The state and local tax deduction still distorts. Capping the state and local tax deduction was a good move, but repealing it would be even better, writes Michael Strain:
[T]he state and local deduction is a subsidy to states with large numbers of high-income individuals. Because they face higher marginal income tax rates, deductions are relatively more valuable to this group of taxpayers. (If you are in the 12 percent bracket, a deduction saves you 12 cents on your next dollar of income, compared with 35 cents if you are in the 35 percent bracket.)
Also, rich states are often high-tax states. And because states with high-income residents also have larger populations (New York, New Jersey, California, Illinois), the state and local deduction benefits places that are doing much better than many others, and distorts the tax-and-spending decisions made by these states’ governments.
Supporters of this write-off argue that it prevents double taxation — to stop the same dollar of income from being taxed by both the federal and state government, taxes paid to the state should be excluded from income subject to federal tax.
But that argument doesn’t really hold. State and local taxes are essential payments for goods and services, like schools, roads, police and fire departments, and public parks. Higher-tax states choose to provide more, or a better quality, of these services. Lower-tax states make a different choice.
Properly understood, state and local taxes don’t reduce your ability to pay federal income tax, and don’t tax the same dollar of income twice. Instead, they reflect a choice you made to live in a place in which the government provides a certain set of goods and services to taxpayers.
Residents of lower-tax states should not be on the hook for spending decisions of governments in higher-tax states.
Of course, higher-income households (many of which are located in higher-income states) do pay relatively more income tax, which is used to finance federal spending programs and transfer payments, some of which benefit citizens in other, lower-income states. Federal programs (like those that make up the social safety net) are supposed to operate this way, and the nation as a whole needs to decide how much to spend on them.
This is a separate issue from the state and local deduction, which distorts the decisions of state governments and finds citizens in one state financing the decisions of different states’ governments.
[Michael R. Strain, “Get Rid of the State-Tax Deduction Altogether,” Bloomberg Opinion, February 28]