Doc 2005-7184 (4 pgs) NEWS AND ANALYSIS

ECONOMIC ANALYSIS Biting the Big Apple According to the latest IRS data, individuals (C) Analysts 2005. All rights reserved. does not claim copyright in any public domain or third party content. 2004. Tax Reform Blues deducted $309 billion of state and local income and For the Blue States property in 2002. The majority of those deduc- tions — 60 percent — were for state and local income taxes. The average deduction for those 45.4 By Martin A. Sullivan — [email protected] million who claimed it was $6,800. Treasury Secretary John W. Snow has great ex- There is a lot of variation among the states in the pectations for President Bush’s tax reform plan. manner and the amount they tax their citizens. ‘‘Knowing this president — who doesn’t like doing Accordingly, the size of the deduction for state and little things, he likes doing big things — if we come local taxes also varies widely, as shown in Table 1 up to him with a little tax package, he’s probably on p. 175. At the top of the list, New Yorkers’ going to send us back to the drawing board,’’ Snow deductions equal 8.2 percent of all adjusted gross said recently. Previously, Bush proclaimed that his income reported by residents of that state. That is tax reform plan will be revenue-neutral. Putting more than six times larger than in lowest-ranked those two statements together, we can surmise that Tennessee, where the deduction amounted to only if the president is going to meet the most basic 1.2 percent of AGI in that state. The table reports a objectives of tax reform — repeal the individual variety of statistics for the deduction by state, but alternative minimum tax, reduce tax rates, and no matter how you measure it, states on the ocean reduce the tax burden on capital — he will have to coasts and in the industrial Midwest have the most jettison some major tax break. to lose from repeal of the deduction. In the , the ‘‘big three’’ deductions There is a striking relationship between high-tax in the determination of individual taxable income states and states that supported Democratic Sen. are the deduction for home mortgage interest (a John Kerry of Massachusetts in the last presidential $70.1 billion tax reduction in 2005), the deduction election (so-called ‘‘blue states’’ because that is for charitable contributions ($34.4 billion), and the invariably how they are depicted on color televi- deduction for state and local taxes, mostly income sion). All of the top 10 states listed in Table 1 went and property taxes ($64.3 billion). More than once to Kerry in 2004. Of the bottom 10, all but one went Bush has declared the first two deductions off for Bush. The figure on p. 176 illustrates the lop- limits. But no such warning has ever been issued sided burden placed on blue states. Although Kerry about the third. On the contrary, in a 2002 internal states are home to less than half the country’s Treasury memo (now public because it was leaked), voters, they account for more than two-thirds of the Treasury staff proposed elimination of the deduc- deduction for state and local taxes. tion for state and local taxes. The Treasury Depart- ment first proposed that in 1984 and, despite much What Would Arnold Say? vocal opposition, it got the blessing of the Reagan This is the part where you may be expecting us to White House and again proposed eliminating the say something snide about how neat it would be for deduction in 1985. Putting all this together, state Karl Rove, White House deputy chief of staff, to pay and local governments should not be surprised if back those states that voted for Kerry with a dis- the federal deduction for their taxes plays a pivotal proportionate tax increase. Or perhaps you are role in Bush’s tax reform plan. expecting us to mention it would be forward- The President’s Advisory Panel on Federal Tax looking on the part of Republicans to hand Sen. Reform is scheduled to submit its report to the Hillary Rodham Clinton, D-N.Y., a major political Treasury Department on July 31. In an April 4 defeat just as she was beginning her bid for the speech to directors, Snow said Trea- presidency in 2008. (In 1985 New York Democratic sury would deliver reform legislation to Congress Governor Mario Cuomo led the attack against re- later this year. Back in early 1985, shortly after peal, and many Republicans at the time liked the release of the Reagan Treasury’s initial proposal to idea of beating up a leading Democratic contender eliminate the deduction for state and local taxes, a for president.) And then there is the ideological bipartisan lobbying effort was funded by rich New nicety that eliminating the deduction would in Yorkers. The coalition was soon joined by Demo- effect put a tax on big government. crats and Republicans from other high-tax states to form one of the biggest and most successful lobby- ing efforts surrounding the Tax Reform Act of 1986. There is little reason to expect history not to repeat itself, in which case it may be as soon as early 2006 that we see a similar coalition forming. (Text continued on p. 176.)

174 TAX NOTES, April 11, 2005 Doc 2005-7184 (4 pgs) NEWS AND ANALYSIS

Table 1 (C) Tax Analysts 2005. All rights reserved. does not claim copyright in any public domain or third party content. 2004. The Federal Income Tax Deduction for State and Local Taxes, by State, 2002 And by the Outcome of the 2004 Presidential Election (Kerry states are shaded. Bush states are unshaded.) Deduction %of for State Tax Benefit Total Deduction and Local of Deduction for Income Taxes as % Deduction, Tax Benefit for State Taxes (as of AGI of Per of and Local opposed to All Deducting Deduction, Taxes property Electoral Jurisdiction Taxpayers Taxpayer Per Capita (billions) taxes) Votes 1 New York 8.2% $2,774 $484 $37.1 67% 31 2 New Jersey 7.5 2,501 530 18.2 47 15 3 Oregon 7.2 1,805 340 4.8 69 7 4 Maryland 7.2 1,986 461 10.0 72 10 5 Connecticut 7.0 2,606 547 7.6 55 7 6 Wisconsin 6.9 1,923 359 7.8 57 10 7 California 6.8 2,221 374 52.3 68 55 8 District of Columbia 6.7 2,309 457 1.0 84 3 9 Rhode Island 6.7 2,065 359 1.5 54 4 10 Massachusetts 6.2 2,164 420 10.8 60 12 11 Maine 6.0 1,825 278 1.4 62 4 12 Minnesota 5.9 1,701 341 6.9 71 10 13 Ohio 5.8 1,680 284 13.0 69 20 14 North Carolina 5.6 1,563 256 8.5 72 15 15 Vermont 5.5 1,731 274 0.7 52 3 16 5.3 1,666 316 9.2 65 13 17 Georgia 5.2 1,490 250 8.5 67 15 18 Utah 5.1 1,272 219 2.0 71 5 United States 5.1 1,701 268 308.7 60 538 19 Michigan 5.1 1,525 262 10.5 55 17 20 Nebraska 5.1 1,648 236 1.6 58 5 21 Kentucky 5.0 1,507 205 3.4 76 8 22 Montana 5.0 1,324 200 0.7 65 3 23 Idaho 5.0 1,284 200 1.1 69 4 24 South Carolina 4.9 1,407 205 3.4 69 8 25 Pennsylvania 4.8 1,637 250 12.3 55 21 26 Iowa 4.7 1,429 213 2.5 65 7 27 Illinois 4.7 1,619 268 13.5 44 21 28 Kansas 4.7 1,558 223 2.4 64 6 29 Missouri 4.5 1,442 209 4.7 66 11 30 Colorado 4.5 1,323 258 4.6 64 9 31 New Hampshire 4.4 1,532 274 1.4 25 4 32 Hawaii 4.3 1,325 211 1.0 84 4 33 Arizona 4.3 1,204 192 4.2 58 10 34 Oklahoma 4.3 1,283 168 2.3 76 7 35 Delaware 4.3 1,373 246 0.8 74 3 36 Indiana 4.1 1,298 194 4.8 66 11 37 New Mexico 3.9 1,269 150 1.1 75 5 38 Arkansas 3.4 1,221 126 1.4 80 6 39 Alabama 2.9 906 118 2.1 76 9 40 West Virginia 2.9 1,331 104 0.8 79 5 41 Mississippi 2.8 992 94 1.1 68 6 42 North Dakota 2.4 1,118 104 0.3 48 3 43 Florida 2.3 927 118 7.9 15 27 44 Washington 2.3 816 129 3.1 11 11 45 Texas 2.2 1,072 100 8.7 6 34

TAX NOTES, April 11, 2005 175 Doc 2005-7184 (4 pgs) NEWS AND ANALYSIS

46 Nevada 2.2 726 120 1.0 24 5 (C) Tax Analysts 2005. All rights reserved. does not claim copyright in any public domain or third party content. 2004. 47 Louisiana 2.1 881 80 1.4 78 9 48 Alaska 1.6 716 92 0.2 6 3 49 Wyoming 1.3 690 67 0.1 35 3 50 South Dakota 1.3 695 53 0.2 17 3 51 Tennessee 1.2 540 53 1.2 21 11 Sources: Calculations by author assuming a marginal 25 percent federal tax rate and using federal tax return data from the IRS ‘‘Individual Tax Statistics — State Income for 2002 through 2004,’’ at http://www.irs.gov/taxstats; population data are from the U.S. Bureau of Census (http://www.census.gov); and data on the electoral college are from the Federal Election Commission (http://www.fec.gov).

Deductions for State and Local Taxes on Federal Individual Income Tax Returns in 2002 (In billions)

$204.2 $250

$200 $104.5 $150 Billions $100

$50

$0 States Won by Bush (286 Electoral Votes) States Won by Kerry (252 Electoral Votes) Sources: Calculations by author using federal tax return data from the IRS “Individual Tax Statistics — State Income for 2002 through 2004,” at http://www.irs.gov/taxstats and data from the Federal Election Commission (http://www.fec.gov).

Those may be the thoughts Republicans are by the American Jobs Creation Act of 2004 (P.L. privately thinking. But it would be a miscalculation 108-357).) There is no reason to believe the odds of on their part to act on those ideas. In 1985, despite success for any effort to repeal the deduction are the seemingly unyielding position of the White better now than they were in 1986. House and the initial support of House Ways and If you are not convinced by that last assertion, Means Committee Chair Dan Rostenkowski, repeal here is a news flash for you: There are powerful of the deduction for state and local income and Republicans in high-tax states. Table 2 on p. 177 shows property taxes was scratched before the bill was that in the 12 states with the most to lose from the approved by his committee. All through the conten- repeal of the deduction, there are 8 governors, 6 tious debate leading to passage of the 1986 Tax senators, and 61 representatives. As demonstrated Reform Act, the issue would never emerge again. by the remarkable cohesion of the Democrats in the (The deduction for state and local sales taxes was current debate on Social Security reform, unless he repealed, but even this has been partially reinstated makes some major concessions, the president will

176 TAX NOTES, April 11, 2005 Doc 2005-7184 (4 pgs) NEWS AND ANALYSIS

Table 2 (C) Tax Analysts 2005. All rights reserved. does not claim copyright in any public domain or third party content. 2004. Elected Republicans in Top 12 High-Tax States Rank State Officials Governor: Pataki. Representatives: (9) King, Fossella, Kelly, Sweeney, McHugh, Boehlert, Walsh, 1 New York Reynolds, Kuhl. 2 New Jersey Representatives: (6) LoBiondo, Saxton, Smith, Garrett, Ferguson, Frelinghuysen. 3 Oregon Representative: Walden. 4 Maryland Governor: Ehrlich. Representatives: (2) Gilchrest, Bartlett. 5 Connecticut Governor: Rell. Representatives: (3) Simmons, Shays, Johnson. 6 Wisconsin Representatives: (4) Ryan, Sensenbrenner, Petri, Green. Governor: Schwarzenegger. Representatives: (20) Herger, Lungren, Doolittle, Pombo, Radanov- ich, Nunes, Thomas, Gallegly, McKeon, Dreier, Royce, Lewis, Miller, Calvert, Bono, Rohra- 7 California bacher, Cox, Issa, Cunningham, Hunter. 8 Rhode Island Governor: Carcieri. Senator: Chafee. 9 Massachusetts Governor: Romney. 10 Maine Senators: (2) Collins, Snowe. Governor: Pawlenty. Senator: Coleman. Representatives: (4) Gutknecht, Kline, Ramstad, 11 Minnesota Kennedy. Governor: Taft. Senators: (2) DeWine, Voinovich. Representatives: (12) Chabot, Portman, Turner, 12 Ohio Oxley, Gillmor, Hobson, Boehner, Tiberi, LaTourette, Pryce, Regula, Ney. Total: Governors:8Senators:6Representatives:61 Sources: National Governors Association, Clerk of the House of Representatives. need every Republican vote he can muster to pass a dent Reagan on repealing the deduction. Ways and ‘‘big’’ tax reform plan. In the Senate, where only 41 Means member Bill McGrath and Sen. Alphonse votes are necessary to block any legislation, Repub- D’Amato were key opponents of the deduction’s licans hold a 55-45 majority. In the House, where repeal. Although the House is generally more sup- 218 votes are needed to pass legislation, they cur- portive of the president than is the Senate, the rently hold 232 seats. stiffest opposition may be in the House where many Of course, not all of those Republicans can be Republicans from high-tax states represent affluent expected to oppose repealing the deduction. But in suburbs. Their constituents are already smarting the face of a united Democratic opposition, even from rising property taxes thanks to the boom in defection by a small number would mean defeat. housing prices. They are expecting their elected Ideology and party loyalty will not matter much for Republicans to protect them from higher taxes, not this do-or-die, bread-and-butter issue. In 1985 New eliminate their deductions. York Republicans did not hesitate to oppose Presi-

TAX NOTES, April 11, 2005 177