State and Local Taxes Shouldn't be Deductible

Back at the end of 2004, the New York Times warned darkly that the Bush Administration had plans up its sleeve to abolish the deductibility of state and local income taxes on federal tax returns. And lo, less than a year later, the President's Advisory Panel on Federal Tax Refrom went ahead and recommended just that. But it never happened. Unfortunately. Maybe President Obama will be able to bite the bullet and make it happen.

Today the Congressional Budget Office released a 54-page report going into lots of detail about the implications of abolishing this deduction, which costs the federal government more than $50 billion per year. (The CBO director's blog entry is here.) Some points to ponder:

• Only about 35% of taxpayers opt to take this deduction, and they're generally rich: more than 80% of the benefits of the deduction in 2004 went to people earning more than $75,000 per year, and 16% of the benefits went to people earning more than $1 million per year.
• Eliminating the deduction would increase federal revenues by an estimated $748 billion during the 2008-2017 period.
• Replacing the deduction with a 15 percent credit would increase federal revenues by $165 billion over those 10 years, and actually increase the after-tax income of people earning less than $75,000 per year.

I've never liked the mortgage-interest tax deduction either, but right now's not the time to abolish it. The state-and-local-tax deduction, however, really makes no sense. Taxpayers should pay income tax on their income: that's what the large majority of Americans do, and that's what the rich minority should do too, if things are to be fair. Instead, more than 90% of people earning more than $100,000 per year get to lop off a sizeable chunk of their income and pay federal taxes only on the remainder.

What's more, the deductibility of state and local taxes, along with the deductibility of mortgage interest, is a large part of the problem when it comes to the Alternative Minimum Tax. If you stop people taking silly deductions which shouldn't exist, then you also obviate a large part of the need for the AMT.

It's true that the impact of this move would be asymmetrical, with New Yorkers hit particularly hard. Well, so be it. New York is a blue state: it should be happy with a more progressive fiscal regime.