State and Property Tax Deductions Need To Go

“Those who voted for the budget and support the full elimination of the SALT [i.e., state and local tax] deduction have shown they understand the key [tenets] of pro-growth tax reform for individuals: lowering marginal tax rates and doing away with tax subsidies.”  — Adam Michel, tax policy analyst at The Heritage Foundation

One of the hot topics these days — and something President Trump is anxious to approve — is the long-awaited tax reform plan being developed in the Republican-led Congress. From what I have seen so far, the proposed plan is sort of a mixed bag — i.e., I would have liked to see income taxes simplified/reduced even more, other things eliminated that were left in or vice versa. While businesses and most middle-class families should benefit, many upper middle-income families may very well see a net tax increase. However, there is a lot to applaud, and overall I think it will have a *very* positive impact on the U.S. economy.

Prior to the unveiling of the House Republicans’ tax proposal last Thursday, I noticed several articles come out last month (mostly just last week) from The Heritage Foundation on the impact of various tax cuts (or non-cuts), and in particular from Rachel Greszler, a senior policy analyst in economics and entitlements. In short, she argues that federal tax deductions for state & local income taxes, municipal bond interest, and property taxes are bad ideas and should be eliminated. This seems counter-intuitive to a layman like me and will likely not be easy for most people to accept. But,…

Leaving property taxes aside for the moment, let’s look at SALT and municipal bond interest deductions:

“A forthcoming analysis from The Heritage Foundation will show that these state and local tax breaks amount to nearly $1.7 trillion in lost federal revenues over 10 years.

By eliminating these deductions, policymakers could reduce marginal tax rates by as much as 16 percent without losing any revenue. This would give tax relief to the 70 percent of federal taxpayers who do not itemize, and therefore receive no benefit from the state and local tax deduction.”

Greszler goes on to explain how:

  • The tax deduction encourages states to tax and spend more than they otherwise would.
  • Wealthy taxpayers receive the bulk of the deduction.
  • The state and local tax deduction benefits high-tax states.
  • The municipal bond deduction distorts infrastructure spending.
  • State and local tax deductions make federal revenues beholden to state and local government decisions.

After reading Greszler’s summarized points, getting rid of these deductions makes sense. Of course, it’s a particularly hard-sell for Congresspersons representing those high-tax states (e.g., CA, NY, NJ, etc.), which is why many of them are pushing to retain the deductions as is or perhaps somehow revised. GOP Representatives in those states are conflicted, but 24 out of the 35 voted in favor of the House bill.

(Full report with charts and graphs can be found here: “Why Tax Reform Should Eliminate State and Local Tax Deductions”.)

Similar reasoning pertains to property taxes:

“[Property tax deductions] only encourage state and local governments to raise their property taxes, hurting low and middle-income Americans[, most of whom] don’t itemize their deductions at all. This means that higher property taxes would not be offset with relief from a federal property tax deduction for many of the most vulnerable taxpayers….

While holding on to the property tax deduction would be a big win for wealthy taxpayers in high-tax states like New York, New Jersey, and California (where the average millionaire deducts $32,000 in property taxes), it would be a huge loss for most Americans because it would mean higher marginal tax rates.

If the final tax plan includes a doubling of the standard deduction, as included in current tax reform frameworks, even fewer Americans would benefit from a property tax deduction.”

Again, lawmakers from high-tax states are working very hard to keep those property tax deductions in the new plan, and a compromise may indeed be reached that does just that. Greszler commented further on the impacts of keeping the property tax deduction while eliminating other deductions:

“That would cause property taxes to gain a leg up over income and sales taxes because property taxes would remain the lone federally subsidized means of revenue collection for state and local governments.

States could relieve wealthy taxpayers of their lost income and sales tax deductions by shifting more of their tax burden onto property taxes. This would, in turn, shift part of that burden onto federal taxpayers.

But this could make it harder for middle-income Americans, especially those on fixed incomes, to become homeowners as they are less able to pay higher property taxes.

Higher property taxes could even displace existing homeowners, as unaffordable and artificially high property taxes could force them to sell their current homes.

Furthermore, keeping the property tax deduction would hurt all Americans by reducing the size of possible marginal tax rate reductions.”

Despite this, I can already hear the liberals exclaiming how mean and unfair it would be for Republicans to eliminate any of these deductions, especially for the poor souls in high-tax states. In fact, they are always screaming that the GOP favors the wealthy, but analysis of 2015 IRS data shows that “the property tax deduction is worth 22 times more to millionaires as it is to middle-income households.”

Of course, the focus needs to be turned right back on those high-tax states’ lawmakers and their own policies.

“If removing the property tax deduction (and other state and local tax deductions) would create a big burden for taxpayers in high-tax states, that’s a problem for state governments to address by lowering their tax burdens. It’s not the federal government’s job to help high-tax states compensate for their poor policy decisions.”

What’s the bottom line?

“Tax reform is supposed to be about lowering rates and getting rid of deductions and credits to help generate higher economic growth, and to let Americans keep more of their hard-earned money.”

The Heritage Foundation is known for its solid research and its conservative approach to economics and policy in general, so I tend to trust their facts and conclusions. I just hope that enough lawmakers will do so (especially Senators, who now get to amend the House Bill or propose their own), so that the best possible tax reform bill can be enacted for the benefit of Americans (and legal residents) everywhere for decades to come.

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