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The one deduction worth breaking the anti-tax pledge over

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Politics,Beltway Confidential,Philip Klein

Ongoing negotiations to avert the “fiscal cliff” have renewed the debate over the influence of Grover Norquist’s anti-tax pledge, with some of the usual Republican suspects saying they’d be willing to break it. For the unacquainted, those who sign the pledge vow to, “oppose any and all efforts to increase the marginal income tax rates for individuals and/or businesses; and…oppose any net reduction or elimination of deductions and credits, unless matched dollar for dollar by further reducing tax rates.”

Generally, my view is that Republicans who were all too eager to sign the pledge not to raise taxes when running for office don’t get badges of courage for breaking their campaign promises. But, if there is one reform worth breaking the anti-tax pledge over, it’s the elimination of the deductibility of state and local taxes. It’s one of the biggest tax deductions in the federal tax code, and eliminating it would raise $862 billion over a decade, according to the Congressional Budget Office – slightly more than the $824 billion that would be generated by President Obama’s proposal to hike taxes on higher income earners to pre-Bush levels. Republicans should offer it to Democrats on a silver platter, without demanding any offsetting rate cuts.

As the Washington Examiner editorialized earlier this month, the state and local tax deduction is unfair for a number of reasons. To start, it means that Americans who choose live in low-tax states have to effectively subsidize those who choose to live in high-tax states. It also means that people who live in high-tax states are somewhat insulated from the effects of electing politicians who raise taxes to pay for more government.

The deduction also disproportionately benefits taxpayers with higher incomes. The CBO has written that, “the deduction largely benefits wealthier localities, where many taxpayers itemize, are in the upper income tax brackets, and enjoy more abundant state and local government services. Because the value of an additional dollar of itemized deductions increases with the marginal tax rate (the rate on the last dollar of income), the deductions are worth more to taxpayers in higher income tax brackets than they are to those in lower income brackets.” In 2009, according to the CBO, those who earned over $100,000 enjoyed 73 percent of the tax benefit from this deduction. An older 2007 study by the Tax Policy Center found that 53 percent of the tax hike associated with repealing the reduction would fall on those earning over $200,000.

If this deduction were eliminated, it would trigger an anti-tax revolt at the state level. Residents of high-tax states would put more pressure on state lawmakers to cut taxes. State lawmakers would now have to weigh more heavily the economic consequences of increasing taxes, because they’d be competing more fairly with lower-tax jurisdictions. To keep tax rates lower and remain competitive, they would have to consider ways to reduce spending.

As for Republican pledge-breakers in red states worried about a primary challenge? They’d be able to argue, “I don’t think our taxpayers should have to subsidize big government liberal states like Massachusetts, New York and California.

Of course, Democrats would never actually agree to this proposal, especially those representing high-tax blue states. Not even if the changes were limited to those with incomes over $250,000. But it would be absolutely hilarious to listen to their contradictory reasoning. Just as a taste, I dug up this quote from none other than Sen. Chuck Schumer, when President Bush’s tax reform panel floated the idea in 2005:

“Nothing could stifle growth and slam hard-working families in New York and around the country more than the repeal of these deductions,” Schumer said. “Thousands of dollars in added taxation will create a giant sucking sound as the best and brightest workers, and the most productive companies, face incentives to move to lower-tax jurisdictions.”

(From the Nov. 6, 2005 edition of Syracuse Post-Standard, accessed via Nexis so no link is available.)

So, let Republicans propose this method of raising hundreds of billions in revenue by increasing the tax burden on wealthier Americans, and watch Democrats squirm as they try to explain why they reject the proposal.

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