SALT margins

I think most of the debate misses one of the most important points about the state and local tax deduction -- incentives.

Suppose you are in the top, (roughly) 40% marginal federal tax bracket.  If you pay an extra $100 in state taxes, you deduct $100 from income, and pay $40 less in federal taxes. So, you really only pay $60 in state taxes. The federal government effectively transfers $40 to the state from taxpayers in other states.

That's a big incentive to raise money as income taxes from high-bracket tax payers! This incentive doesn't work if the state raises taxes from lower  bracket taxpayers, or by other means such as sales taxes.

California's tax system, for example, seems to respond heartily to this incentive. California's income tax rate is highly progressive, topping out at 13.3%.  As reported in the Sacramento Bee

Nearly 90 percent of the money [income tax receipts]  comes from one-fifth of the taxpayers – those making $91,000...Forty-five percent of the state’s income tax money comes from the top 1 percent of filers – those with adjusted gross income of at least $501,000.

and, therefore, in the highest Federal tax bracket, and also likely to itemize deductions.


The state of California also relies a lot on income taxes. The state of California gets 65% of its revenue from individual income taxes, 22% from sales taxes, and 8% from corporate taxes.

Property taxes in California raise about $60 billion, roughly equal to the total raised from personal income taxes.  Since the state is home to extremes of housing values, thanks to land use and building restrictions, property taxes are also raised largely from people in high tax brackets, and therefore benefiting from the 40 cents on the dollar subsidy from the rest of the country. (If you know of data on property tax by income brackets, I'd like to see it.)

The usual stories about California rest on its progressive, redistributionist politics, and there is certainly much of that rhetoric around. But it also happens to be responding perfectly rationally to a strong incentive.

Conservatives have long objected to governments that spend other people's -- taxpayers' -- money unwisely.  But money raised from taxpayers from other states, who do not vote in your elections, provide doubly bad incentives.

This strikes me as a potent economic argument against deductibility of state and local taxes, that hasn't been made loudly enough. Of course no argument (pro or con) based on incentives has been made loudly enough!

This strikes me as a larger picture of many things needing reform America. The New York Times  report on astounding infrastructure costs rang a nerve. Most infrastructure is directed by state and local officials, who spend Federal money.  Medicare remains a matching fund -- the state spends a dollar, the federal government chips in a dollar.  The move to turn it in to a block grant, which failed last summer, would have removed this incentive.  Federal money and state control is a common pattern in social programs, and John Cogan explains well the legal and institutional reason for this separation in our history. But it leads to atrocious incentives.

Perhaps a general reform lesson is that states should have to raise the marginal dollar for anything from their own voters.



from The Grumpy Economist http://ift.tt/2CqONEF