US Economy

State and local tax deduction: an item blurring party lines

Patricia Cohen
A visitor looks out at the city from the top of 30 Rockefeller Plaza, in New York, March 29, 2017. President Donald Trump and House Republicans are making the latest push to end the federal deduction for state and local taxes, which would challenge longstanding tradition and powerful opponents, in wealthy and populous states.
Karsten Moran | The New York Times

To some, it is a tax on blue-state liberalism. To others, President Trump's plan to end the federal deduction for state and local taxes would eliminate a costly perk for the wealthy.

But to many taxpayers, the deduction is a cherished break that can save them thousands of dollars in double taxation.

Mr. Trump and House Republicans, riding a wave of conservative and populist sentiment, are pushing to end the provision. Yet they must overcome a long tradition and powerful opponents, including Republican and Democratic officials in wealthy, populous states like California, New Jersey, New York and Texas.

More from New York Times:
Winners and Losers in the Trump Tax Plan
How Best to Tax Business
Art of the Bluff: The Limits of Trump's Negotiation Strategy

"I don't think they're going to seriously restrict it at all," said William G. Gale, a co-director of the nonpartisan Urban-Brookings Tax Policy Center and a former economic adviser to President George Bush.

Congressional Republicans have indicated that they will go it alone on tax legislation, but taking on such an entrenched interest usually requires bipartisan support.

"If Republicans do it by themselves, they put a big target on their backs," Mr. Gale said. Members of Congress generally take a "political Hippocratic oath" to "never be seen to do obvious harm," he said, but eliminating the deduction, which would increase taxes and undermine the ability of cities and states to raise revenue, would violate that precept.

A raft of organizations that represent state and local governments — including the National Governors Association, the United States Conference of Mayors and the National Conference of State Legislatures — denounced the measure, saying it would upset the balance between local and federal interests and undermine growth. "We fundamentally believe that Americans' income, property and purchases should not be taxed twice," the organizations said in a statement.

Other interest groups have also registered their opposition, like the National Association of Realtors, which said that eliminating the state and local deduction would help "nullify the current tax benefits of owning a home for the vast majority of tax filers."

The idea of preventing the federal government from taxing money that citizens must pay to state and local tax collectors goes back to the Civil War, and the deduction was included in the first income tax legislation. One fear, articulated by Alexander Hamilton in the Federalist Papers, was that the federal government might try to monopolize taxation "to the entire exclusion and destruction of state governments."

Striking a blow at the taxing power of cities and states has long appealed to conservative Republicans. They argue that the deduction works like a subsidy and encourages states — particularly those dominated by Democrats — to set higher rates and spend more taxpayer money.

The deduction is also one of the code's most costly items. A 2016 report from the Tax Policy Center said ending of the deduction would save the federal government $1.3 trillion over 10 years.

That pot of money is particularly tempting because most of the other big-ticket items in the tax code — including the deduction for mortgage interest and charitable donations — have been labeled off limits by the White House and House Republicans.

The total cost of the president's tax-related wish list is still a mystery, given the scarcity of detail, but deep cuts in corporate and individual taxes certainly would leave a gaping budget deficit that could run into the trillions.

Like most other deductions, the state and local tax provision primarily benefits wealthier taxpayers who itemize deductions. The Tax Policy Center's report finds that households with annual incomes exceeding $100,000 would bear roughly 90 percent of the increase; those with incomes over $500,000 would absorb 40 percent. More precise calculations are impossible because other proposals — like eliminating the alternative minimum tax — would create savings for some of these taxpayers.

For example, roughly 30 percent of taxpayers itemize deductions, but that number would certainly fall if the standard deduction were increased, as Mr. Trump proposed, or if various breaks were erased.

While the upper middle class would feel the biggest hit, the wealthiest would mostly be unaffected because of limits on the value of deductions, said Edward D. Kleinbard, a professor of tax law at the University of Southern California. "People affected are those with six-figure incomes, not seven-figure incomes," he said.

What is clear is that residents in states that impose the highest combination of property taxes and individual and corporate income taxes would pay the most. Taxpayers in 10 states — California, Illinois, Maryland, Massachusetts, New Jersey, New York, Ohio, Pennsylvania, Texas and Virginia — claim more than half of the total amount deducted, according to the Tax Policy Center. (Even in some states with low income taxes, including Nevada and Washington, residents benefit because they can deduct sales taxes instead, the center said.)

The Partnership for New York City, a group of large employers, estimated that the value to New York City taxpayers of itemized deductions for state and local taxes was $7.7 billion in 2014, or $6,600 per affected taxpayer. For those earning more than $200,000, the average deduction for state and local taxes exceeded $30,000. Pressure to cut local taxes is likely to mean less spending on programs and services.

Conservatives have complained that the deduction causes low-tax, often poorer, states to subsidize high-tax areas.

But as Kathryn S. Wylde, president of the partnership, pointed out, even with those deductions, New York City still sent far more money to the federal government than it received back. City residents paid $96 billion in personal income taxes, and businesses paid $19 billion. In return, the city received about $61 billion from Washington.

In any case, she said, ending the state and local deduction would hurt states like New York most. "You can say for sure," Ms. Wylde added, "that high-tax states like New York, New Jersey and Connecticut will not get as much benefit as states like Florida," where taxes are significantly lower.