"Restoring confidence in our tax system means restoring and respecting the principle of fairness for all," President Reagan said from the Oval Office in May of 1985. "This means curtailing some business deductions now being written off; it means ending several personal deductions, including the state and local tax deduction, which actually provides a special subsidy for high-income individuals, especially in a few high-tax States."
Reagan eventually did pass major tax reform. His Tax Reform Act of 1986 cut the number of tax brackets from 15 to two, slashed the top income tax rate from 50 percent to 28 percent, and ushered in more than two decades of economic prosperity.
Unfortunately, thanks to opposition from liberals like Rep. Charlie Rangel, D-N.Y., Reagan was not able to include the elimination of the state and local tax deduction in his final bill. As a result, one of the most regressive and expensive tax loopholes is still subsidizing wasteful spending in some of the nation's most profligate states.
According to the Congressional Budget Office, "high-income households are more likely than low-income or moderate-income households to benefit from the taxes-paid deduction." In 2009, approximately 73 percent of state and local tax benefits went to taxpayers with incomes above $100,000.
Not only does the state and local tax deduction benefit Hollywood millionaires and Wall Street billionaires, but it also encourages wasteful state and local spending. According to the CBO, "The taxes-paid deduction encourages state and local governments to impose higher taxes and to provide more services than they otherwise would. ... It is not evident why the federal government should subsidize those citizens who prefer to consume more of such services. In fact, the original legislation enacting the federal income tax explicitly labeled as nondeductible local taxes paid in return for local benefits."
Not only would eliminating the state and local tax deduction make our tax code more progressive and discourage wasteful state spending, but it would actually raise more revenue than the marginal tax rate hike that Obama is now calling for. America is about to get higher taxes, because elections have consequences -- so why not do it right?
Obama's plan to raise top marginal rates on family income over $250,000 a year will raise only about $824 billion in revenue over the next 10 years. Were he to eliminate the deduction for state and local taxes paid, the federal government would raise more than that -- $862 billion.
Don't hold your breath waiting for Obama to embrace this common-sense approach to tax reform. The top 15 states that benefit the most from this exemption all went for Obama in both the 2008 and 2012 presidential election. In fact, wealthy residents in California and New York alone account for more than 30 percent of all revenue lost to the deduction.
If President Obama is truly interested in a "balanced approach" to reducing the deficit, one that "asks for the wealthy to pay a little bit more," then elimination of the state and local tax deduction would be the perfect place to start. We won't be too surprised when it doesn't happen.