Republicans may regret eliminating the state and local tax deduction

In 2013, Sen. Harry Reid (D-Nev.) became so frustrated by the Republican filibusters of judicial nominees that he invoked the so called “nuclear option” and changed the Senate rules. In a remarkably accurate prediction, then Senate Minority Leader Mitch McConnell (R-Ky.) famously warned the Democrats, “You’ll regret this, and you may regret this a lot sooner than you think.”

As Republicans consider the proposed tax bill, this same prediction seems applicable. In almost every election since 1952, we choose a president from the other party every eight years. In both 2008 and 2016, voters gave the new president majorities in both the House and the Senate. It could happen again, perhaps as soon as 2020. If this tax bill passes, Republicans may come to regret the process they used to pass it, as well as some of the provisions, especially the one about state and local taxes.

{mosads}The U.S. government taxes corporations based on their profits and individuals based on their income. The tax system has become complicated, in part, because we then allow individuals to deduct certain expenses from their income such as charitable donations and mortgage interest. Of all the deductions, the one that makes the most sense is the deduction for state and local taxes. If one earns $100,000 and pays state taxes of say $5,000, then one’s effective federal taxable income is currently $95,000.

Since taxes paid to states go to pay for government services it seems like a logical deduction. Why should we pay taxes on our taxes? So eliminating this deduction may well set us on a path to eliminating all deductions. Eliminating all deductions would have a number of benefits. It would greatly simplify the tax code. It would allow for lower tax rates for the middle class. If tax rates for the wealthy remained at the same level, it would increase the tax burden on the wealthy, since they benefit the most from allowable deductions.

Until now, the tax code has been used to create incentives for all kinds of activities such as charitable giving, saving for retirement, and buying a home. Each expense that the tax code allows individuals to deduct from their reported income has a rationale. But no rationale is stronger or more logical than allowing individuals to deduct their state and local taxes. If that gets eliminated, it undercuts the rationale for all other deductions.

In the short term, changing the tax code in this way seems like a way to punish people who live in states with higher taxes. People living in these states have generally favored Democratic candidates in recent election. But as Mitch McConnell correctly observed, actions that change precedents like those contained in this tax bill may have long term consequences that the party in power will come to regret.

John Vogel is a recently retired professor from the Tuck School of Business at Dartmouth College, where he was associate faculty director for the Center for Business, Government & Society.