White House

How a Trump tax-rate cut could cost California and other high-tax states big time

President Donald Trump shakes House Speaker Paul Ryan’s hand as he is joined by GOP leaders and his family in formally signing his Cabinet nominations into law in the President's Room of the Senate at the Capitol on Friday, Jan. 20, 2017.
President Donald Trump shakes House Speaker Paul Ryan’s hand as he is joined by GOP leaders and his family in formally signing his Cabinet nominations into law in the President's Room of the Senate at the Capitol on Friday, Jan. 20, 2017. AP

For millions of families in California and other high-tax states, there is one bright spot when filling out their federal tax forms each year: They can deduct the hefty state taxes they pay.

That might change under the administration of President Donald Trump, who will meet with GOP congressional leaders this week to discuss tax revisions and other legislative proposals.

House Speaker Paul Ryan last year unveiled a GOP proposal that would eliminate the deduction for state and local taxes as part of a plan to reduce federal tax rates. Trump hasn’t called for outright scrapping of the deductions, but his tax blueprint calls for making the deduction more difficult to itemize on federal returns.

In 2013, California taxpayers deducted $96 billion from their federal returns – nearly one-fifth of the national total – followed by their counterparts in New York, with $67 billion, according to a study last year by the Tax Policy Center, a nonpartisan research group based in Washington. If taxpayers from such states could no longer claim the deduction, they’d effectively face a tax hike, although that would be offset to some degree by proposed cuts in tax rates.

“The data shows a large percent of deductions are claimed by people in those two states,” Frank Sammartino, a senior fellow at the Tax Policy Center, said in an interview. “They certainly would bear a large share of any changes.”

So far, the Trump and Ryan tax proposals have triggered little reaction in California, unlike in New York, where Democratic Gov. Andrew Cuomo recently met with Trump and reportedly urged him not to scrap the federal deduction for state taxes.

It would be “devastating on the state of New York, California, et cetera, if you didn’t allow the people of this state to deduct their state and local taxes,” Cuomo told reporters after meeting with Trump last Wednesday.

In California, 5.8 million individuals and families deducted state and local taxes from their federal returns in 2013, the most recent year for which data were available, according to the Tax Policy Center report. Their deductions averaged $5,624 per household. Nationwide, more than 44 million taxpayers claimed the deduction in 2013, averaging $3,465 per household.

The state and local tax deduction dates to the creation of the federal income tax in 1913. At the time, it was argued that taxpayers should be able to deduct state and local taxes to avoid double taxation and preserve their after-tax income.

Over the years, critics on the right and left have taken aim at the deduction. Conservative groups, such as the Heritage Foundation, have argued that it rewards states that choose to impose high taxes, forcing “federal taxpayers in low-tax states to subsidize taxpayers in high-tax states.”

Liberal groups have also taken aim at the state and local tax deduction. Some see it as a regressive part of the tax code, since it is mostly claimed by taxpayers with higher incomes.

Despite those arguments, numerous attempts to eliminate the deduction have failed, starting with President Ronald Reagan in 1986. “There are a number of states that would be affected by this and so far, they’ve had enough political power to keep this from happening,” said Sammartino, of the Tax Policy Center.

That may no longer be true. Republicans control the White House and both houses of Congress and have little regard for protests from California, New York, Illinois and other blue states with deep attachments to the deduction.

Congress has shown before that it is willing to eliminate popular deductions. In 1978, it eliminated the deduction for taxes on motor fuels. In 1986, it eliminated the deductions for general sales tax and credit card interest.

Currently, higher-income families are the biggest beneficiaries of the state tax deduction since they are more likely to itemize their taxes and claim the deduction. Although Cuomo says it would be “devastating” for New Yorkers and Californians to lose the deduction, many of the higher earners would be helped by an overall lowering of tax rates. How much they would be helped would depend on how large a tax cut Congress and Trump agree on.

Over the long term, however, eliminating the deduction could affect states’ ability to tax their wealthy residents. Without the state tax deduction, high-income taxpayers are likely to press for tax cuts at the local level, too.

Eliminating the deduction “would come at a cost to state and local governments,” said the Tax Policy Center report, co-authored by Sammartino. “It could affect the mix of revenue sources used by state and local governments and could lead to reductions in spending for programs and services.”

Congressional Republicans are holding a retreat Wednesday through Friday in Philadelphia where they will set priorities for their legislative agenda, ranging from “repealing and replacing” the Affordable Care Act to drafting tax restructuring legislation. Trump is scheduled to join the gathering Thursday.

While he and Congress could cut taxes without eliminating the state tax deduction, such a move would widen the federal budget deficit, unless Congress were to enact sweeping spending cuts beyond what the GOP has already proposed. Ryan’s tax plan, for instance, would reduce federal revenue by $2.4 trillion over the next decade, according to an analysis by the nonpartisan Tax Foundation. Eliminating the deduction for state and local taxes would increase revenue by $1.3 trillion over 10 years, according to the Tax Policy Center.

So far, no California agency has analyzed how the state would be affected if Congress eliminated the deduction, according to officials in the California State Controller’s Office and other agencies. In New York, a 2013 report commissioned by Cuomo declared that New Yorkers would face a $14.8 billion tax hike if the deduction were eliminated, but that report didn’t analyze potential offsets, such as a general lowering of the tax rate.

“Allowing taxpayers to deduct their state and local taxes from their federal taxable income is a fundamental statement of the long-standing historical right of state and local governments to raise revenues and taxpayers not to be double taxed,” the report said.

Stuart Leavenworth: @sleavenworth

Top states claiming state tax deductions

State............Households claiming deduction ..................Total value (2013)

California......................5.8 million.............................................$96.5 billion

New York......................3.2 million.............................................$66.8 billion

New Jersey...................1.7 million ............................................$29.8 billion

Illinois...........................2 million................................................$25.3 billion

Texas............................2.6 million.............................................$19.4 billion

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