Poor Tax Policy

Of all the arguments made in behalf of the Reagan Administration’s tax-reform program, perhaps the most flawed is the contention that the state and local tax deduction is a subsidy for the wealthy in high-tax states. The Administration corollary to this argument is that the deduction penalizes poorer states, in effect, to permit places like New York and California to enjoy luxuries provided by state, county and city governments and school districts.

To support its argument, the Administration uses data based on per-capita income in the 50 states and the District of Columbia. As might be expected, the largest per-capita savings gained from the state and local tax deduction are in places like New York, the District, Maryland, New Jersey, Delaware, California and Massachusetts. These tend to be areas with large personal incomes, but also states with large budgets for social programs--many mandated on the states by federal law.

But the per-capita figures tell only part of the story. The U.S. Advisory Commission on Intergovernmental Relations reports that per-capita income is not a particularly accurate measure of a state’s ability to tax itself or how it does, in fact, actually make use of its potential tax base.

The ACIR has adopted the Representative Tax System as a more realistic yardstick. The system has a tax-capacity index that measures a state’s tax base and its ability to raise revenues from a variety of 26 common taxes. Alaska has the largest tax-capacity index, 312, because of its small population and great wealth. Alabama and South Carolina are the lowest, with indexes of about 74.

The ACIR system then measures the actual amounts of taxes that the states levy in the various categories, and rates them against the average of all states. This is called the tax-effort index.

The Administration’s tax plan contends that residents in the 15 states with above-average tax savings per capita gain at the expense of taxpayers in the other 35 states. But this is not necessarily so if you consider the total economic resources of a state and how heavily they are taxed. For instance, the Administration plan notes that South Dakota residents receive the smallest average deduction for state and local taxes, $20.

This does not mean that South Dakota is a low-tax state. Under the ACIR guide, South Dakota has a tax-capacity index of 87.4 but a tax-effort index of 90.8. Thus South Dakota levies higher taxes relative to its tax base than many other states, including Connecticut, Delaware, Missouri, Oregon and, yes, California. California’s tax-capacity index is 115.9, but its tax-effort index is only 98.8.

Other states that have high taxes relative to their economic tax bases include Tennessee, Mississippi, Alabama, Kentucky and Maine--all of which rank in the bottom half of per-capita state and local tax deductions.

As for individual taxpayers, is the deduction merely a benefit for the privileged class? No, insists Virginia’s Democratic Gov. Charles S. Robb, speaking for the National Governors’ Assn. “This is primarily a deduction for middle America--for those families where both husband and wife work, who own a home and who pay most of the federal, state and local tax burden.”

This is one of several areas where the program ignores the major economic phenomenon in American life today, the growing number of families where both husband and wife have to work to make ends meet. While the Administration claims that only a third of the taxpayers benefit from the state and local deduction because they are able to itemize their deductions, a majority of two-earner families now fall into this category.

Those families would be hit in other parts of the tax plan, such as the elimination of the marriage-penalty deduction and the change of the child-care credit to a deduction. And the IRA deduction would be extended for the first time to non-working spouses. An attempt to promote a return to the romantic ideal of one-wage-earner families may be a worthy notion, but it flies in the face of reality and does not make good tax policy.