Recently, Jim Geraghty proposed that congressional Republicans embrace a tax reform strategy that would have a disproportionate impact on high-earners residing in high-tax, high-cost jurisdictions, i.e., in blue metropolitan areas in blue states. One of the key elements:
Means-test or eliminate entirely the federal deduction of state and local taxes, which is disproportionately utilized by those in high-tax blue states: “In 2005, taxpayers in California and New York together made up 20 percent of those claiming the deduction and accounted for 30 percent of its value. Itemizers in New York, New Jersey, Connecticut, and California claimed on average over $12,000 per household.”
I strongly favor eliminating the federal deduction of state and local taxes, as it implicitly subsidizes high-tax jurisdictions. Apart from encouraging spending restraint, eliminating this deduction would, as Seth Hanlon of the Center for American Progress has observed, have an enormous fiscal impact. The fiscal cost of the deduction for FY11-15 is $451.2 billion. Though it’s not exactly right that the 10-year cost would be twice that amount, it’s not far off, i.e., eliminating this deduction alone would generate revenue in the neighborhood of $900 billion. Note that while the average deduction for state and local taxes per tax return for households earning $30K to $50K is $70, the average deduction per tax return for households earning $100K to $200K is $1,334. For households earning more than $200K, the average deduction per tax return is $5,166. It is convenient that eliminating this deduction alone will get us past the $800 billion in tax increases that many Republicans seem to have accepted as a baseline for negotiations.
Rather remarkably, the fiscal cost of the mortgage interest deduction in FY12 alone is expected to be $84 billion. President Obama has called for a modest reform of the mortgage interest deduction that would yield only modest savings, and the real estate industry is, not surprisingly, staunchly opposed to converting the deduction into a 15 percent tax credit, an approach that would yield substantially larger savings.
Recently, the Tax Policy Center analyzed the potential fiscal impact of a conversion of the mortgage interest deduction into a 15 percent tax credit:
We consider a proposal that: (a) would limit the amount of deductible interest to the amount incurred on the first $500,000 of debt on a primary residence only, not indexed for inflation; and (b) would replace the itemized deduction with a nonrefundable tax credit equal to 15 percent of eligible home mortgage interest. Under current law, the value of the itemized deduction for mortgage interest depends on a taxpayer’s marginal tax rate. For example, a taxpayer in the top 35 percent tax bracket would save $35 from an additional $100 of mortgage interest whereas someone in the 15 percent bracket would save only $15.3 In addition, many lower-income taxpayers do not benefit directly from the mortgage interest deduction because they claim the standard deduction instead. In contrast, the proposed 15 percent nonrefundable credit for mortgage interest would provide the same percentage tax savings regardless of tax bracket and would be available in addition to the standard deduction.
The fiscal impact is dramatic:
Compared with current law, immediate enactment of the full proposal would raise approximately $573 billion over the 2012–21 budget window (see option 1 in table 1). The proposal would generate $378 billion when compared with current policy. Repealing the current mortgage interest deduction would generate less revenue against current policy because of that baseline’s lower marginal tax rates, which results in a lower value of the deduction to taxpayers in higher tax brackets than under the current law baseline for tax years after 2012.
Reforming the mortgage interest deduction to make it more equitable and eliminating or phasing out the state and local tax deduction would, when taken together, go a long way towards addressing President Obama’s revenue goals. One word of caution: these numbers aren’t quite apples-to-apples, as we’d need to know the fiscal cost relative to a current law and a current policy baseline for both.