Here's why Trump's tax plan will hit Californians especially hard

Many Californians face a big financial hit under the Republican tax plan, which would eliminate a major tax break that benefits state residents more than those anywhere else in the U.S.

The federal deduction for state and local taxes allowed Californians to reduce their taxable income by $101 billion in 2014, according to an analysis by the nonpartisan Tax Foundation.

The tax outline released Wednesday by President Trump and top congressional Republicans would ax the break, which largely benefits residents in states that are Democratic strongholds.

“Republicans in Washington have once again zeroed in on California to punish us and make our state the single biggest loser in their reckless tax scheme,” said Senate President Pro Tem Kevin de León (D-Los Angeles).

Sen. Dianne Feinstein (D-Calif.) said the elimination of the deduction was one reason the plan was a “non-starter” for her.

“I don’t believe California should suffer in order for President Trump to give tax cuts to the rich,” she said.

The plan also left open the possibility of another big hit: new limits on the deduction for home mortgage interest, which would have a greater effect on states with higher housing costs, such as California and New York.

Homeowners now can deduct interest paid on as much as $1 million in mortgage debt. Some Republicans have been considering reducing the limit to $500,000. If that were to happen, about 489,000 filers in California would see an average increase of about $3,290 in their federal taxes, according to an analysis by the nonpartisan Tax Policy Center.

The Republican tax outline would slash business tax rates, nearly double the standard deduction for individuals and married taxpayers filing jointly, and compress the current seven tax brackets to three. But the plan still lacks many crucial details.

That made it difficult to analyze the effect on the nation, let alone specific states, experts said. The plan, for example, doesn’t specify the income levels of the new tax brackets. Those details and others — such as whether to limit the mortgage interest deduction — are being left to members of Congress to figure out.

“It’s a slapdash wish list that does not deserve the dignity of the word ‘plan,’ ” said Edward Kleinbard, a USC professor and former chief of staff to Congress’ Joint Committee on Taxation.

“We don’t know what the effect will be on lower-income Americans vs. middle-income Americans vs. higher-income Americans except that we know that the highest-income Americans come out way ahead,” he said. “That’s the only thing we know for sure.”

The proposed reduction of the top marginal tax rate to 35% from 39.6%, along with the elimination of the estate tax and the alternative minimum tax, would help California’s wealthiest residents, analysts said.

And the huge reduction in the corporate tax rate, to 20% from 35%, would be a boon to major California companies such as Apple Inc., Chevron Corp., Wells Fargo, Alphabet and Disney. The state is home to 53 Fortune 500 companies, second only to New York’s 54.

“I think on net, it probably would have a tiny positive impact” on California, Christopher Thornberg, an economist at Beacon Economics in Los Angeles, said of the tax plan.

But within that small impact there could be major differences in who benefits and who doesn’t, he said.

“The ultra-wealthy in the state are going to benefit,” Thornberg said. “The upper-middle class are going to get hurt.”

The elimination of the state and local tax deduction would deliver a lot of that hurt to those upper-middle-class and middle-class residents.

About 44 million taxpayers claimed the deduction in 2014, including 6 million in California, according to the Tax Policy Center.

The break has been in the tax code since the U.S. began collecting income taxes in 1913. If taxpayers have enough deductions to itemize, they can deduct without limit what they pay in state and local real estate, personal property and income taxes.

The deduction lowers taxable income but only partially translates into less taxes paid. Still, it reduces federal tax revenue nationwide by $96 billion this year, according to the Treasury Department.

That makes it one of the most costly breaks in the individual tax code. Eliminating it would increase federal revenue by about $1.3 trillion over 10 years, the Tax Policy Center said.

Republicans argue the deduction is an indirect subsidy to some state and local governments and largely shifts money from lower-income people in low-tax states to higher-income earners in high-tax states.

The Tax Foundation found that 88% of the benefit of the deduction in 2014 went to people with incomes of more than $100,000.

Californians received one-fifth of the total value of the deduction nationwide in 2014, the Tax Foundation said. And of the top 10 states for the deduction, including California, New York, New Jersey, Illinois and Texas, Trump carried only three in the 2016 election.

“It’s difficult to resist the theory that it’s going away because it primarily benefits residents in blue states,” Kleinbard said.

While the possible trimming of the mortgage interest deduction would directly reduce the benefits of owning a home, the California Assn. of Realtors is also worried about eliminating the state and local tax deduction, which reduces the effective cost of property taxes.

Association President Geoff McIntosh said losing the tax deduction, along with a doubling of the standard deduction, would remove the incentives for home buying and hurt the state’s housing market. He predicted the average California home buyer could end up paying $3,000 more a year in taxes.

“Congress should look at ways to incentivize and increase homeownership rates, not increase taxes on families wanting to buy a home,” McIntosh said.

State Controller Betty T. Yee warned that the change could have a broad economic impact.

“Elimination of the state and local tax deduction could lead to an economic downward spiral in California, including the loss of good-paying jobs and cuts to critical public safety and social service programs,” she said.

A coalition including the National Governors Assn., the U.S. Conference of Mayors, labor unions and other state and local government organizations has formed to fight to keep the deduction.

“This plan threatens necessary infrastructure investments and vital state and local public services, including education and public safety, that benefit all Americans,” said the group, called Americans Against Double Taxation.

Among their arguments is that the deduction prevents people from being taxed twice because otherwise they would pay federal taxes on income they are using to pay state and local taxes.

Rep. Judy Chu (D-Monterey Park) said she and other California lawmakers plan to fight to keep the deduction.

“We are already a high-tax state that delivers more in revenue to the federal government than it receives back,” said Chu, who serves on the tax-writing House Ways and Means Committee. “We should not be further burdened by another tax increase.”

Eliminating the deduction could pose problems for Republicans in getting the tax plan through Congress. In June, 69 House members, including several Republicans from New York and New Jersey, wrote to Treasury Secretary Steven Mnuchin urging the Trump administration to keep the deduction.

No California Republicans signed the letter, but pressure could build on those lawmakers in high-cost parts of the state, such as Orange County.

Rep. Steve Knight (R-Palmdale) said Republican leaders seemed open to addressing concerns of lawmakers about the deduction.

“That’s a big, big issue and that’s a big issue to us Californians,” he said. “We can’t just be left out on the side of the road without fixing this. I don’t know that there will be a catchall way of fixing this, but I do think we can mitigate this down.”

Times staff writer Sarah D. Wire contributed to this report.

jim.puzzanghera@latimes.com

Twitter: @JimPuzzanghera

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