A Fair Trade for the Sequester?

by Reihan Salam

Ezra Klein argues that Democrats have reason to like the sequester while Republicans have reason to want to replace it with tax increases. This could be an elaborate exercise in reverse psychology, but there is at least something to it:

Typically, when we think about increasing taxes, we think about raising marginal tax rates. But that’s not what Democrats are proposing. They’re talking about cutting subsidies we give wealthier people to buy bigger homes or donate to charity or live in high-tax states or get health insurance from our employers. All of that, as any economist will tell you, is spending. But because the spending comes in the form of tax deductions, cutting it counts, in a narrow budgetary sense, as increasing taxes. [Emphasis added]

My preference would be to curb these subsidies and apply the resulting revenue to create an expanded child credit, but there is one tax expenditure that might be a fair trade for the Sequester — the state and local tax deduction:

One of the most costly tax expenditures, for example, is the deduction for state and local taxes, which in effect subsidizes high-tax jurisdictions by softening the blow of high state and local tax burdens. Eliminating this deduction would make voters in states such as New York, New Jersey and California more tax-sensitive, which might make them more likely to back state and local candidates who promise a more cost-effective government.

Elimination of the deduction would also be a bonanza for the U.S. Treasury. In fiscal year 2011, the state and local tax deduction cost the federal government $70.2 billion in forfeited revenue. In April, the Committee for a Responsible Federal Budget estimated that eliminating the state and local tax deduction would raise $1.3 trillion relative to current policy (the tax rates that prevail today) and $950 billion relative to current law (the tax rates that will be in place if we go over the fiscal cliff) from 2013-2022. This alone would go a long way toward meeting Obama’s revenue goals. Even if Congress only eliminated the state and local tax deduction for households earning $200,000 or more, it would raise $500 billion relative to current policy. [Emphasis added]

I realize that the chances that congressional Republicans would rally around elimination of the state and local tax deduction are vanishingly slim, yet the conceptual argument is straightforward: we should care about public spending at all levels, not just the federal level, and the state and local tax deduction tends to weaken spending discipline at the state and local level.