Photo by FEMA/Bill Koplitz
Last month, the National Review published an article called, “Deduction of state and local taxes is a gift to high-tax states. Trump wants to end it.” In it, author Stephen J. K. Walters echoed the sentiments of many Republicans when he said that “deep-blue states have been exporting their tax burdens to more fiscally prudent jurisdictions for decades.”
So why is the tax deduction a benefit for some states when it’s the taxpayer who gets to take the discount?
First, let’s explain how the deduction works. When filing their federal taxes, taxpayers can deduct their state and local taxes and thus decrease the income they pay federal taxes on. Proponents of the deduction argue that allowing the federal government to tax the portion of an individual’s income already claimed by state and local taxes amounts to double taxation. The less income a person declares, the less tax revenue the federal government collects from them. In states with higher income tax rates, those tax deductions are more valuable.
All told, the deduction is one of the federal tax code’s most costly items. According to the Tax Foundation, it costs the feds more than $100 billion a year in forgone revenue. That’s roughly what the federal government spends on education each year.
How does this help states differently? Many fiscally conservative organizations like the Tax Foundation and the Heritage Foundation argue that the deduction doesn’t incentivize states to keep taxes low: The more a taxpayer shells out in state and local taxes, the bigger the perk on his or her federal income tax form. “The deduction allows states to raise taxes higher than they otherwise would,” argues Heritage’s Rachel Greszler and Kevin Dayaratna.
Opponents also argue the tax deduction redistributes income from people in low-tax states to people in high-tax states. That’s not quite true. The deduction certainly benefits the wealthy and upper middle class the most. According to the Tax Policy Center, 90 percent of the tax increase from eliminating the deduction would be paid by people earning more than $100,000 a year. In fact, taxpayers with incomes over $500,000 would pay for 40 percent. Many of those taxpayers live in higher-tax states like California, Connecticut and New York.
To be sure, wealthier taxpayers benefit more from the deduction. But it doesn’t mean they are doing so at the expense of lower-tax states. Many of these high tax states are the least dependent on the federal government. That is, taxpayers in these states might collectively send more to the U.S. Treasury than their state gets back in federal funding. That exchange is documented by the Tax Foundation, which shows that Alabama, for example, received $1.66 for every $1 it sent to the federal government in 2005. Connecticut, on the other hand, received just 69 cents for every $1 it sent. Illustrated more broadly, Wallet Hub’s map of state reliance on the federal government shows that more conservative states, which tend to have lower tax rates, are more likely to have a greater reliance on the federal government for funding.
Lastly, what’s the real political threat to the deduction? Most experts put low odds on the benefit being nixed. Scores of powerful governmental associations like the National Governors Association and the National Conference of Mayors have quickly banded to lobby against the proposal, terming it double taxation.
And while Congressional Republicans have said they can go it alone on tax legislation, The New York Times’ Patricia Cohen notes taking on such an entrenched interest usually requires bipartisan support. “I don’t think they’re going to seriously restrict it at all,” William G. Gale, a co-director of the nonpartisan Urban-Brookings Tax Policy Center and a former economic adviser to President George Bush, told The Times. “If Republicans do it by themselves,” he added, “they put a big target on their backs.”
Disclaimer: Please note that each investor has their own unique tax implications. Please consult your tax professional for further information.