“Here’s the simple pitch. If you and I make the exact same amount of money, we live in the exact same value of house, we have the same kind of car, our kids go to the same kind of schools, shouldn’t we pay the same federal income tax? The answer is yes, but the real world is no. If I live in a high tax state and you live in a low tax state, you actually pay more towards the federal government than I do. And that’s just not fair. It’s not right.”
–White House budget director Mick Mulvaney, interview on Fox Business Network, Sept. 29
Tax policy is often complicated. In pitching the Trump administration’s plan for eliminating the deductibility of state and local income taxes, officials have gone on television with a few simple messages about ensuring fairness in the tax code – across states and among taxpayers.
For many people, these talking points might be confusing. So here is a guide to what they mean – and what’s missing in the pitch.
Why can state and local income taxes be deducted?
This has been a feature of the U.S. tax code from the beginning. A Civil War income tax bill passed in 1862 included this provision, and then it became part of the code more than a century ago after the Constitution was amended to allow for an income tax. Over the decades, various presidents or lawmakers have attempted to do away with it – most notably Ronald Reagan as part of the 1986 overhaul – but the efforts have always failed.
Amusingly, among tax wonks, this is known as the SALT deduction.
Who benefits from it?
Generally, wealthier Americans.
Every taxpayer has a choice of taking either a standard deduction or to itemize deductions, which in addition to state and local taxes can include mortgage payments, charitable contributions and medical expenses above a certain threshold. For most people, especially those who do not own their homes, the standard deduction is larger than itemized deductions – and Trump administration proposes to boost the standard deduction. Currently, about 30 percent of tax filers opt for the itemized deduction – and virtually all take the SALT deduction, according to the Tax Policy Center. Among taxpayers making more than $100,000, 81 percent claimed the SALT deduction.
With itemized deductions, the value of the deduction increases as you move into a higher tax bracket. So $1,000 in deductions would be worth almost $400 to someone in the highest tax bracket but only $250 for a taxpayer in the 25 percent tax bracket.
The alternative minimum tax (which Trump also proposes to eliminate) takes away this deduction from many wealthy taxpayers. (The AMT also takes away the personal and dependent exemption – something else Trump has pledged to eliminate). If the SALT deduction and the dependent exemption were eliminated from the AMT, the number of tax filers facing the AMT would drop by 95 percent, according to the Joint Committee of Taxation.
Still, most taxpayers who are hit with the AMT benefit from the deduction. The Tax Policy Center “found that 75 percent of AMT taxpayers nationwide would pay higher tax under current law if both the SALT deduction and the AMT were repealed,” said Frank Sammartino, an Urban Institute senior fellow who is an expert on the SALT deduction.
What’s the argument for the SALT deduction?
Proponents say without the deduction, taxpayers face double taxation. That’s because without the SALT deduction, taxpayers are paying taxes on income that has already been given to the state or local governments in the form of taxes. The income tax rate in California is as high as 13.3 percent and in New York 8.82 percent. If you live in New York City, there’s an additional income tax rate as high as 3.876 percent, for a total of nearly 12.7 percent.
In fact, when individual tax rates were as high as 92 percent (in the 1950s and 1960s before the tax cuts proposed by John F. Kennedy), in theory a person would have faced the prospect of taxes higher than 100 percent if there had been no SALT deduction.
Since higher-income people can write off part of their tax, it also encourages states to make the tax code more progressive. A $1,000 increase in taxes does not bite as much if someone can reduce it almost to $600 because they are in a 39.6 percent tax bracket.
Why does Mnuchin say the federal government is subsidizing states?
In 2017, the SALT deduction is estimated to reduce revenue to the federal government by nearly $60 billion. (Deducting property taxes, which Trump also wants to kill, reduces revenue by another $36 billion.) So he’s saying that a high-tax state benefits more from this provision than a low-tax state, and in effect gets more back from the federal government than low-tax states.
McCarthy put it another way – that the low-tax states are subsidizing the high-tax states because the taxpayers in those states can’t deduct as much from their taxes. Indeed six states—California, New York, New Jersey, Illinois, Texas, and Pennsylvania—claim more than half of the value of all state and local tax deductions nationwide, according to IRS data. (Texas has no state income tax.)
As it happens, the high-tax states also tend to be the wealthiest states – and also blue states in presidential elections. Under this particular provision, one could perhaps make the case that they are being subsidized by low-tax states. But when you step back and look at the total revenue and spending picture, blue states could make the case that they are subsidizing other states, as various reports show they receive far less in federal spending than they pay in federal taxes.
A report released on Oct. 3 by the New York State Comptroller said that New York generated 9.4 percent of the federal government’s income-tax receipts, even though it represented 6.1 percent of the U.S. population. It received 5.9 percent of federal spending allocated to the states. According to the report, New York contributed $12,914 per capita in tax revenue to the federal budget — but received $10,844 in per capita federal spending. The problem has only gotten worse in the three years since the report was last produced, state officials said.
“In New York state, the idea that we are being subsidized by other states holds no water,” Deputy New York Comptroller Robert Ward said in an interview.
Another report, released in September by the Rockefeller Institute of Government, had similar findings. Rockefeller calculated that New York made payments of $12,820 per capita, or $3,401 higher than the national average, while federal spending in New York was $10,395 per capita, $329 lower than the U.S. average.
Yet another calculation was done by the financial website WalletHub, which shared its calculations of the mismatch between federal taxes contributed by states and the federal spending received. Again, the wealthier, bluer states tended to fare worse on their return on taxes paid.
New York gets 56 cents back for every dollar and California gets 64 cents. But states such as North Dakota, South Carolina, Alabama, Kentucky, West Virginia and Indiana get more than two dollars back in federal spending for every dollar in taxes. (There are some outliers: New Mexico, which votes for Democrats, gets nearly $2.50 back for every dollar, while Nebraska and Ohio, both Republican, get back only about a half-dollar.)
Should people in the same house in different states be treated the same?
Mulvaney, in his TV appearance, offered this example: “We live in the exact same value of house, we have the same kind of car, our kids go to the same kind of schools, shouldn’t we pay the same federal income tax?” This would be a more compelling argument if the administration had not exempted the mortgage-interest deduction from its drive to make the tax code simpler. Note that Mulvaney carefully said the “exact same value” house — even though such houses would vary greatly from state to state, as does the cost of mortgages.
The mortgage-interest deduction is estimated to reduce federal tax revenue by $64 billion in 2017.
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