Will Congress kill a $101-billion tax break for Californians?
For California, it’s the $101-billion question: Will Congress eliminate a major tax break that benefits state residents more than those anywhere else in the country?
A plan by House Republicans calls for axing the federal deduction for state and local taxes. The provision allowed Californians to reduce their taxable income by that amount in 2014, according to an analysis by the nonpartisan Tax Foundation.
That figure was one-fifth of the total value of the deduction nationwide.
California’s pain may be Republicans’ gain, though, as lawmakers and the White House turn to tax reform after the failed attempt to repeal and replace President Obama’s healthcare law.
The break, one of the most costly in terms of lost federal revenue each year, largely benefits states with high taxes and high earners — and most of those states are Democratic strongholds.
California and New York receive nearly a third of the deduction’s total value, the Tax Foundation found. Of the top 10 states for the deduction, President Trump carried only three in last fall’s election.
“The only reason to single out state and local taxes is because the Republicans view it as a poke into the eye for the blue states,” said Edward Kleinbard, a USC professor and former chief of staff to Congress’ Joint Committee on Taxation. “They view this as a war on blue states and that’s really quite unfair.”
Officials from California and other states whose residents would be hit hard by the loss of the deduction are concerned. They worry about the cost to taxpayers and the broader effect of possibly increasing resistance to state and local tax hikes.
“California’s got a deal that’s working well and allows our state to deliver the services that our citizens need and if you pull something like that it disrupts it,” said Rep. Mike Thompson (D-St. Helena), a member of the tax-writing House Ways and Means Committee.
“I think you’re going to see opposition come out of the woodwork,” he said.
New York Gov. Andrew Cuomo has warned that eliminating the deduction would be “devastating” for his state, California and others. New Yorkers used the provision to reduce their taxable income by $68 billion in 2014, according to the Tax Foundation.
The break has been around since the U.S. began collecting income taxes in 1913. It allows taxpayers to deduct what they pay in state and local real estate, personal property and income taxes.
The Treasury Department estimated the deduction would reduce federal tax revenue by $96 billion this year. (The deduction lowers taxable income by much more money, but that only partially translates into less taxes paid.)
It is one of three major deductions for individuals, along with those for home mortgage interest and charitable contributions. The “A Better Way” tax reform plan released by House Republican leaders last year called for eliminating all individual itemized deductions except those for mortgage interest and charitable giving.
“These two provisions help accomplish two important goals that strengthen civil society: home-ownership and charitable giving,” the plan said.
The changes are designed to simplify tax filing and offset the revenue lost from lowering rates and increasing the standard deduction.
Rep. Kevin Brady (R-Texas), chairman of the Ways and Means Committee and a driving force behind the House GOP plan, said that the state and local deduction was unfair. Residents of his home state of Texas were major beneficiaries of the break, reducing their taxable income by $20 billion in 2014.
“Today, Washington increases taxes on everyone so a few people can receive help,” he said. “Our plan lowers taxes for everyone — regardless of what they earn or where they choose to live — so families can keep more of their hard-earned dollars or put that money toward state and local taxes.”
The tax plan President Trump campaigned on called for keeping the state and local tax deduction but offsetting rate reductions by capping itemized deductions at $100,000 for single filers and $200,000 for married couples filing jointly. The Trump administration is working on its own tax overhaul proposal but has not yet released it.
Eliminating the state and local tax deduction would increase federal revenue by about $1.3 trillion over 10 years, according to the nonpartisan Tax Policy Center, which is run jointly by the Urban Institute and the Brookings Institution.
The deduction has been targeted in the past because eliminating it would result in a big revenue boost. But opposition from lawmakers in large states such as California and New York have kept the provision mostly intact.
A bipartisan coalition from New York helped save most of the deduction in the Tax Reform Act of 1986 under President Reagan. It was trimmed to eliminate the deduction for state sales taxes, but Congress later partially restored that for a while.
Jared Walczak, a policy analyst at the Tax Foundation, said the state and local tax deduction is an unusual provision that shifts money “largely from lower-income individuals and lower-tax states to higher-tax individuals and higher-tax states.”
Only about 30% of taxpayers — mostly high earners -- itemize their deductions and are eligible for the break. Walczak’s analysis noted that 88% of the benefit in 2014 went to people with incomes of more than $100,000.
States with higher taxes and more wealthy taxpayers benefit the most. For Californians claiming the deduction, it reduced adjusted gross income by an average of nearly 8% in 2014, Walczak found.
I don’t know who in California, who in New York votes for this.
— Rep. Mike Thompson, (D-St. Helena)
The Tax Policy Center said the deduction “provides an indirect subsidy to state and local governments...in effect allowing those jurisdictions to export a portion of their tax burden to the rest of the nation.”
But eliminating the deduction “could lead to reductions in spending for programs and services,” the center’s analysis said.
California Gov. Jerry Brown’s 2017-18 budget summary warned that the Trump administration and congressional leaders “have suggested major changes to Medicaid, trade and immigration policy, and the federal tax structure.”
“Many of the proposed changes could have serious and detrimental effects on the state’s economy and budget,” the summary said.
It’s difficult to know the impact of tax changes until a specific bill is introduced, said H.D. Palmer. a budget spokesman for Gov. Jerry Brown.
Palmer said California residents who filed state returns reported $206 billion in federal itemized deductions in 2014. Eliminating all but the mortgage interest and charitable contribution breaks would have reduced itemized deductions by about $120 billion.
Thompson, whose district includes expensive areas in Contra Costa, Napa and Sonoma counties, said he opposed eliminating the state and local tax deduction. He predicted it would be difficult for Republicans from California and some other key states to support it.
“I don’t know who in California, who in New York votes for this,” Thompson said. “That’s a big bloc.”
Matt Sparks, a spokesman for House Majority Leader Kevin McCarthy (R-Bakersfield) wouldn’t comment on the state and local tax deduction. But McCarthy supports the House Republican tax blueprint, Sparks said.
“We are focused on a tax code that is simpler and fairer so that Americans keep more of their hard-earned money,” Sparks said.
Spokespeople for several other House Republicans from California did not respond to requests for comment.
Kleinbard, the USC law and business professor, said the only way to lower individual tax rates without “sending the country into a tailspin of uncontrollable deficits” is to reduce or eliminate the major personal deductions.
But it’s not fair to get rid of the state and local tax deduction while keeping the mortgage interest and charitable giving breaks, said Klienbard, author of a 2015 book titled “We Are Better Than This: How Government Should Spend Our Money.”
“I think there is a case for scaling back all of them collectively and funneling that very large amount of additional revenue toward the real middle class,” he said.
Targeting only the state and local tax deduction, however, “is just political warfare by Republicans” aimed at Democrats in blue states, Kleinbard said.
1:35 p.m.: This article was updated with comment from House Ways and Means Committee Chairman Kevin Brady.
This article originally was published at 11:45 a.m.