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High-Tax States are Inconsistent on the State and Local Tax Deduction

2 min readBy: Jared Walczak

If the state and local taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. deduction is necessary to prevent double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. , why don’t states offer a deduction for federal and local taxes?

Representatives of several high-tax states, most notably New York and California, have excoriated the possible repeal or diminution of the state and local tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. as an assault on their states. The provision, which subsidizes high-income, high-tax jurisdictions, would be limited under the tax reform bill, with both the House and the Senate limiting the deduction to property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es and capping its value at $10,000.

Opponents of the provision only occasionally delve into the thorny question of whether there is any justification for current law. When they do, the arguments typically boil down to concerns about double taxation, the idea that the deduction is necessary to avoid the federal government imposing a tax upon a tax.

But if that concern is genuine, then states need to step up as well. If the federal government taxing gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” , including the amount forgone in state and local taxes, is a tax upon a tax, then what exactly should we call it when states tax gross income, including the amount forgone in federal and local taxes?

The key, of course, is in the term itself: gross income, or more accurately adjusted gross income, which does include certain exemptions and deductions, but is meant to capture both saved and consumed income. Whereas corporate income taxes are imposed on net—which is to say, on profits—individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es fall on gross income. You don’t get to deduct the cost of housing, food, clothing, or transportation, even though all those are important and make claims upon your income.

Many states, including New York and California, conform to federal treatment of the property tax deduction. However, most disallow the income tax deduction without any sort of subtraction for local income taxes, and they decidedly do not permit a deduction for federal income taxes paid. Only six states do that, and three of them cap the benefit.

There’s nothing wrong with this, of course. As we’ve noted before, in a federal system, individuals receive services from federal, state, and municipal governments. Each layer of government can be viewed as providing its own package of services, which one would expect to be “priced” separately.

When two taxes levied by a single government, or similar types of governments (for instance, multiple states), fall disproportionately upon the same income or economic activity, this represents a clear case of double taxation. When different levels of government levy taxes for discrete sets of services, the rationale for a deduction for taxes paid is far weaker.

Still, what’s good for the goose is good for the gander. If elected officials from New York and California believe that the federal government shouldn’t tax the share of income expended on state and local income taxes, shouldn’t they be equally concerned that their states tax the share of income expended on federal and local taxes?