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Tax Federalism

by Stephen Eide

Ending the state-and-local deduction would help make blue states pay their way

At this early stage in the debate over President Trump’s tax plan, much of the discussion has centered on his proposal to eliminate the state-and-local-tax deduction. Conservatives have long viewed closing this loophole as the great lost cause of President Reagan’s 1986 tax reform, though it has sometimes been criticized by Democrats as well. Everyone agrees that repealing the state-and-local-tax deduction would disproportionately affect blue states, where taxes are high and rising due to ongoing fiscal strain. It might be possible to make good on the Trump administration’s pledge of one of the biggest tax cuts in American history without targeting this particular deduction. But it probably won’t be possible to do so in a fiscally responsible way.

When a filer tallies up how much he owes the IRS in a given year, a deduction shrinks his “adjusted gross income,” creating a smaller base to which the federal income-tax structure is applied. The theory is that you shouldn’t have to pay full income taxes on earnings that you used to cover certain unavoidable or justifiable expenses. Seventy percent of households claim the standard deduction, currently $12,600 for a married couple filing jointly. The remaining 30 percent “itemize” deductions, and more or less all of them claim state and local taxes paid. They take how much they paid in property and income or, in rarer instances, sales taxes and multiply that sum by their top marginal federal income-tax rate (the highest is now 39.6 percent). This figure may then be subtracted from their taxable earnings.

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