Why Eliminating The State And Local Tax Deduction Is A Terrible Idea

Authored by Ryan McMaken via The Mises Institute,

The tax "reform" currently being discussed in Washington is mostly a political exercise for politicians who can use the process to extract more campaign contributions from supporters, and punish non-supporters. The actual tax burden imposed on Americans overall will change little.

The proposed elimination of the deduction for state and local taxes (SALT) is an excellent illustration of how the tax reform is really about playing political games. Forever in pursuit of "revenue neutral" tax reform, the GOP is simply turning to the elimination of the SALT deduction so it can raise federal revenues, and this allows for a tax cut for some other well-heeled special interest group. Using bizarre "logic," supporters of the deduction's elimination claim that an increase in the federal tax burden will somehow lower state and local taxes — some day. Why? They imagine that if they raise federal taxes for people in states with high taxes (i.e., California, New York) then the majority of voters in those states will then be clamoring for a cut in state and local taxes. The GOP also relies on the tired claim that that a tax deduction (e.g., the home mortgage interest deduction) "subsidizes" those who claim the exemption. But only in the Orwellian world of Washington doublespeak is a tax break a "subsidy."  Moreover, given that states like California and New York are among the least reliant on federal funds, claiming that taxpayers there are "subsidized" by the rest of the country is an odd claim indeed.

There are several problems with this approach...

First of all, the SALT  deduction — like all federal tax increases —  will drive ever more tax revenues to the federal government, putting more power, both in relative terms and absolute terms, in the hands of the federal government. This is one reason federal tax increases are even worse than state and local tax increases. They skew political power in the US ever more toward the federal government. By increasing the federal government's share of all tax revenues collected, the federal government will also then be in a better position to manipulate state governments and state policymakers with federal grants. The federal government does this today by using federal highway funds. As the old saying goes, "he who pays the piper calls the tune." 

An additional problem is that the elimination of the deduction is specifically aimed at increasing federal power at the expense of state and local power. There is no doubt that some conservatives and libertarians will cheer this. For many of them, the federal government and the county government are pretty much the same thing. In their minds, a Congress of out-of-touch millionaires 2,000 miles away is more or less the same thing as — or maybe even preferable to — a cash-strapped local government headed by middle-income part-time legislators.

This naive attitude is totally understandable for those who have never witnessed the very real differences between Washington politics and the politics of the local city council. But, there is a reason that subsidiarity and decentralization in politics have long been foundational elements of libertarian ideologies. Decentralization weakens political institutions, increases options for taxpayers, and contributes to a more vibrant private sector. 

The GOP's efforts at eliminating the state and local tax deduction works in the opposite direction. The reform's likely effect will be to further federalize the tax burden while making states more reliant on federal programs and federal grants. 

Americans Pay Most of their Taxes to the Federal Government 

At the core of the GOP's drive to eliminate the SALT deduction is the assumption that state and local taxes are "too high" while federal taxes are apparently either just right, or even too low.  

But, it's hard to see how anyone could come to the conclusion that the federal tax burden is the more harmless piece of the puzzle. The federal government already — by far — receives the largest share of the tax revenue pie.

revenues1.png

If we look at how much Americans pay to each level of government, we find that the federal government receives approximately two-thirds of all tax revenue, while only one third goes to state and local governments — combined.

In 2016, the federal government collected more than $3.4 trillion dollars in revenue via income taxes, customs duties, fees, and revenues from federally-owned lands. 

State governments, on the other hand, collected only $1.1 trillion in revenues. Local governments pulled in even less, with under $800 billion in revenues.

What the GOP is now telling us is that the federal government's huge share of the pie is too small, and federal revenues ought to be increased further via elimination of the deduction. This, we're then told, will lead to declines in state and local taxes. 

The GOP doesn't mention, naturally, that state and local governments are already falling in their share of overall tax collections. 

During the current economic expansion, the share of local tax collections — as a percentage of all tax collections — dropped from 17 percent to 15 percent. State tax collections meanwhile dropped from 22 percent to 20 percent. The federal government's share of the pie, however, increased from 60 percent to 64 percent. 

The federal government now controls nearly two-thirds of all revenues paid into governments in the United States, and if current trends continue, we may soon see the feds in control of 70 percent, or maybe even three-fourths of all tax revenue. 

If this is the GOP's plan, this is a rather odd position to take for a political coalition that claims to be in favor of "local control" and decentralization and federalism. In reality, the outcome of this war on the SALT deduction is to make the American political system even more dominated by federal power. 

Federal Revenues vs. State Revenues 

Even in high-tax states, the federal government plays a disproportionately large role in tax collection.

If we compare state tax collections to IRS collections in each state, we find that taxpayers pay much more to the federal government than they pay to the state government. 

taxrev1_0.png

In California, for example, the federal government collects $405 billion from California taxpayers. The state government, meanwhile, collects $155 billion. Federal revenues in California are more than two-and-a-half times as large as state-level revenues. 

In many states, of course, the results are even more lopsided. 

In Minnesota, for example, federal revenues are more than four times the size of state revenues. In Colorado, federal revenues are more than three times the size of state revenues. 

We don't have data on specific local revenues here, but given that local revenues make up only 15 percent of tax collections nationwide, its a safe bet that federal taxes are considerably larger than local revenues in most cases. 

And yet, to hear the GOP tell it, its state and local taxes that are imposing the real burden on Americans. Their solution? Pay more taxes to the federal government! 

Decentralize the Taxes 

None of this is to say that state and local taxes are a good thing. There is no shortage of waste, corruption, and cronyism at the state level — but compared to the federal government the dollar amounts are tiny in state-level boondoggles. 

Nevertheless, the diversity of tax regimes across states and localities has long been one of the good things about the relatively decentralized political system in the United States. 

As we've already been seeing, this reality has allowed countless productive Americans to vote with their feet and to move from high tax jurisdictions to low tax ones. This phenomenon thus imposes pressure on many jurisdiction to keep taxes low compared to other nearby jurisdictions. This is known as "tax competition" and it results only when states and localities have considerable autonomy over their tax rates.

Unfortunately, tax competition is restrained by the fact that tax revenues in the United States are primarily a federal matter. Taxpayers thus have far less power to change their tax fortunes by moving across state lines that would be the case in a truly decentralized system. 

The downside to local autonomy, of course, is that some states and localities will have especially high taxes. The solution to this, of course, is to avoid investing in those areas until tax competition is sufficient to force more restraint on tax rates. 

Raising federal revenues via eliminating the SALT deduction — as the GOP seeks to do — is hardly any sort of solution at all. Indeed, Congress should be moving in the opposite direction. Instead of eliminating the deduction, Congress should substitute a tax credit instead. Every dollar that state and local taxes increase would lead to an equal drop in federal taxes. Then, we might start to see some real diversity in tax burdens across the United States. 

In reality, we're seeing quite the opposite. Our current situation is made worse as federal taxes make up a larger and larger share of the overall American tax burden. This leads to greater homogenization of tax rates across the United States, which makes it even harder to escape from especially bad tax policy. If the tax burden is ever "equalized" across all states, then taxation will all simply be equally bad nationwide, and moving across state lines will bring no relief.

Comments

johngaltfla tmosley Thu, 11/30/2017 - 19:09 Permalink

Amen. A truly dissapointing view from the allegedly Mises philosophy on taxation. No individual or corporation should receive any type of break from the Federal Government based on geography, need, or other factors.This clown sounds like a whiny Northeast/Commierfornia Liberal who thinks that his shit is special, compared to the rest of us of course.

In reply to by tmosley

greenskeeper carl tmosley Thu, 11/30/2017 - 19:43 Permalink

It would likely lead to an exodus of people from these high states. One point McMacken seemed to miss is that these states only get away with these exhorbinately high tax rates is because people ARE allowed to write the taxes off. That does, indirectly, mean that places with low or no state income tax subsidize these states. Again, if people weren't allowed to write them off, they'd be a lot less likely to live there and pay them. I do get the argument that the blue states pay for a lot of the red states, but theres a very important little fact that is NEVER mentioned when telling that story. States like MA and LA get the most of any states in handouts from the federal government, thats true, but thats because those states have the highest percentages of black people in the country. No state with that many blacks is NOT going to be poor. 

In reply to by tmosley

you enjoy myself greenskeeper carl Thu, 11/30/2017 - 20:31 Permalink

Mises isn't even thinking ahead.  Not only does the SALT deduction allow blue states to get away with insane rates at the state and local level, it allows some percentage of their citizens to not feel the pain of voting blue at the national level.Take a state like NJ.  It's high-income, high-tax, and blue.   But it's not landslide blue.  At least 5% of their citizens will change their voting behavior if they now have to start paying for the true cost of goverment.  Sure, some will move.  But not everyone can just pick up and leave their jobs, homes, family, etc.  So they're stuck, and now pissed.  And that anger will start being directed at *both* the state and federal pols.It'll happen at the margins, but those margins are more than enough to tip states like NJ, FL, OH, PA, even IL, to red.  If you're making more than $60k you were already getting screwed by taxes.  But maybe you could deal with an overall 35% burden.  What happens when that jumps to 45%, 50%?  The rational response is to go after anyone and everyone responsible for that rate.  And, realizing that odds are low your state is suddenly going to 0%, you start voting in different people in your national elections too.  

In reply to by greenskeeper carl

Citizen_x you enjoy myself Thu, 11/30/2017 - 22:22 Permalink

Trump came into office full of bluster and stopped  TPP.https://www.nbcnews.com/business/economy/why-trump-killed-tpp-why-it-ma… not one word about eliminating corporate tax loop holes or corporate welfare reforms, Trump is instituting much of the TPP perks and having the tax payer foot the bill. Look up ExxonMobil profits and  the amount of federal tax paid.  Look up how little taxes Amazon paid in 2016 versus Walmart.  Without corporate welfare, no one buys a Tesla, no one buys First Solar solar panels.  But the mortgage interest credit was put back in faster than the campaign contributions checks were signed.  Hmm, I guess we know who is in charge, but hey, let's have a war.  That will cheer us up.The next election cycle you will have a choice of the scumbag on the left or the thief/perv on the right.Wake up people. 

In reply to by you enjoy myself

SeaMonkeys Citizen_x Thu, 11/30/2017 - 22:47 Permalink

What you say requires too much dispassionate thinking for ZeroHedgers.Too many readers here are just Republican snowflakes looking to beat up the "other side." They are too intoxicated with mass psychological group think to realize that both parties are corrupt.There is no "other side." Both sides are feeding off of the American people. ZeroHedge is not a libertarian website. Not in the least. It's a joke.

In reply to by Citizen_x

Buckaroo Banzai HockeyFool Thu, 11/30/2017 - 18:46 Permalink

"The tax "reform" currently being discussed in Washington is mostly a political exercise for politicians who can use the process to extract more campaign contributions from supporters, and punish non-supporters."Ha ha, no shit, tell us something we don't know. Politicians love the income tax because it's a great way to reward your friends and punish your enemies. King Nigger probably did that better than anybody, he turned the IRS into a finely-tuned political weapon.If you want to advocate for change, advocate for the elimination of the income tax, and replace it with something else that is less subject to political manipulation, like excise taxes. Otherwise, STFU.

In reply to by HockeyFool

ChinaCatRider HockeyFool Thu, 11/30/2017 - 20:38 Permalink

 I don't get to deduct my property taxes, why should high tax libtard state residents get to? The coastal blue states subsidize all those red states sucking up at the Federal trough. I get 75 cents back for every federal tax dollar I send. Those republicant red states are sucking up $1.30 for every dollar they get taxed. Make a deal, guarantee that 95% of the taxes go back to the states who deliver it and THEN repeal the SALT deduction. 

In reply to by HockeyFool

heavens-door Lost in translation Thu, 11/30/2017 - 21:29 Permalink

That is so wonderful to read.  You don't even know the trouble we went through wondering how much our upper classes could screw a poor worth nothing fellow like you over.  At first it was only a theory that we could tighten your screw as much as we want so long as you can see your "enemies" squirm as well.  Now we know it's real.  You don't even want to know the amount of coffee (rife with pinkies in the air) our upper classes drank staying up late, coming up with ways to convince you poor-have-nothings that your fellow American poor-have-nothings were your enemy. You people really like your political, religious, and race cliques, we the upper classes, group you into.  From my vantage point it's like watching so many monkeys fling turds at each other. Hilarious.

In reply to by Lost in translation

Bernie Madolf takeaction Thu, 11/30/2017 - 19:11 Permalink

Dude just incorporate as an scorp (need 1 other owner with 0.00001% so it's not a disregarded entity) and lease your house from the scorp. Create another LLC to 'manage' the other LLC and expense your heart out.

Tadaa, you can also now enjoy a depreciation expense to further reduce any income and amortize any bank charges

Most super wealthy have no assets in their name

In reply to by takeaction

Ecclesia Militans Thu, 11/30/2017 - 18:35 Permalink

Progressive income taxation has been in effect for how long and you're just now figuring out that it's political gamesmanship?I audited the Department of Treasury's Bureau of Public Debt back in the late 90s, major trust funds (including the Highway Trust Fund.)  The enabling legislation for the Highway Trust Fund capped total assets at $80B and the government was clearly collecting far more than that - all the excess went into the General Fund and was used for things like foreign military cooperation and more farm subsidy programs than I can recall.  I even remember the "Rural Telephone and Electrification Act" which was still being continuously funded after it was passed back in the 1920s.Tax is theft.

razorthin Thu, 11/30/2017 - 18:36 Permalink

Exactly, don't take it out on me.  NYS will in-turn fuck me in the ass but good and soon enough.  Take it up with my liberal state directly.

socalbeach Thu, 11/30/2017 - 18:40 Permalink

I don't have a problem with liberals in CA and NY paying about the same, and other more conservative states paying less.  Shouldn't the higher personal deduction and lower tax rates more than offset the loss of the SALT deduction, on average?

Dumpster Elite razorthin Thu, 11/30/2017 - 19:10 Permalink

Same state, but at the other end. I don't think people here realize how hard we're gonna get hit by this. Gonna cost my household plenty. Our Rep. is a Republican, and loudly supports this. He will not be re-elected, guaranteed. Already are calls for his head on a platter here. And do you think that Cuomo will do ANYTHING about this, other than raise our State taxes even more? Unfortunately, in this State, however NYC goes, so does the State. No getting around it. And when 65% of those residents are illegals and/or don't speak English other than "do you take SNAP?", it's a sad situation. When the last of our kids is out of the house, we are so done with this State. Very sad though, because we live in a beautiful area.

In reply to by razorthin

ChinaCatRider Dumpster Elite Thu, 11/30/2017 - 22:39 Permalink

Upstate NY is a great place to live except for the weather and taxes. I spent 30 years there.I agree with you. The coastal states are gonna remove anyone who votes for this piece of shit tax plan. Conservatives vote thier wallet and any republicant who votes for this plan will be out of office. Thier financial backers will be taking it up the ass and leave the state. 

In reply to by Dumpster Elite

silentlurker Thu, 11/30/2017 - 18:41 Permalink

I am (sadly) a California resident. Eliminating the SALT will act as a wakeup call to the locals who never met a local bond/tax measure that they could not pass overwhelmingly.The SALT deduction essentially masks their bad behaviour (net neutral to the resident), now, each new tax means additional (new) money from their pockets - a great teachable moment for them.(Sadly I am also affected by these idiots and their silly spending)

Quivering Lip Thu, 11/30/2017 - 18:42 Permalink

"First of all, the SALT  deduction — like all federal tax increases —  will drive ever more tax revenues to the federal government, putting more power, both in relative terms and absolute terms, in the hands of the federal government. This is one reason federal tax increases are even worse than state and local tax increases. They skew political power in the US ever more toward the federal government."Exactamundo!!And I always thought the Republicans were for a smaller Central government. Silly fucking me taxation without representation is the way the Central Government works and has worked for at least 104 years.