By Richard Rubin and Siobhan Hughes
WASHINGTON -- House Republicans are moving toward an agreement that preserves part of the federal deduction for state and local taxes, backing away from a controversial initial plan announced last month to abolish it entirely.
The aim, lawmakers say, is to focus on keeping the break for middle-income households while repealing it for higher-income households.
One idea is to cut off the deduction for households whose incomes exceed a certain level. The challenge will be finding agreement on where that dividing line should be.
If it is too low, the change won't win support from lawmakers representing communities in states like New York and New Jersey with high taxes or a high cost of living. If the dividing line is too high, then changing the deduction won't generate the revenue needed to help fund reductions in overall tax rates and expansion of other breaks like the child tax credit.
Other options under consideration include allowing deductions for property taxes but not for state and local income taxes, or capping the overall amount of deductions households can take on state and local taxes.
The exact details of a deal remain elusive. Lawmakers from high-tax states planned to meet with House leaders and the chairman of the House Ways and Means Committee on Thursday to discuss the issue.
House Republicans plan to release a full bill within weeks and pass it by the end of November.
One problem is that eliminating the deduction could hurt households that consider themselves middle class in expensive places, because their high incomes are offset by a high cost of living.
"This is a race to 218," said Rep. Peter King (R., N.Y.), citing the number of House votes needed to pass a tax bill. He suggested $400,000 in annual household income is the right dividing line in his high-cost Long Island, N.Y., community. "This is a really life-or-death issue for my district."
Mr. King's district could be an outlier. Many of the Republican members from high-tax states represent more rural districts that could fare fine with a much lower cutoff. In those areas, for most households, the benefits of lower tax rates, a larger child tax credit and a bigger standard deduction could outweigh the loss of the state and local tax deduction.
At the moment, with the GOP plan filled with blank details, it is hard for lawmakers and taxpayers to know exactly where they would stand under the proposed new tax rules.
"What we're trying to target is the hardworking middle class," said Rep. Tom Reed (R., N.Y.), who represents a district south and east of Buffalo. "So making sure that they're held harmless, that takes care of 99% of the people we represent back home."
The unresolved question on state and local deductibility is one of many challenges Republican leaders face as they try to muster the votes to pass a major tax bill this year. They face other internal debates on a number of issues, including how much to expand child tax credits, rules determining which businesses get a 25% top tax rate, limits on businesses' ability to deduct interest and the top tax rate for individuals.
Democrats, who represent most of the high-tax areas, are united in defense of the break. Senate Minority Leader Chuck Schumer of New York says no compromise is acceptable.
"To actually have an effect to prevent it from building a hole in the deficit, you have to go very deep into the middle class [in limiting the state and local deduction], the upper middle class," Mr. Schumer said last week.
President Donald Trump, speaking Wednesday evening on Fox News, said the state tax deduction is on his radar screen. He suggested he wants to get rid of the deduction, which is a boon to states with high individual tax rates, but was short on specifics.
"It's unfair that a state that is well run is really subsidizing states that have been horribly mismanaged," Mr. Trump said. "It's finally time to say, hey, make sure that your politicians do a good job of running your state. Otherwise, you're not going to benefit."
Mr. Trump has promised a tax cut for middle-income households and could be sensitive to the complaints of lawmakers like Mr. King who say their constituents will be hurt disproportionately.
Entirely repealing the state and local deduction, including property taxes, would generate about $1.3 trillion in added revenue for the federal government over a decade, a windfall that could help Republicans push overall tax rates down steeply. Without the full repeal, rates might not go down as much without causing deficits, or the party might have less room to maneuver on other debates such as the child credit.
"You want to flatten rates as much as possible," said Rep. Dave Brat (R., Va.).
Republicans can't afford to lose many votes from high-tax states that would be most affected by repeal. They passed their House budget 219-206 last week, and nine of the 18 GOP no votes came from representatives from New York, New Jersey and eastern Pennsylvania, an early warning sign about the potential depth of the resistance on the state and local deduction.
Republicans can lose just 22 members on a House vote if all Democrats are opposed.
"I'm for tax reform, but I'm for the right kind of tax reform," said Rep. Leonard Lance (R., N.J.), who voted against the budget.
Currently, about 30% of households claim the state and local deduction, which is available only to those who itemize deductions instead of taking the standard deduction. Taxpayers can deduct property taxes as well as either income or sales taxes.
Most people who get the benefit aren't high-income households, but the dollar value of the tax break is concentrated at the top of the income scale.
For real estate taxes, households with income over $200,000 make up 18% of the people who claim the deduction but get 40% of the benefit, according to the congressional Joint Committee on Taxation. The deduction for income and sales taxes is even more concentrated among high-income households.
The state and local break was the only specific item that House Speaker Paul Ryan (R., Wis.) mentioned during a speech and comments at the Heritage Foundation on Thursday, in which he called on conservatives to be the "foot soldiers" defending the tax plan against an "army of lobbyists" who want to protect their favorite provisions.
"We have to help members see the big picture," Mr. Ryan said. "We have to appeal to the general interest."
Rep. Kevin Brady (R., Texas), the Ways and Means chairman, said Thursday's meeting will help lawmakers exchange ideas. Mr. Brady plans to release a detailed bill once the House and Senate finish their budgets, giving him a few weeks to sort this out.
Mr. Ryan said the House would pass a tax bill in November and that he may keep the House in session until Christmas to finish the legislation.
It isn't clear what income line Republicans might draw to separate the middle-income households from higher earners those who might lose the break.
"Everyone's got a different view," Mr. Brady said, depending in large part on where people live. "You can have a very high income and the cost of living is just atrocious and you're living paycheck to paycheck. So that's one of the things we're going to talk about."
Opponents of the deduction argue that low-tax states are effectively subsidizing high-tax states, because New York and New Jersey can raise taxes, knowing that their residents can get part of that back in lower federal taxes.
That argument works broadly among Republicans, but it does little good in the pitch to members from New York and New Jersey, who note that their states already get back far less in federal spending than they pay in taxes.
"The balance of payments will go even worse," said Rep. Tom MacArthur (R., N.J.). "We'll get less than 50 cents on the dollar. It's ridiculous."
Despite the clashes, representative and their aides say they are working through disagreements and moving toward a deal, not an impasse.
"There's been a recognition that we're not going to get steamrolled on this," Mr. MacArthur said. "We have to have something that gets us to yes. I want to do tax reform, but not at any cost."
Write to Richard Rubin at email@example.com and Siobhan Hughes at firstname.lastname@example.org
(END) Dow Jones Newswires
October 12, 2017 13:19 ET (17:19 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.