Chairman Camp Eyes State and Local Tax Deduction

Yesterday, House Ways and Means Committee Chairman Dave Camp (R-MI) took a hard look at the deduction for state and local income taxes at a hearing on tax expenditures that affect state and local governments. There is a significant amount of forgone federal revenue in this particular tax provision, $50.3 billion in 2013 and $277.6 billion from 2013-2017 according to estimates by the Joint Committee on Taxation (JCT).

In his opening statement, Camp said that the the state and local income tax deduction should be considered in reform not only due to the lost revenue, but also for distributional reasons:

Over the last several years we’ve heard much about how the tax code might be changed in ways that could affect State and local government activity. Some, such as President Obama, argue that exclusions (such as those for State and local bonds) and deductions (such as those for State and local taxes) inappropriately provide larger subsidies for high-income taxpayers and have advocated limiting the value of deductions and exclusions or replacing them with credits.

A Tax Policy Center analysis confirms this observation, as much of the tax benefit for the state and local deduction goes to higher-income earners. 

^{Source: Tax Policy Center}

With substantial forgone revenue from the deduction, it is worth asking whether the deduction should be eliminated or changed to make it less costly and more progressive. Changing specific tax expenditures can be difficult, as Camp acknowledges, because there are many taxpayers that benefit from this preference:

But we are not writing a tax reform bill in some ivory tower. Changes to the tax code will have a real impact on State and local economies, and the Committee needs to hear directly from these stakeholders before considering any proposals as part of comprehensive tax reform.

But its worth noting that many commissions that have taken up tax reform proposed changes to the state and local deduction. The Fiscal Commission, the Domenici-Rivlin Deficit Reduction Task Force, and the 2005 Advisory Panel on Federal Tax Reform eliminated the deduction in their plans. The current tax code disallows the deduction of state and local taxes in the Alternative Minimum Tax.

Many different changes could lessen the revenue loss in the state and local tax deduction while improving progressivity, including ending the deduction outright; converting it into a credit; limiting the value of the deduction to a percentage of adjusted gross income (AGI), a nominal dollar amount, or a tax rate; capping the amount that can be deducted; or having different tax treatment of state and local property taxes, sales taxes, and income taxes. CBO scored two of these changes in their 2011 Spending and Revenue Options, estimating that eliminating the deduction would save $862 billion from 2012-2021 and capping the deduction at 2 percent of AGI would save $629 billion over the same period. That score would be different if done today, but it's not clear if it would be higher or lower.

It is good to see Camp examining this tax provision, as well as the many other provisions the Ways and Means Committee's 11 working groups will investigate in the coming weeks. Tax reform could lead to a simpler and more efficient tax code that could promote growth, although this will require some popular tax expenditures to be eliminated or reduced. Our leaders will have to make hard choices, but given our fiscal circumstances, these are choices we have to make in order to get a more efficient tax code that raises the revenue we need.