By Richard Rubin
WASHINGTON -- A big tax break skewed toward
Democratic-controlled blue states is the next major battleground as
President Donald Trump and congressional Republicans attempt to
rewrite the tax code.
The tax policy outline Mr. Trump unveiled Wednesday proposes
repealing the deduction for state and local taxes, which lets
individuals subtract their home-state levies from their federal
taxable income. That move was a major shift for Mr. Trump, who
previously had called for capping deductions but not killing the
break.
What makes the latest proposal politically divisive -- and could
lead to a split inside the Republican Party -- is that it would
shift the tax burden from low-tax states such as Texas and Florida
to high-tax states such as New York and New Jersey. Blue-state
Democrats criticized the proposal, as expected, but Republicans
from those states don't like it either.
Congressman Peter King (R., N.Y.), who represents part of Long
Island, says he is on board with the GOP's philosophy eliminating
tax breaks and cutting rates, right up to the point where it
thwacks his constituents and their ability to subtract $12,000
annual property tax bills from their federal income.
"I am a Jack Kemp Republican," he said in a recent interview. "I
believe in supply-side economics. I'm all for that. But again, this
has a unique hit on Long Island."
In the weeks leading up to the White House's announcement, Mr.
King, New York Democrats and business groups had been urging
Republican leaders in Congress to back off their proposal to repeal
the deduction. Instead, the administration -- in which the
president and his two top economic advisers are high-income
residents of blue states -- chose repeal.
"I never thought I could leave New York and go to a state that
had higher taxes, but I did when I moved to California," Treasury
Secretary Steven Mnuchin said at a Wednesday morning briefing
before justifying an end to a major break for New Yorkers and
Californians. "We want to get the federal government out of the
business of what's the states' business."
Republicans focused on lowering marginal tax rates have been
targeting the deduction unsuccessfully for decades. They contend
that it props up bloated state and local governments with support
from federal taxpayers. Repealing it, they argue, could put
pressure on states to limit or reduce spending and taxes.
Removing the deduction could raise more than $1 trillion over a
decade, according to independent estimates, which would help offset
the cost of GOP rate cuts.
The deduction, one of the largest breaks for individuals, saves
taxpayers about $103 billion this year, according to the
congressional Joint Committee on Taxation. That is $38 billion more
than the mortgage-interest deduction and $46 billion more than the
deduction for charitable contributions.
Without repealing the deduction, Republicans would have to
settle for smaller tax-rate cuts, higher budget deficits or
temporary tax policies. They will be constrained by congressional
rules that prevent them passing a tax plan on a party-line vote in
the Senate unless they refrain from increasing budget deficits
beyond a decade.
Democrats mobilizing to defend the deduction are in the awkward
position of standing up for a tax measure that helps some of the
highest-income Americans -- the same people they typically say
don't pay enough in taxes. To win, they will need to transcend
party politics by appealing to hometown interests. During the 1986
tax code overhaul, a coalition of business groups, state officials
and blue-state Republicans protected the same tax break.
Administration officials argued this week that it isn't the
federal government's job to be subsidizing states, though the
federal government does redistribute income across state lines
outside of the tax system.
"We also think about being fair. We're being fair," Gary Cohn,
the director of Mr. Trump's National Economic Council, said at the
briefing with Mr. Mnuchin. "And there are those that argue that
allowing state and local taxes to be deductible is not fair because
certain states are subsidizing other states, and this is a
field-leveler."
At the center of the fight is New York, home of Mr. Trump, Mr.
Cohn and Senate Democratic Leader Charles Schumer, who says killing
or scaling back the break would be "devastating for middle-class
families in New York and elsewhere."
In New York, the deduction equals 9.1% of adjusted gross income,
the highest in the nation, according to an analysis of government
data by the Tax Foundation, a Washington group that favors a
simpler, flatter tax system. New York residents thus face a
particularly heavy state tax burden, which gets mitigated by the
deduction.
The Republican tax plan is "very anti-New York in many ways,"
says Rep. Joseph Crowley, a Democrat from Queens. "It's going to
cost more for New Yorkers. It's going to be more federal taxes for
them. And that simply isn't right."
Repealing the deduction, before taking into account other
changes in the GOP plan, would raise taxes on about 27% of New York
households, increasing their federal bills by an average of $4,250,
says the Tax Policy Center, a joint project of the Urban Institute
and Brookings Institution. In New Jersey, 32.9% of households would
see their federal taxes go up if the deduction were repealed, with
an average increase of $3,522. Similar increases would happen in
Maryland, Connecticut, California and Massachusetts.
The proposed reduction of individual tax rates and repeal of the
alternative minimum tax would temper those hits. High-income
households subject to the alternative tax already can't take the
state tax deduction. Overall, the Trump plan would mean big tax
cuts for many high-income Americans, but some households might
still see tax increases. Congress and the White House haven't
released enough details to make full calculations.
Rep. Kevin Brady, the Republican chairman of the House Ways and
Means Committee, contends that repealing the break leads to equal
treatment of residents of high-tax states and low-tax states. He
hails from Texas, which doesn't have a state income tax and where
individual deductions for property and sales taxes make up just
2.5% of income, near the bottom of the pack.
"It is a sort of a fresh approach to moving away from having
deductions for some, usually wealthy, or those in high-tax states,"
he says. The goal, he says, is to make sure that "Washington
doesn't reward or punish you based on where you live or choose to
live."
Defenders of the deduction have a different view. Though blue
states benefit from the deduction, they contend that red states get
a lion's share of federal spending on the military and government
benefits for elderly and poor households.
Kathryn Wylde, chief executive officer of the Partnership for
New York City, a group that represents the city's biggest
businesses, says the tax break helps the broader economy by
supporting an agglomeration of media, finance, accounting and
professional-services jobs. She worries about a populist backlash
against "clusters of very high earners in the nation's economic
centers."
The state and local tax deduction is one of the oldest breaks in
the U.S. income tax, dating back to an 1862 tax on incomes imposed
by the federal government to finance the Civil War. It has proven
resilient, reappearing with the 1913 imposition of a federal income
tax and surviving the last tax-code shake-up in 1986, when
President Ronald Reagan tried to repeal it.
Democrats controlled the House in 1986, and Ways and Means
Chairman Dan Rostenkowski of Illinois forged an alliance with New
York Republicans.
James Baker, who was Mr. Reagan's chief of staff and then
Treasury Secretary, said the deduction was the only subject that
caused Mr. Rostenkowski to hang up on him.
"We had a little shouting match, and it was just one of the
deductions that they were damn well determined to protect," Mr.
Baker said in a recent interview. "We ended up having to let it
go."
The break is an itemized deduction. That means most households
don't use it. To claim an itemized deduction, total deductions --
largely for mortgage interest, charity and state and local taxes --
must exceed the standard deduction of $6,350 for individuals and
$12,700 for married couples. Mr. Trump wants to double the standard
deduction, so many middle-income households might not feel the
pinch of the lost break because it would be covered by the bigger
standard deduction.
Just 30% of U.S. households itemize their deductions. Those who
do -- people who benefit from the state and local tax break -- are
concentrated in high-income, high-tax states. More than 90% of
filers with incomes over $200,000 claim the deduction, according to
the Tax Policy Center. Overall, 38% of the deduction's value goes
to California, New York and New Jersey, which have 21% of U.S.
households, the center says.
The top nine states for the deduction, measured as a percentage
of income, all voted for Hillary Clinton, and they have 18
senators, all Democrats. In the House, those same states have 33
Republicans, a number that exceeds the party's overall governing
margin. That means they have the numbers to protect the break -- if
they all agree on the policy and use their leverage.
New York and New Jersey Republicans already resisted the GOP
leadership's health care bill in March. Rep. Dan Donovan of Staten
Island, N.Y., says losing the deduction would "crush" his
constituents, and Rep. John Faso of Kinderhook, N.Y., says it would
be "double taxation." Rep. Tom Reed of Corning, the lone New York
Republican on the tax-writing Ways and Means Committee, says he
intends to fight to protect the break.
Mr. King of Long Island says he spoke out against repeal during
House Republicans' January retreat in Philadelphia. His district,
he says, is full of police officers and firefighters whose biggest
asset is their house, and losing the ability to deduct property
taxes could hurt home values.
"This is really bread and butter. This is blood and guts," he
says. "The Democrats will run wild with it."
New York, in a 2013 report by Gov. Andrew Cuomo on the "tax
threat" to the state, called repeal of the deduction and other
potential federal changes an "unfair double taxation scheme" that
would adversely affect New York. State residents who are used to
taking the tax break would have to pay the full New York tax --
with a top rate of 12.7% in New York City and 8.82% for the state
outside the city -- on top of their federal income taxes.
For the very highest-income New York households -- think Wall
Street bonuses -- loss of the deduction would make the full cost of
being a state resident more apparent than ever. That could increase
the incentive for individuals to move away and for businesses to
pick another state.
"If you talk to the very wealthy and hear them talk about their
tax burdens, they're conscious of the difference between being here
and being there," says E.J. McMahon, research director of the
Empire Center for Public Policy, a conservative policy think tank
in Albany.
There isn't much evidence that high-income households move
because of state taxes on individuals, says Kim Rueben of the Tax
Policy Center. The exceptions are retirees who don't need access to
high-paying jobs in states like New York and may be looking to move
to a state without an estate tax.
The lawmakers to watch in coming weeks are the blue-state
Republicans in the House, including Rep. Chris Collins of New York,
an early supporter of Mr. Trump. He said Wednesday that repeal is a
"big concern" for GOP lawmakers from New York, New Jersey and
California.
"Ever since our proposal first came out in January, I said I
will fight to keep those deductions," he said.
--Janet Hook contributed to this article.
(END) Dow Jones Newswires
April 27, 2017 12:56 ET (16:56 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.