A Stitch in Haste

I have blogged previously on the subject of whether it is justifiable to allow state and local taxes to be deductible from one's federal income tax. To review, the argument against deductibility goes something like this: "Allowing deductibility in essence subsidizes high-tax states, which both serves as a disincentive for high-tax states to lower their taxes and also transfers the federal tax burden from high-local-tax states to low-local-tax states."

My previous response, which I reiterate, is that the overall federal-state-local, income-sales-property, tax-and-spend complex is simply too convoluted a labyrinth to look at any one part of it in a vacuum and declare it "unfair" --

Partitioning tax burdens (i.e., not allowing deductibility of state taxes) only makes sense if government activities are likewise partitioned (i.e., the national government does national things and pays for them with national taxes, while state governments do state things and pay for them with state taxes and local governments do local things and pay for them with local taxes). Unfortunately that is not the current American model of governance...

Now comes word from the Urban Institute that the whole "redistribution of the tax burden" phenomenon doesn't even exist. The think tank reminds us of two easily-overlooked facts:

1. Not everyone actually deducts their state and local taxes -- only filers who itemize can claim the deduction. Those taxpayers tend to be higher-income (and therefore more heavily taxed) anyway. Also, many of those filers are hit with the insane Alternative Minimum Tax and lose all or part of the benefit of state & local deductibility even if they do itemize.

In each of the three states with the greatest dollar amount of state & local tax deductions on federal returns (California, New York and New Jersey), the number of filers who are actually deducting is less than 40%; In each of the top ten deduction states, fewer than 50% of filers actually deduct. So the question of "who is subsidizing whom" is far less ubiquitous as some might think. Regardless of interstate comparisons, it's still the rich who are subsidizing the poor, regardless of which state they happen to live in.

2. The high-deduction states still tend to be net contributors to Washington. Consider some examples: California has 13.0% of taxpayers, who pay 13.2% of the nation's income tax; New Yorkers are 7.4% of all returns but pay 8.7% of the nation's income tax. Seven of the top ten deduction states pay more than their proportional share of federal income tax. So much for the argument that low-tax states subsidize high-tax states.

Neither I nor Blogger are good with posting tables, so review the numbers yourself here.

Questions of how best to simplify taxes mean nothing, absolutely nothing, unless the overall tax burden declines. Questions of what should be deductible, which states are subsidizing which states, etc., are mere distractions from the real debate of how high the overall tax burden on Americans should be.

I once heard that the "correct" libertarian position on tax reform is that anything that reduces anybody's taxes is to be supported, no matter how inequitable or discriminatory the policy may be (i.e., "starve the beast" at all costs). I'm not sure I would go that far, but I think there's more truth than error in it.

Related Posts:
Should State & Local Taxes Be Deductible?
Red Tax, Blue Tax
Which States Have the Best/Worst Tax Policies?
New Species Discovered: The Alaskan Tax Vulture