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Trump’s Tax Plan Giveth, and Taketh Away

eye on the news

Trump’s Tax Plan Giveth, and Taketh Away

The president’s proposal to end the deduction for state and local taxes would hammer wealthy residents of high-tax places—maybe including him. April 27, 2017
Economy, finance, and budgets
Politics and law

Critics of President Trump have long suggested that his tax-reform plan would heavily benefit the rich. And indeed, the program that the Trump administration just unveiled does cut personal income-tax rates for everyone, including the top rate, which would drop to 35 percent from 39.6 percent. Trump’s plan would also slash the rate on business income that gets reported on individual tax returns to just 15 percent. Currently, that income is subject to tax rates as high as 39.6 percent.

But to help pay for these cuts, Trump’s plan imposes an expensive penalty on the wealthy. It would eliminate a set of deductions including, crucially, the deduction for state and local taxes, which currently generates as much as $100 billion a year in savings, largely for high-income taxpayers. Don’t expect to hear Trump’s critics in Congress praise the plan—many of them represent high-tax states whose wealthy residents largely benefit from the deduction. Eliminating it will only increase their tax pain and put further pressure on states like New York and California to reduce taxes.

The state and local deduction has long been a target of reformers because it complicates the tax code and represents a huge subsidy for upper-income earners in certain states, at the expense of everyone else. A Tax Foundation report recently estimated that 88 percent of the deduction’s benefit goes to taxpayers with $100,000 or more in income. The deduction also disproportionately benefits taxpayers in just six states—New York, California, New Jersey, Illinois, Texas, and Pennsylvania. They rack up half the savings from the deduction.

Critics have argued for years that a better approach would eliminate such special treatment for individuals while lowering tax rates across the board—as Trump is proposing. The last serious attempt to end state and local deductibility as part of a simplified, fairer tax code was the tax reform battle of 1986. That effort failed in part because of furious opposition from high-tax states, especially New York, California, and New Jersey. Since Democrats controlled the House of Representatives back then, and each of those states’ votes were crucial to tax reform, the deduction was sacrificed in pursuit of a deal that cut both corporate and personal income-tax rates. But reformers have never taken their eye off the target. A 2005 report for President George W. Bush urged repealing the deduction; the Simpson-Bowles tax commission empaneled by President Obama similarly urged eliminating virtually all deductions, including the one for state and local taxes.

Though Trump is himself a New Yorker and would presumably pay higher state taxes under his own proposal, eliminating the deduction is attractive to the administration because it helps make the numbers work. To avoid a potential filibuster, any proposed tax cuts must not be projected to increase the nation’s budget deficit beyond 10 years. By penciling out the state and local deduction, the administration can claim a savings of more than $1 trillion over the next 10 years, which would help pay for other parts of its tax-reform program. That would enable Trump to construct a tax package that Republicans alone might get through Congress, though it would need the votes of GOP representatives in states like New York and California—against the interests of some of their own constituents. Trump could also hope to win votes from Democrats in states like Indiana, Washington, and Tennessee, where taxpayers don’t benefit substantially from the deduction. He may need to make his pitch directly to voters there, while also pressuring local Democrats to get behind the plan. The message would be simple: the current arrangement amounts to lower-taxed states—like yours—subsidizing higher-taxed states through the federal tax code.

For wealthy individuals in high-tax states, the pain would be significant, perhaps prompting many of them to reconsider their residency. New York, New Jersey, and Connecticut already have outmigration problems, with wealthy residents fleeing to lower-tax jurisdictions. Last year, New Jersey’s richest resident, hedge-fund manager David Tepper, decamped to zero-income-tax Florida. Some reports suggested that Tepper paid an astounding $200 million in state taxes alone. Imagine not being able to deduct that sum from your federal tax bill!

Earlier this month, New York governor Andrew Cuomo, anticipating that Trump might target the deduction, released an analysis estimating that the proposal would cost New York taxpayers an additional $17 billion a year. That would increase the impact of state and local taxes in New York—where the tax bite is already the nation’s second-highest—by between 20 percent and 44 percent per taxpayer, the governor said. A separate analysis by New York City’s Independent Budget Office estimates that Gotham residents alone could see their tax bill rise by $8 billion. Most of that would come from wealthy taxpayers. E.J. McMahon of the Empire Center estimates that for many middle-income taxpayers, the federal cuts Trump proposes would offset the pain of higher state taxes. But further up the scale, the balance shifts the other way, especially for the very rich: those married households that file their taxes jointly and earn more than $2 million a year.

Trump’s tax plan has scrambled the narrative for his opponents. For years, they have characterized virtually any tax cut as a gift to the rich. By proposing to end the deductibility of state and local taxes within a broader tax-reduction plan, Trump has both given to and taken away from the rich, in pursuit of lower taxes for others. It’s hard to tell what effect this would have on his own income without seeing his tax returns.

On the other hand, maybe Trump plans to relocate from New York to Florida when he’s finished in Washington. After all, he already owns a little vacation home there.

Photo by Andrew Burton/Getty Images

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