by Joseph Coletti
Senior Fellow, Fiscal Studies, John Locke Foundation
Roy Cordato, my colleague here at the John Locke Foundation, last week said it would be immoral to eliminate the federal deduction on income and property taxes paid to state or local government. His argument rests on the idea that personal income that has been taxed away does not really belong to the person who earned it, which begs the question of the state or local government’s right to the money in the first place. I respectfully disagree.
While it is true that taxes paid in a year are not available to a person, the tax rate can change from year to year and from place to place. Taxes are the price of government and taxation is a necessary power of government, but there is no moral principle for establishing the correct tax rate. If you think taxation is theft, you could try to itemize it on the line for casualty, disaster, and theft losses, though the IRS may not agree that the taking was “illegal under the law of the state where it occurred and … done with criminal intent.” Federal deductibility provides a subsidy to those who itemize deductions and so raises the price they would be willing to pay for government. People who itemize tend to have higher incomes and those with higher incomes tend to be more involved in government, which makes those who are more likely to have a voice less concerned about using it for lower taxes.
People can and do move from jurisdictions. Taxes are not a top reason for moving from a place, but high taxes can keep a person from moving to a place and can lead a family to leave when other attachments weaken. Because people can influence taxes through both voice and exit, their tax burden is not beyond their control.
If taxes are a price and that price can change, then policies can provide a subsidy to the taxing authority. Former president Ronald Reagan, who understood economics on an instinctual level said, “If you want more of something, subsidize it; if you want less of something, tax it.” The state and local tax deduction is a federal subsidy that leads to higher tax rates at lower levels of government.
The state and local tax deduction may have survived tax reform efforts in the 1980s, but it was not because Reagan agreed with Norman Turé, as Cordato suggested. The president called it the most sacred of sacred cows and his Treasury Secretary Donald Regan called it one of the “dragons” they sought to slay when they tried to eliminate the deduction entirely Jack Kemp, supply-side economics’ greatest Congressional champion, sought to limit it to just real property taxes.
Changes in tax law have produced different taxes being deductible at different times. Still today, you cannot deduct both sales and income taxes you pay to states or local governments. Advocates of the deduction would likely agree that this is inconsistent and would argue that all taxes should be deductible, including franchise tax, excise taxes on cigarettes, and others. But that could cause a paperwork nightmare and probably wouldn’t be worth the trouble, despite the fact that some people do keep all of their receipts for online purchases to make sure they pay those accurately.
Without going into the morality question, one could reasonably argue that the subsidy for state and local taxes works against the propensity to centralize decision-making in the national government, just as the charitable donation deduction strengthens non-government responses to social problems. There is some evidence that charitable deductions would decline if they were not tax deductible. You could even extend the argument back to morality and say it is right and just for the federal government to forgo money it would otherwise collect in the name of federalism and subsidiarity, but this is a different kind of moral claim than Cordato and Turé make.
At best, there are competing moral claims. The federal government should not tax income that never actually went to a person, but not all money taken by state and local governments is necessarily rightly taken to pay for services. And to the extent that the cost of taking is reduced for some people, they are less likely to use their powers to advocate for more appropriate levels of taxation at the state or local level.
As for the efficiency argument, withholding has been a much more efficient method of collecting income and payroll taxes. This has led people to anticipate their tax refunds and complain when they are too small, rather than considering the total tax they pay. Eliminating the deduction on state and local income taxes would treat taxes more like consumption instead of saving. This seems perfectly reasonable and moral.