People Start To Notice The State/Local Income Tax Deduction

Here at Manhattan Contrarian, we try to pay attention to where the big money is.  When the talk turns to raising Federal revenue and avoiding or minimizing increases in marginal tax rates, then that must mean limiting deductions; and as soon as you start to look at limiting deductions, you realize that the real money is in one place:  the state and local income tax deduction.

Today Charles Lane of  the Washington Post has the story, also linked by Instapundit.  (Manhattan Contrarian was first on this story back on November 6, although the post was originally written as an e-mail newsletter on October 9).  From Lane:

What’s the least defensible special break in the U.S. tax code? With so many distortions to choose from, it’s hard to name just one. If forced to pick, I might say the deduction for state and local taxes, which cost $67 billion in fiscal 2011, according to the congressional Joint Committee on Taxation.

This one overwhelmingly benefits upper-income households in a handful of upper-income states, while rendering the entire nation’s finances less transparent.

$67 billion per year is only about 7% of the current annual deficit; but it's the most you will find in any one place.  Also, as Lane points out, this one benefits the highest income people way disproportionately.

The interesting tension will arise from the fact that the benefits of this deduction go mostly to a very small number of states.  And those states are almost entirely the "big blue" states:  California, New York, New Jersey, Connecticut, Illinois, etc.  According to Lane, residents of "California and New York reaped almost 30 percent of the deduction's value in 2009."  If you don't have an income tax (Florida, Texas, Nevada, Washington, etc.) you won't even notice when they eliminate this deduction.

The Republicans in Congress have the potential with this one to corner the left-wing Democrat California and New York delegations as defenders of the rich, which they are.  That could be fun.

I have mixed feelings about what elimination of this deduction would mean for New York and for me.  When I first moved here (1975), New York, and particularly New York City, were wildly non-competitive in income tax relative to everybody else, although most notably New Jersey and Connecticut, which then had no income tax at all.  Combined New York State/City income tax at that time was 18%, starting at income as low as about $25,000.  As I have mentioned elsewhere, in the 70s New York City lost over 10% of its population in a decade; the Bronx was burning; businesses were leaving; and New Jersey and Connecticut were booming.  After that bad time, New York State and City struggled to regain tax competitiveness, and the City has returned to prosperity (although it could be far better if we could get taxes and spending further under control). 

The elimination of the state/local income tax deduction would greatly exacerbate the uncompetitiveness of our current tax levels, not so much as against the immediate neighbors, but definitely as against the large no-income-tax states like Texas and Florida.  Our high-income investment community is substantially more mobile today than it was in the 70s.  Erosion of this business base could happen with a speed that could surprise everyone.  That would be terrible for everyone in New York who lives off the wealth generated by these businesses.

On the other hand, New York needs a kick in the pants to move it toward competitiveness.  Right now we are wastefully way overspending on things that other states somehow provide for far less.  It can't go on forever, and it's actually well time to get started on getting our costs in line.

Oh, and did I mention that I'm one of the people paying the big state/local income taxes?  Well, not for too many more years.