End Deductions for Local Taxes

If they want to avoid across-the-board tax hikes and steep cuts in programs, both liberals and conservatives should be willing to back an end to federal deductions for state and local taxes.

If they want to avoid across-the-board tax hikes and avoid steep cuts in defense and entitlement programs, liberals and conservatives should be willing to come together around one proposal for, um, revenue enhancement (okay, I’ll say it. . .tax hikes):  an end to federal deductions for state and local taxes.

Some background: since the modern income tax began in 1913, the law has allowed people to take a deduction for at least some local taxes.  Right now, most individuals can deduct property taxes and either income or some sales taxes (but not both) on their federal tax returns. This deduction amounts to what the Congressional Budget Office calls a “revenue expenditure” of about $80 billion a year.  (The Committee for a Responsible Federal Budget estimates that a partial elimination -- which is more politically realistic than outright repeal -- of it would bring in about $470 billion between 2012 and 2018.)

Small-government conservatives should dislike the current deductions because they encourage higher government spending at the state and local level. Already high tax jurisdictions can raise taxes knowing that the feds will, for all intents and purposes, pick up part of the tab. Lower tax jurisdictions have less pressure to avoid raising their own taxes. Without deductibility, states would have more pressure to cut spending rather than raising taxes.  Since lower tax states, on balance, tend to be more conservative, much of the Republican base would see only minimal consequences from the end of deductibility.  Over time, total tax burden might even fall if deductibility ended.

The move also should have an obvious appeal to liberals because it’s likely to be highly progressive. Just as they pay most federal income taxes, well off people pay most state income taxes and live in homes with the highest property tax assessments. The current deduction isn’t refundable so Americans who pay no net income taxes or receive a “negative income tax” subsidy in the form of the Making Work Pay and Earned Income Tax Credits would see little or no consequence from the end of state and local tax deductibility.  Individuals in key high-tax Democratic strongholds (New York City, Chicago, Los Angeles) would pick up most of the increased tax bill but, at a minimum, it might sting less than another type of increase since withholding usually doesn’t take all deductibility into account. Instead of seeing weekly paychecks dive, individuals would see refunds get a little smaller. All-in-all, it’s a good trade.