As Republicans try to figure out a way to deliver on tax cuts President Donald Trump promised, they’re taking a hard look at the possibility of eliminating the income tax deduction for state and local taxes.
Though Congress is unlikely to go along, it’s a move that would sock many Maine taxpayers who file federal tax forms with itemized deductions. They would see their tax bills rise by an average of $1,839 annually, the Tax Policy Center figured this spring.
But accompanying rate cuts and an increase in the standard deduction might well more than offset the proposed change for many. In general, though, axing the deduction would smack richer people far more than ones with lower incomes.
However, it could also create political pressure on states to rein in spending and lower their own taxes, steps that would hurt the poor most.
It’s a complex issue that doesn’t necessarily break down along party lines.
For U.S. Sen. Angus King, a Maine independent, the deduction “is part and parcel of an intergovernmental partnership that has existed for decades,” so he’s concerned “that eliminating it would undermine how the local, state and federal governments are able to interact with one another,” spokesman Scott Ogden said.
“As he always does, though, he will approach this proposal with an open mind,” Ogden said.
Annie Clark, a spokeswoman for U.S. Sen. Susan Collins, said, “The details of the president’s tax proposal have not yet been released, so it is difficult to evaluate its impact in its entirety. This includes whether or not the proposed increase in the standard deduction would compensate for the elimination of the deductibility of state and local taxes for most Maine families.”
U.S. Rep. Chellie Pingree, a 1st District Democrat, opposes the idea because “right now, that revenue is used for vital state and local services, and while wealthy Americans use the state and local tax deduction when they itemize their deductions, this proposal would disproportionately hurt working Mainers who rely on the services this money supports,” said her spokeswoman, Victoria Bonney.
U.S. Rep. Bruce Poliquin, a 2nd District Republican, didn’t respond to a request for a comment.
Axing state and local deductions would bring in about $1.3 trillion in additional federal tax revenue over the course of a decade, according to the Tax Policy Center. That amount makes up just a fraction of the nonpartisan tax center’s estimated $9.5 trillion the Trump plan will cost in terms of lost revenue during the same period.
One complication for anyone analyzing the fiscal impact is that the president hasn’t released the details of his tax cut plan yet, despite a weekend tweet from him that claimed the tax “reform that I have submitted is moving along in the process very well, actually ahead of schedule.”
Trump said his plan, which he outlined on one page last month, would bring “big benefits to all.”
According to the outline, it would cut the tax rate for businesses to 15 percent and reduce the number of individual income tax brackets from seven to three, at 10, 25 or 35 percent. They now range from 10 to 39.6 percent.
Trump also aims to abolish the estate tax and the alternative minimum tax created to ensure wealthier Americans can’t avoid paying something by racking up deductions.
It would also throw out the deductions for state and local taxes, a move that hits mostly better-off Americans in states with high tax burdens.
During a recent fiscal summit for the Peter G. Peterson Foundation, Treasury Secretary Steve Mnuchin said that “one of the biggest deductions that rich people take are state and local taxes, and we’ve said we think we should get the federal government out of the job of subsidizing the states on taxes.”
“That raises a significant amount of money,” he added, which helps cover some of the cost of slicing other taxes.
Whatever Congress and the president wind up doing with taxes likely won’t occur soon despite calls from administration officials to act by August. Both the House Committee on Ways and Means and Senate Finance Committee, the panels that would initiate any revisions, are still just gearing up.
Getting rid of the deduction for state and local taxes would be a drastic change in the nation’s tax system. They’ve been allowed since the beginning of the federal income tax in 1913.
Abolishing the state and local deduction would hit states with high taxes hardest, since its residents get the most benefit from the deduction. Those who benefit most, though, are generally the ones who pay the most local and state taxes.
The Tax Policy Center said that only 30 percent of tax filers itemize deductions — with state and local taxes almost always among the items cited on their forms — but richer residents are much more likely to do it.
The center said 10 percent of tax filers with income under $50,000 itemize deductions rather than relying simply on the standard deduction, while 81 percent of those with incomes higher than $100,000 list the deductions.
In 2014, the average deduction claimed in Maine was for $10,900, a combination of income and real estate taxes paid by filers.
The tax center said the state and local deduction “indirectly subsidizes state and local governments by decreasing the net cost of non-federal taxes to those who pay them.”
“For example,” it said, “a $100 increase in state income taxes costs a taxpayer in the 35 percent federal income tax bracket just $65 — the $100 increase minus $35 saved in federal taxes, if the additional tax is deductible.”
“This subsidy encourages state and local governments to levy higher taxes (and, presumably, provide more services) than they otherwise would,” the center said. “It also encourages them to use deductible taxes in place of nondeductible taxes (such as selective sales taxes on alcohol, tobacco and gasoline), fees and other charges.”
Simply by more than doubling the standard deduction, which Trump apparently seeks, would reduce the number of people itemizing anything from 45 million to 18 million people, the tax center estimated, drastically reducing the impact of tossing out the state and local tax provision.
Bonney said Pingree believes that updating the tax code for the first time since 1986 is a good idea, “but penalizing some states and moderate-income households is the wrong way to do it.”
“Much like his cruel budget proposal, President Trump’s tax plan lacks foresight and would cause working Mainers to shell out more in order to support tax breaks for corporations and the wealthiest Americans,” Bonney said.
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