Deducting Taxes from Taxes

She may be the youngest woman ever elected to Congress and an up-and-coming Republican, but Elise Stefanik is running cover for high taxes.

Stefanik, joined by six other New York Republican House members, this week urged Treasury Secretary Steve Mnuchin to drop the proposal to eliminate a federal tax deduction for state and local tax payments from the Trump administration’s tax reform plan.

One way to look at this, of course, is that it’s just Rep. Stefanik looking out for her constituents, who just happen to be in the highest tax state in the nation. Okay, fine. But should Secretary Mnuchin and Stefanik’s Republican colleagues yield to her pleadings?

Absolutely not.

Put simply, we encourage higher state taxes through the federal tax code by allowing the deductibility of state taxes from federal income taxes. The deduction of state taxes partially insulates taxpayers who otherwise might resist higher taxes or flee to a lower-tax state.

The high taxes in these states are essentially subsidized through the federal tax code by taxpayers from low tax states.

According to the Tax Foundation, California alone is responsible for 19.6 percent of the national tax cost of the state tax deduction, with New York second at 13.3 percent, New Jersey at 5.9 percent and Illinois at 5 percent. Adjusting for population, New York is #1, New Jersey is #2, Connecticut is #3, California is #4, and Maryland is #5. Hence Rep. Stefanik’s entreaties.

It’s perfectly appropriate and federalist for states to determine for themselves their appropriate level of taxation. Fine, have your high taxes if you want. But federal policy should be neutral toward state taxes, rather than subsidizing higher taxes through the federal tax code.

And it certainly doesn’t make sense for taxpayers in low-tax states like Texas and Florida to be subsidizing high-tax states like California and New York.

That’s why many tax reform plans, including those currently being discussed on Capitol Hill, rightly remove the deductibility of state income taxes.

So either removing the deduction for state taxes entirely (best), or limiting\capping the deduction (okay), is a welcome and appropriate element in Congress’ current tax reform efforts.

Ronald Reagan famously said, “If you want more of something, subsidize it; if you want less of something, tax it.” [i] And while Reagan wasn’t an economist, his logic on taxes and subsidies was simple and impeccable, and we would do well to bear his maxim in mind as we work through the details of fundamental tax reform.