The main Republican argument for killing the state and local tax deduction is that the break forces residents of low-tax states to subsidize those in California and other high-tax states.
But when it comes to federal taxes, the data show that it’s the other way around. And it could get worse for Californians if the deduction is eliminated as part of the GOP tax overhaul.
California is among 13 states that ship more tax money to Washington than they get back in federal spending, according to the Rockefeller Institute of Government, a public policy think tank in Albany, N.Y.
They’re known as donor states, a title California has held for years, mostly because of the state’s relatively younger population and large number of high-income earners.
Killing the state and local tax deduction, as President Trump and congressional Republican leaders have proposed, probably would tilt the equation even more against California.
“We will end up being an even greater donor state,” said Rep. Judy Chu (D-Monterey Park). “That’s not fair.”
In 2015, California residents and businesses pumped $410 billion worth of income, corporate and other federal taxes into the U.S. Treasury, the Rockefeller Institute said.
At the same time, Washington sent the state $393 billion worth of payments and services, including Social Security checks, Medicare payments, federal employee salaries and government contracts.
That $17-billion shortfall ranked as the fourth-worst state balance of payments.
Calculated another way, California received 96 cents of federal spending for each dollar paid in federal taxes. While that’s close to break even, it’s well off the $1.14 national average and ranked 40th in the nation. New Jersey was last at 74 cents.
Three states — New Mexico, West Virginia and Mississippi — received more than $2 in federal outlays for every dollar in taxes paid, according to the Rockefeller Institute.
“The reason a lot of states ... have a bad balance of payments is because the relatively rich states are paying into a tax system that has progressive rates — and they pay a lot,” said Don Boyd, director of fiscal studies at the Rockefeller Institute, which is the public policy research arm of the State University of New York.
On a per capita basis, Californians paid $10,510 in taxes to the federal government in 2015. That ranked 12th in the nation. The leader was Connecticut at $15,643. Mississippi was last at $5,740.
The state and local tax deduction helps offset some of the higher costs for donor states by reducing the amount of tax money flowing to Washington, analysts said.
The deduction allowed Californians to reduce their combined taxable income by $101 billion in 2014 — one-fifth of the total value of the deduction nationwide, according to the nonpartisan Tax Foundation.
If the break is killed, taxes would increase for about 24% of all taxpayers, according to the nonpartisan Tax Policy Center. But the effect would be greater in high-income states. In California, about 26% of tax filers would see an increase averaging about $3,200.
The deduction is available only to people who itemize their taxes and do not take the standard deduction — about 30% of filers. Many are wealthier and own homes, with mortgage interest one of the top write-offs, although 56% of those who itemize have adjusted gross incomes of less than $100,000 a year, according to the Congressional Research Service.
But other changes in the tax overhaul also would affect the equation.
If the plan significantly reduces taxes on the wealthy and corporations, as Republicans have proposed, that would disproportionately benefit states such as California with high earners and big businesses.
This week, House Republicans plan to unveil a bill based on the framework released last month. It will follow Thursday’s passage of a budget that allows for tax cuts that add as much as $1.5 trillion to the deficit over the next decade.
The local and state tax deduction has become a key element of the tax overhaul because it is one of the most popular in the federal tax code and is claimed by about 43 million Americans.
The Treasury Department estimated it will cost the Treasury $111 billion this year and about $1.5 trillion over the next decade. Eliminating it would help offset the revenue lost by the proposed cuts in individual and business tax rates.
The House bill also could simply limit the state and local tax deduction to property taxes instead of killing it altogether after an outcry from some Republicans in states that would be hardest-hit by the loss of the break, particularly New York and New Jersey.
But the Republican argument has been that the deduction encourages states and localities to increase taxes and that killing the break would make the tax code more equitable.
“Is it fair that other states subsidize states that have high state taxes?” House Majority Leader Kevin McCarthy (R-Bakersfield) said on Fox Business Network last month.
“California is one of the most mismanaged, highest-tax states in the nation and they use an argument inside that [state] Capitol that, ‘Let's raise taxes because you can write it off on your federal income tax,’ ” he said, referring to Sacramento lawmakers. “Well, that's not fair for all of America.”
It’s an unusual argument coming from California, where politicians of both parties have complained for years that the federal tax code is stacked against the state.
California has been a donor state since 1987, when defense spending that had flowed to Southern California’s aerospace industry and other contractors began declining. The balance of payments has improved in recent years, but the state still gets less back than it sends to Washington.
“In general, taxes paid are higher because we have more wealthy people in California and in general expenditures are lower because we have fewer people who are 65 and older who are receiving Social Security,” said Ann Hollingshead, a senior fiscal and policy analyst in the state’s Legislative Analyst’s Office.
California Controller Betty Yee wrote to lawmakers in June warning them that “subjecting our taxpayers to several billion dollars in additional federal tax liability will hamper the economic growth of our nation.”
Rep. Kevin Brady (R-Texas), chairman of the tax-writing House Ways and Means Committee, disagreed, saying the economic boost from the tax overhaul would more than make up for any additional dollars that high-tax states send to Washington.
“Our state and local governments tend to receive the first benefits from a much stronger economy,” he told reporters last week. “We think that’s good for California and New York and New Jersey and others.”
Chu, the Monterey Park Democrat, said California would take a big hit from the loss of the deduction, further skewing its balance of payments.
“We are the donor states that support the economies in states like Mississippi,” she said. “And to think they would dare to say they’re the ones supporting us, that doesn’t make much sense.”