Treasury Secretary Steven Mnuchin is not backing away from the Republican proposal to eliminate the federal tax deduction for state and local taxes, a provision that would hit hardest in highly taxed, politically liberal states like New York and California.
“We can’t have the federal government continue to subsidize the states,” Mnuchin said in an interview on CNBC’s Squawk Box Thursday. “That’s a major loophole that we’re trying to close in simplifying taxes.”
Current law allows taxpayers to deduct certain state and local tax payments from their income for federal tax purposes. As a result, states and local entities can raise taxes without raising the net tax bill of local taxpayers. This not only encourages high taxes and high spending at the state level, it allows high tax states to capture revenue that would otherwise have gone to the federal government. In effect, high tax states get to export a portion of their tax burden to the rest of the nation.
Eliminating the state and local deduction would be a huge boon to the federal government, potentially reducing future budget deficits. The Tax Policy Center has estimated that it would increase federal revenue by $1.3 trillion over 10 years.
Taxpayers in New York and California would pay over 30 percent of the increased revenue, according to the Tax Policy Center. Ninety percent of the tax increase would fall on taxpayers with incomes over $100,000. Taxpayers with incomes over $500,000 would pay about 40 percent. Wealthier taxpayers in New Jersey, Connecticut, Maryland, and Massachusetts would also be among the hardest hit. All of those states went for Hillary Clinton in the 2016 election.
Republican lawmakers from New York and other states with a high number of taxpayers who benefit from the deduction have been pressuring the administration to back down from its proposal. Recently, some Republicans have proposed capping the deduction as a compromise. This would limit the revenue gains to the federal government but also assure that its impact would be to raise taxes only on those with very high incomes in those states.