Best part of Republican tax plan is repeal of the state tax deduction

Best part of Republican tax plan is repeal of the state tax deduction
© Greg Nash

The latest Republican tax reform framework promises to lower statutory rates and repeal scores of tax preferences. The centerpiece of the reform of the individual income tax is the repeal of the largest itemized deduction, which is for for state and local taxes. Repealing this deduction alone can finance a cut in the top tax rate to 35 percent and a reduction in other rates, preserve the tax code’s progressivity, substantially increase the number of taxpayers on the standard deduction, and cut taxes for half of all filers.

Under current law, taxpayers who itemize their deductions can deduct state and local income taxes and property taxes, or they can choose to deduct sales taxes in place of income taxes. The deduction is often defended as a way to avoid double taxation. But state and local taxes are best understood as payments for consumption, such as schools, and police and fire protection. There is no more reason to deduct those payments than the purchases of other consumer goods. The deduction also distorts tax decisions made by states, inducing them to impose heavier income taxes on high-income individuals in order to maximize the federal subsidy.

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For these reasons, repealing the state and local tax deduction would be an important move toward broadening the tax base. By my estimate, it would raise more than $1.4 trillion in the coming decade, which could fund the following tax rate cuts and expansion of the standard deduction, while leaving federal revenue unchanged. The top three rates of 39.6 percent, 36 percent and 33 percent could be consolidated at 35 percent. The next two highest rates of 28 percent and 25 percent could be cut to 25 and 20 percent, respectively. The 10 percent tax bracket could be consolidated into the 15 percent bracket. The standard deduction could be increased from $6,350 for single filers and $12,700 for married filers to $10,250 and $20,500, respectively.

Besides allowing for lower tax rates and a larger standard deduction, this single reform would be a big tax simplification, with 28 million taxpayers switching from itemizing their deductions to the much simpler path of claiming the standard deduction. It would also make the tax code fairer, as the disparity in tax burdens for those with similar incomes will decline when taxpayers in low-tax states and counties no longer subsidize taxpayers in high-tax states and counties. Finally, it would offer a tax cut for 80 million taxpayers, offset by additional taxes paid by those who benefit the most from the current tax subsidy.

A total immediate repeal of the deduction may be too disruptive for state and local governments. To ensure a manageable glide path toward this goal, the deduction could be limited to 6 percent of a taxpayer’s adjusted gross income in 2018, with the limit phasing down to zero in 2021. This transition relief is included in the revenue-neutral rate cuts and standard deduction expansion outlined above. Tax reform will certainly be hard. Removing popular but inefficient tax breaks will take political strength, but it is not impossible.

The effort devoted to fiscally responsible individual income tax reform will prove well worth it when we have a broader tax base, lower tax rates and simpler tax code. While lawmakers should protect tax incentives for charitable giving and savings, the myriad of other deductions, credits and exclusions should be considered fair game, starting with the state and local tax deduction. By continuing to pair successive revenue raisers with additional cuts, tax rates can be pushed even lower and more distortions can be removed from the tax code.

Alex Brill is a resident fellow at the American Enterprise Institute. He previously served as chief economist and policy director for the House Committee on Ways and Means.