Stop Giving High-Tax States an IRS Deduction

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We have long advocated making the IRS sales tax deduction permanent, instead of having to renew it every year or so, because Nevada is one of only nine states with no state income tax to deduct, which has been deductible practically from the start of the federal income tax in 1913. It’s only fair.

Actually, the fairest thing to do would be to eliminate all itemized state and local tax deductions for IRS taxes, because residents of high-tax states — mostly run by tax loving Democrats — get to deduct a disproportionate share. This causes low-tax states — and Nevada still ranks nearer the bottom despite recent tax hikes — to essentially subsidize the higher-taxed states by paying a greater share of federal taxes.

Although it has been tried before — by Ronald Reagan in 1986 — in this election year a number of GOP presidential candidates are including in their tax reform packages elimination of state and local tax deductions.

According to The Wall Street Journal, Ted Cruz, Marco Rubio, Chris Christie, Jeb Bush, John Kasich and Ben Carson all have proposed repealing this tax break, while Donald Trump, as usual, is vague on specifics.

The Heritage Foundation has estimated that dropping this deduction could allow the federal tax rates to be reduced by as much as 12.5 percent across the board.

Nevadans — along with residents of New Hampshire, Florida, Wyoming, Texas, South Dakota and Alaska — get to deduct about 1 percent or less of their adjusted gross income, while those who live in New York, Maryland, D.C. and California deduct more than 5 percent.

Not surprisingly, The Wall Street Journal reports that all of the top 10 high-tax states voted for Obama, while most of the lower-taxed states voted for Mitt Romney, with Nevada as one of the exceptions. Nearly one-third of the cost of the repeal would be borne by Californians and New Yorkers, both heavily Democratic states.

“If marginal tax rates were reduced in a revenue-neutral and distributionally neutral manner, the more than 70 percent of taxpayers who do not itemize would face lower combined federal and state income tax burdens,” write Heritage researchers Rachel Greszler and Kevin D. Dayaratna. “Additionally, this could lower overall taxes for some taxpayers who itemize but who have relatively lower incomes or live in lower-tax states.”

They concluded that the deductions subject federal tax revenues to the whims of state lawmakers and largely benefit wealthy taxpayers and those in high-tax states.

“The rationale for it is that since state and local taxes reduce individuals’ after-tax income, the income used to pay those taxes should be excluded from federal taxation. …” Greszler and Dayaratna write. “In practice, however, the deduction allows states to raise taxes higher than they otherwise would and has significant perverse distributional impacts, redistributing income from the poor to the rich and from people in low-tax states to people in high-tax states. Despite some efforts to eliminate it, the deduction for state and local taxes remains one of the largest deductions in the federal tax code.”

Using 2010 statistical data from the IRS, you find Californians who filed for state and local income tax deductions claimed deductions of $10,700 per return. Nevadans who filed for the state and local sales tax deduction claimed only $1,430 per return.

Calculated on a per capita basis, Californians claimed $2,116 in federal income tax deductions, while Nevadans claimed only $166 per person for sales tax deductions. — TM

Comments

  1. Derek DeVries says:

    I have a couple of concerns with this analysis. First, California residents have a higher median income than Nevada residents ($61,094 vs. $52,800), so wouldn’t it only be natural that they would claim more in Federal income tax deductions? This analysis also doesn’t include the likely disparities that may exist in the economies of both states which may assign a higher or lower tax burden based on the structure of either economy.

    Second, is Nevada willing to give up the disproportionately higher revenue it receives back from the federal government in exchange for this policy change? According to the Tax Foundation, Nevada received $1.31 back for every $1 it paid in federal taxes compared to only $1.09 for California. That revenue is, ostensibly, used to pay for Nevada’s lower tax rates (as the state doesn’t collect enough revenue to operate) – which is theoretically the same sort of practice as allowing California to subsidize its higher tax rate with a federal tax deduction.

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