THE GOVERNORS, or some of them, contend it wouldn't be fair to increase federal revenues by capping the deduction now allowed for state and local income taxes, as the Bush administration is said to be considering. They argue that in the budget-cutting of recent years, the state and local sector has already borne more than its share.
This would compound the problem by making it harder for those state and local governments reliant on progressive income as distinct from regressive sales and property taxes to raise their rates, since the federal government would no longer be fully cushioning the increases. The states even now are having to satisfy more federal mandates with less aid, the governors say. That is the reverse of what they mean by healthy federalism; they want the federal deficit reduced at some other sector's expense.
The lament is true in part -- that many states are under great financial strain, for example -- and it would be wrong if this were the only or major revenue-raiser in the final federal plan. But no tax increase is going to fail to provoke complaints, and our sense is that the administration's proposal, still not formally made, is to be treated much more as a metaphor for the kind of tax increase the administration would prefer than as a firm demand or indicator of where it expects the negotiations to end up.
The fairest, easiest way to increase federal revenues would be to steepen income tax rates. The administration resists this; the lower rates that the Reagan administration achieved are a major Republican symbol. The administration has turned instead toward excise tax increases (and a beer increase was included in its unmade proposal), but these have the disadvantage of being regressive. For distributional balance while retaining the low Reagan rates, it has therefore also reverted to the idea of capping or, as income rises, phasing down income tax deductions.
This is an intriguing idea no matter what is done with rates. The current deductions and exclusions are upside-down subsidies. The higher a person's income and the larger his house and mortgage or more generous his employer-paid health insurance plan, the larger the federal subsidy he gets for housing and health care. That's backward, and in fact a rate increase would only make the unfairness worse. It wouldn't hurt to leave higher rates as a counter to and weapon against the regressive capital gains tax cut that the president also wants.
The state sales tax deduction was lost in the federal reform act of 1986. The income tax deduction as the administration proposed it would not be lost entirely. The cap would only affect those with the highest incomes; a state could raise its income taxes with about as much (or little) impunity as now. A cap could indeed turn out to be unfair; that would depend on how it was drawn, and the broader package of which it was a part. But it's much too early in the negotiating process to brush the idea off entirely.