The blue states’ tax break

In the negotiations to avoid falling off the “fiscal cliff,” Republicans are proposing cutting out tax deductions in exchange for lower tax rates.  I worry about the fate of charitable giving deductions and the impact eliminating them might have on  churches.  (One option being discussed is to just cap them for the wealthy, but many non-profit organizations–museums, colleges, and just about any entity running a capital campaign–depend heavily on big donors.)  Another potential casualty is the home-mortgage deduction, doing away with which may deal yet another blow to the housing market.

These may all make economic sense and, if rates are lowered, individuals may not take a tax hit.  But they will still have consequences.  Charles Lane looks at another IRS deduction that most of us appreciate, that for state and local taxes.  He shows, though, how the most liberal states have been using this provision to soften the blow of raising state taxes, forcing the rest of the country to subsidize their profligate spending:

Taxpayers have been allowed to deduct state and local income and property taxes since the federal income tax began in 1913. (Sales taxes have at times been deductible, too, but that’ s a relatively minor issue.) The theory is it’s unfair to make people pay twice for the public services they receive. That’s doubtful, though, since, despite some overlap, federal taxes support different services than state and local.

What the deduction does is enable higher-income states and localities to tax — and spend — more than they otherwise would, while shifting some of the cost to other states. It also encourages them to collect revenue in forms that are easier to deduct on federal returns.

Two states, California and New York, reaped almost 30 percent of the deduction’s value in 2009, the latest year for which I could find Internal Revenue Service data. Other states that benefit disproportionately include Connecticut, New Jersey, Illinois, Massachusetts and Maryland.

In 2009, 73 percent of the deduction’s benefits went to taxpayers with annual incomes above $100,000, according to the Congressional Budget Office; fully 20 percent of the benefits went to taxpayers with annual incomes above $1 million.

Starting to notice a pattern? Basically, what we have is a significant federal tax subsidy for “blue” state governments. These also happen to be the states having the most difficulty living within their means, what with their expensive urban school systems, bloated pension liabilities and all. Yet they have an incentive to close their budget gaps by raising income taxes rather than reining in spending, because the deduction helps them pass the tab to other states, most of them red.

California Gov. Jerry Brown addressed his budget woes through a referendum this year to boost the top income tax rate, just as Illinois Gov. Pat Quinn pushed an income tax rate increase through his legislature last year.

Now you’re beginning to understand how this seemingly innocuous tax break distorts financial flows within and among the 50 states, as well as between the states on the one hand and Washington on the other.

As for negotiations over a “grand bargain” between President Obama and the Republican House, the state and local tax deduction complicates that process, too.

The main bone of contention is the federal income tax rate on top earners, currently 35 percent. Obama says it is going to be hard to raise enough revenue without returning that rate to 39.6 percent, the level during Bill Clinton’s presidency.

Republicans insist that eliminating deductions and tax breaks could bring in more revenue without raising rates — while getting most of the money from the wealthy, just as the president wants to do.

In fact, the Tax Policy Center, a nonpartisan Washington think tank, has shown that eliminating all itemized deductions while leaving tax rates where they are now would raise $2.2 trillion over 10 years. That’s $600 billion more than President Obama is seeking from Congress.

Of course, not even the Republicans are proposing such a sweeping reform, which would certainly make the tax code more efficient — but also wipe out breaks for charitable giving and mortgage interest that enjoy wide red-state support, too. And the president himself has suggested limiting deductions in combination with rate increases, perhaps by capping the rate at which deductions may be claimed.

But because its impact is so heavily concentrated in blue states, the state and local deduction creates an asymmetry: Democrats have an extra reason to insist on raising rates, and Republicans have an extra incentive to demand loophole-cutting. Perhaps it’s just coincidence, but I have noticed that those most skeptical of the loophole-closing approach include Sen. Charles Schumer (D-N.Y.) and House Minority Leader Nancy Pelosi (D-Calif.).

So let’s all say a pre-Thanksgiving prayer for a successful negotiation — and remember that even a very grand bargain would still leave our state and federal tax and budget systems in need of major reform.

via Charles Lane: The best deduction to chop – The Washington Post.

About Gene Veith

Professor of Literature at Patrick Henry College, the Director of the Cranach Institute at Concordia Theological Seminary, a columnist for World Magazine and TableTalk, and the author of 18 books on different facets of Christianity & Culture.

  • Rose

    Eliminating the tax exemption is a good idea. There’s never been an exemption for Social Security taxes, often the biggest bite.

  • Rose

    Eliminating the tax exemption is a good idea. There’s never been an exemption for Social Security taxes, often the biggest bite.

  • Patrick kyle

    Expect your taxes to double in the next five years. There is really no way to avoid it.

  • Patrick kyle

    Expect your taxes to double in the next five years. There is really no way to avoid it.

  • Suzanne

    I think the far right, for all their talk of morality, believes that anything which does not turn a profit is a drain on society. They’ve gone after libraries and schools with a vengeance (at least in my very red state) and have tried to privatize anything that doesn’t move. Why should anyone be surprised they are going after churches, in a round about way?

  • Suzanne

    I think the far right, for all their talk of morality, believes that anything which does not turn a profit is a drain on society. They’ve gone after libraries and schools with a vengeance (at least in my very red state) and have tried to privatize anything that doesn’t move. Why should anyone be surprised they are going after churches, in a round about way?

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    Eh, it would hurt the non-sectarians far more. The religious who put their money where their mouth is will not stop giving. Do you think Romney will give his church any less? Those who are not big donors often don’t even itemize, so I would guess that the impact on churches will be very small. The taxes that would most impact churches are local taxes which the federal gov’t can’t legislate. Do you think Texas is going to start taxing their own churches? Just silly. Do you think New Yorkers are going to vote to tax all those synagogues and their religious schools? Hmm. I don’t. Taxing charity is just so stupid, it is hard to believe anyone is even talking about it. It will go nowhere. Those who give tons of money to non-charible non-profits like the opera and symphony aren’t going to want that money funneled to bureaucrats. They want to use it to pay for big galas for them to attend with their friends.

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    Eh, it would hurt the non-sectarians far more. The religious who put their money where their mouth is will not stop giving. Do you think Romney will give his church any less? Those who are not big donors often don’t even itemize, so I would guess that the impact on churches will be very small. The taxes that would most impact churches are local taxes which the federal gov’t can’t legislate. Do you think Texas is going to start taxing their own churches? Just silly. Do you think New Yorkers are going to vote to tax all those synagogues and their religious schools? Hmm. I don’t. Taxing charity is just so stupid, it is hard to believe anyone is even talking about it. It will go nowhere. Those who give tons of money to non-charible non-profits like the opera and symphony aren’t going to want that money funneled to bureaucrats. They want to use it to pay for big galas for them to attend with their friends.

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    Here you go, $50k for a table, $650 for an individual ticket. $275 fair market value per seat. The rest is tax deductible. They won’t be sticking it to the fundies by taxing non-profits.

    http://www.houstonsymphony.org/media/1213ongreplycard.pdf

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    Here you go, $50k for a table, $650 for an individual ticket. $275 fair market value per seat. The rest is tax deductible. They won’t be sticking it to the fundies by taxing non-profits.

    http://www.houstonsymphony.org/media/1213ongreplycard.pdf

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    One other thing, for some reason I seem to remember reading that it was red states that paid less in federal income taxes than they get back. Does anyone else recall that or remember seeing that?

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    One other thing, for some reason I seem to remember reading that it was red states that paid less in federal income taxes than they get back. Does anyone else recall that or remember seeing that?

  • rlewer

    The red states have more military installations (because they have more space and better weather). The western red states also have a huge amount of federal land that they are compensated for. So red states might get more back.

    The per capita income of people in the red states is also lower than the per capita income of blue states. So the red states put less in per capita.

  • rlewer

    The red states have more military installations (because they have more space and better weather). The western red states also have a huge amount of federal land that they are compensated for. So red states might get more back.

    The per capita income of people in the red states is also lower than the per capita income of blue states. So the red states put less in per capita.

  • http://www.bikebubba.blogspot.com bike bubba

    Let’s repeal the 16th Amendment and put this issue to rest!

  • http://www.bikebubba.blogspot.com bike bubba

    Let’s repeal the 16th Amendment and put this issue to rest!

  • Klasie Kraalogies

    Tax loopholes, evasion and other tricks (with bugger-all philantropy):

    Greek Style: http://www.spiegel.de/international/europe/the-crisis-has-yet-to-hit-the-wealthiest-greeks-a-866693.html

  • Klasie Kraalogies

    Tax loopholes, evasion and other tricks (with bugger-all philantropy):

    Greek Style: http://www.spiegel.de/international/europe/the-crisis-has-yet-to-hit-the-wealthiest-greeks-a-866693.html

  • Kirk

    @7

    From what I’ve heard, red states, on the whole, take in more federal funding per tax dollar they spend than blue states. About $.30 more per dollar than blue states.

    http://www.economist.com/blogs/dailychart/2011/08/americas-fiscal-union

  • Kirk

    @7

    From what I’ve heard, red states, on the whole, take in more federal funding per tax dollar they spend than blue states. About $.30 more per dollar than blue states.

    http://www.economist.com/blogs/dailychart/2011/08/americas-fiscal-union

  • DonS

    The risk of cutting deductions is that the left will still eventually demand higher tax rates, which will apply to much more of your gross income. We have seen this since 1986, when Reagan overhauled taxes, in conjunction with a Democratic Congress, to reduce the top tax rate from 50% to 28%, in exchange for sharply limiting deductions. Prior to 1986, you could deduct, for example, all of your medical expenses (now that is true only for expenses exceeding 10% of your gross income), any miscellaneous expenses from the first dollar (now only in excess of 2% of gross income), all interest expenses, including credit card interest, now all entirely non-deductible unless secured by a qualifying residential property, and a host of other changes. Since that time, most deductions and tax credits have been capped (i.e. not available to taxpayers earning over a certain gross income). Yet we have dopes like Paul Krugman writing that we should bring back the 91% top tax rate of 1955, as if the same deductions are available now as were available in 1955.

    Nonetheless, I liked Romney’s idea of lowering rates across the board and limiting tax deductions to a cap of a particular value, for all taxpayers. For example, say the cap is $50,000, which you can apply to any deductible expense (I would use the old list of deductions to maximize the flexibility of each taxpayer to tailor deductions to their needs). You could mix and match between charitable giving, home mortgage interest, state and local taxes, medical expenses, etc. At the same time, we would get rid of all means tests for credits and deductions, and the alternative minimum tax, thereby greatly simplifying tax returns. This could be phased in, ratcheting the deduction cap and tax rates downwardly year-by-year, to give charities time to adapt to the new reality — that they have to earn a contribution on their own merits, rather than just appealing to the donor’s desire to keep their money from the tax man.

  • DonS

    The risk of cutting deductions is that the left will still eventually demand higher tax rates, which will apply to much more of your gross income. We have seen this since 1986, when Reagan overhauled taxes, in conjunction with a Democratic Congress, to reduce the top tax rate from 50% to 28%, in exchange for sharply limiting deductions. Prior to 1986, you could deduct, for example, all of your medical expenses (now that is true only for expenses exceeding 10% of your gross income), any miscellaneous expenses from the first dollar (now only in excess of 2% of gross income), all interest expenses, including credit card interest, now all entirely non-deductible unless secured by a qualifying residential property, and a host of other changes. Since that time, most deductions and tax credits have been capped (i.e. not available to taxpayers earning over a certain gross income). Yet we have dopes like Paul Krugman writing that we should bring back the 91% top tax rate of 1955, as if the same deductions are available now as were available in 1955.

    Nonetheless, I liked Romney’s idea of lowering rates across the board and limiting tax deductions to a cap of a particular value, for all taxpayers. For example, say the cap is $50,000, which you can apply to any deductible expense (I would use the old list of deductions to maximize the flexibility of each taxpayer to tailor deductions to their needs). You could mix and match between charitable giving, home mortgage interest, state and local taxes, medical expenses, etc. At the same time, we would get rid of all means tests for credits and deductions, and the alternative minimum tax, thereby greatly simplifying tax returns. This could be phased in, ratcheting the deduction cap and tax rates downwardly year-by-year, to give charities time to adapt to the new reality — that they have to earn a contribution on their own merits, rather than just appealing to the donor’s desire to keep their money from the tax man.

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    We can pass any tax rate we want. It doesn’t mean that anyone will actually pay that rate. The connected will just use loopholes. Romney, not being a liar nor cheater, wanted to close loopholes cuz he knows that is where the money is. Billionaires don’t really want to dump their fortunes into the federal bureaucratic bucket. They want to donate to their pet projects and get a tax deduction, etc. They only say they want higher rates because they know they won’t personally be paying those rates, but those annoying upwardly mobile folks will. That will slow down that upward mobility.

  • http://www.biblegateway.com/versions/Contemporary-English-Version-CEV-Bible/ sg

    We can pass any tax rate we want. It doesn’t mean that anyone will actually pay that rate. The connected will just use loopholes. Romney, not being a liar nor cheater, wanted to close loopholes cuz he knows that is where the money is. Billionaires don’t really want to dump their fortunes into the federal bureaucratic bucket. They want to donate to their pet projects and get a tax deduction, etc. They only say they want higher rates because they know they won’t personally be paying those rates, but those annoying upwardly mobile folks will. That will slow down that upward mobility.

  • rlewer

    Raising tax rates does not necessarily increase the amount of revenue the federal government gets ( in spite of Obama’s claims of 1.6 trillion in additional money if the rates are raised on the “rich.”)

  • rlewer

    Raising tax rates does not necessarily increase the amount of revenue the federal government gets ( in spite of Obama’s claims of 1.6 trillion in additional money if the rates are raised on the “rich.”)

  • Michael B.

    @sg

    So I’m probably reading you wrong, but it sounds like you’re saying that the super rich aren’t paying their fair share in taxes? And instead of raising the tax rate, you’d like to see loopholes closed. I’d like to see some more data, but that may be a fair point. Despite being in a higher tax rate, Romney’s effective tax rate was probably lower than most of ours on the forum.

  • Michael B.

    @sg

    So I’m probably reading you wrong, but it sounds like you’re saying that the super rich aren’t paying their fair share in taxes? And instead of raising the tax rate, you’d like to see loopholes closed. I’d like to see some more data, but that may be a fair point. Despite being in a higher tax rate, Romney’s effective tax rate was probably lower than most of ours on the forum.

  • Michael B.

    I personally would like to see some huge cuts on what gets to be defined as “non-profit”. Churches are just one of them. The Religious Right and Religious Left would both fight this hard, so it’s unlikely to happen. Maybe if they understood that for the tax cuts they are getting, someone on the opposite side of the fence is also getting one, and they are usually of a different religion.

  • Michael B.

    I personally would like to see some huge cuts on what gets to be defined as “non-profit”. Churches are just one of them. The Religious Right and Religious Left would both fight this hard, so it’s unlikely to happen. Maybe if they understood that for the tax cuts they are getting, someone on the opposite side of the fence is also getting one, and they are usually of a different religion.


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