylvania—claim more than half of the value of the deduction. The state and local tax deduction in New York and California represents 9.1 and 7.9 percent of adjusted gross income respectively, compared to a median of 4.5 percent. The deduction reduces the cost of state and local government expenditures, particularly in high-income areas, with lower-income states and regions subsidizing higher-income, higher-tax jurisdictions.
The National Association of Counties takes a contrary view.
Those favoring the move ask why frugal states should subsidize high-spending states that show lesser fiscal prudence. They note that the overall reduced federal tax rate made possible in part by eliminating the deduction would more than make up for any burden placed on those in high state and local tax states. those opposing removing the deduction point to the burden that would be placed on residents in high-tax states who would, in essence, pay double taxation.While finance plays the central role in the debate, differences in philosophy about what government should do, and the relationship between the states both amongst themselves and Washington is also a key to understanding both points of view. Interestingly enough, the lines blur sharply and don’t necessarily follow typical liberal vs. conservative or Democrat vs. Republican lines. Some conservative GOP leaders might believe that the federal government shouldn’t have a deduction that, in essence, forces his or her constituent to pay for the expenses of another state government that their constituent has no voice in electing, and for programs in those other states that they object to. One example comes from New York City, where, as noted for the New York Post, Mayor de Blasio is spending $3.5 million a year to spare thousands of repeat offenders a trip to [jail] instead sending them to group counseling and job-readiness workshops …The program—quietly launched this month in Manhattan, Brooklyn and The Bronx—lets recidivists avoid jail time by spending as little as one day undergoing ‘motivational interviewing’ and psychological ‘interventions.”Another conservative perspective, however, could be that Washington shouldn’t usurp the financial abilities of states to tax their own citizens by also taxing the same income already taxed. Similarly, many liberals, who believe that Washington should have a more direct role in governance, might believe that eliminating the deduction gives the federal government more revenue for nationwide programs. Others on the left note that the higher spending states generally spend more on their favored social welfare programs, and should not be hampered by eliminating the deduction.While proponents of either perspective have voiced passionate arguments, the potential of compromise is high. There could be a maximum amount of taxes that could be deducted, so the highest-spending states would not be able to have a massive advantage over lesser spending states. Another alternative in discussion concerns ending or limiting the deduction for higher earners.
Deductibility of these taxes prevents double taxation, since state and local taxes are mandatory payments. States and local governments deploy revenues from state and local property, income, and sales taxes to finance infrastructure projects, local law enforcement, emergency services, education costs and many other services. Deductibility allows state and local governments to maintain authority over local tax structures supporting these services. Eliminating or capping federal deductibility for state and local property, sales, and income taxes would represent double taxation on American taxpayers, a principle strongly rejected throughout the rest of the tax code. Additionally, by eliminating federal deductibility of state and local taxes, Congress would shift the intergovernmental balance of taxation and limit state and local control of our tax systems.