Wednesday, November 1, 2017

Should a Libertarian Support the Elimination of the Local and State Tax Deductions on Federal Income Taxes?



I am getting some feedback on my post, BASTARDS: State and Local Tax Deductions to be Eliminated in Tax Reform, where I condemn the GOP House plan to eliminate the deductions for state and local taxes.

One commenter writes:

As a Rothbardian I support every deduction and tax reduction, but there is some benefit from the elimination of state/local tax deductions. It will put political pressure on high tax states to lower taxes - especially coastal states like CA, NY, NJ - because their high taxes will no longer be partially offset by the federal deduction.
The problem with this thinking is that it is the same type of thinking that neocons use when they support sanctions on a country. That is: We will put so much pressure on a country that they will overthrow their evil leader or he will heel.

That never works.

It is the same with the elimination of the state and local tax deduction. Does the commenter really believe that in California, New York and New Jersey are going to come to their senses and cut taxes because there is no longer a Federal tax deduction?

Consider this scenario.

In the high tax states, suppose we have a situation where a majority of the people gain from high state and local taxes and it is only the wealth-producing entrepreneurs and capital owners who are taxed at the state and local level. In this case, the majority are certainly incentivized to keep the high taxes even if the deductions are eliminated at the Federal level.

The argument that eliminating the deduction will push states to lower taxes is an argument generally made by government technocrats who are government house economists and not to be trusted. Their argument that state and local taxes will be lowered when a Federal deduction is eliminated is simply a shady theoretical justification to increase taxes via elimination of the tax deduction at the Federal level. And, in reality, it is an increase in the total tax burden for the productive entrepreneurial and capitalist tax payer class. Is this something a libertarian wants to support?

An EPJ reader emails (My comments are in blue.)
Regarding the SALT deduction I am of two minds:
On the one hand, spending by government that is locally funded and distributed is better than less-local; in this case, that's an argument for town better than county taxes; county > state; state > federal. Thus, this is an argument FOR SALT, because it encourages (to some extent) local taxation over non-local.
Why should local taxation be better than federal taxation? They are both evil. Do I really care if a street mugger is local or a traveling mugger? This should have nothing to do with the argument.
But, in subsidizing local taxation over non-local in the deduction, it means that a no-income tax state subsidizes the federal burden of an income tax state, and an income tax state is distorted in favor of marginally larger government than otherwise.

For instance, Texans pay for the size of government they have through various taxes - just not income tax. So their entire local/state government apparatus is paid up with no (or smaller) deduction to their federal income tax burden; they pay full price for local gov and a little extra for fed gov. But for Californians this means that growth of local government is encouraged (because part of their overall local/state tax burden is a write-off) AND their use of fed gov services is subsidized and they'll vote for or support more fed gov on the margin.

Thus not only does a Texan pay more for their "share" of fed give-backs, but governments that collect income taxes (e.g. California) are artificially encouraged to grow. So it sure looks like SALT deductions A) subsidize big-local-government states at the expense of low/no-income tax states, all while B) encouraging more overall government (with the mitigating factor that more of the government is "local" to some). 
This argument has at its foundation the premise that there is, or can be, some measure of fairness to a tax system. This is an even bigger joke when it comes to the US tax system.

How does the state and local tax deduction match up in, say, New York and California versus a greater tax burden in Texas? Texas has the oil depletion allowance which gives it a great edge over non-oil producing sectors and states.

As of 2016, the  Federal tax code was some 74,608-pages-long. It is silly to think that all the provisions in the tax code can somehow be balanced out to claim who is getting the edge, Further, it is sillier to take one provision of the tax code in isolation and declare some grievous imbalance is occurring when it is unclear how that provision balances out with provisions for other states, other industries and other deductions.

As Murray Rothbard pointed out when arguing in favor of the mortgage interest rate tax deduction and the lower capital gains, against those who wanted to eliminate such:
 None of these arguments is simple, but it’s instructive that in each and every case, the reformers have come down fiercely on the side of including all these incomes or assets in the taxation category. Their bias in favor of tax, tax, and more tax should be clear by now.
The libertarian position should be the opposite: less taxes however they come about. We want to shrink government and the government take. Not bring out some tax balancing scale that doesn't exist and proclaim a non-determinable tax imbalance.
So if you live in Cali, then, sure, you want the SALT deduction in the short run. But is it giving you a bigger-than-otherwise government in the long run? And is it subsidizing socialists on the backs of people with the good and moral sense not to impose an income tax on each other?
This subsidization argument is taxist nonsense. See above. Further, what kind of libertarian lumps all people coerced in a high-tax state as somehow immoral compared to Texans? As I say, perhaps those taxed are the productive minority that will not see their state and local taxes reduced. These people are immoral?
I will bring Rothbard once more to slam the door shut on this (with a little help from the late lefty New York state governor Mario Cuomo):  
Let us now consider the vexed question of ending deductibility of state and local taxes—a vital point to our reformers—because ending deductibility will provide a huge bonanza for our federal tax collectors. The flat taxers argue that by allowing deductions, the citizens of low-tax cities and states are “subsidizing” the citizens of high-tax states, and that an end to deductions will put all regions on a plain of fairness and uniformity. Governor Mario Cuomo, on behalf of the notoriously tax-oppressed citizens of New York, ac­cepted the charge of subsidy, and then eloquently threw it back to the critics of New York, asking, in effect, “What’s wrong with a sub­sidy? Are you against the citizens of New York subsidizing tobacco farmers in North Carolina, or subsidizing highway contractors in Iowa?” As a rare consistent supporter of left-liberalism, Cuomo was able to reveal the hypocrisy of those whose attacks on subsidies habitually suffer from a convenient double (or triple) standard. Be­ing a left-liberal, Cuomo was not equipped to go one step fur­ther—to step outside the mammoth subsidy system and ask the crucial question: Are Iowans really subsidizing New Yorkers under deductibility? Or are the oppressed and cruelly taxed New Yorkers being spared from being doubly taxed on their own income? The average New Yorker is not responsible for his high taxation; he suffers unwillingly under the highest sales, income, and property taxes in the country. Why should he suffer more than the average Iowan? What is so “fair” about that?
The Reagan administration supporters of ending deductibility offer a pragmatic or strategic argument in reply. If you tax New Yorkers higher up by eliminating deductions, then they will rise up and roll back New York state and city taxes to the lower Iowan level. This is the old the-worse-the-better argument that unfortunately, in addition to being strategic rather than moral, never seems to work. One of the main arguments for bringing in the income tax in the early twentieth century was that now, in contrast to the indirect tariff, everyone would directly feel such a tax, and therefore the public would rise up to keep taxes low. Obviously it didn’t work that way. Instead, we kept and increased tariffs, and we exploited a new tax source and raised it to gigantic and crippling proportions.
 -RW

14 comments:

  1. "Government is the great fiction where everyone endeavors to live at the expense of everyone else." -Bastiat.

    This what needs to remembered about taxation. It's all about shifting the burdens around. As such there will be no lowering of state or other taxes with the elimination of the deduction. The vast majority of these taxes are how people socialize the costs of their choices. That is to make someone who made other choices pay for theirs. Those who feel (because most people go on feelings not mathematical reality) their life choices are being subsidized vastly out number those who don't.

    The deduction of state and local taxes is being eliminated while mortgage interest preserved and child deductions increased such that debtors and people with children will benefit at the expense of people without debt and/or children. This is how this tax "reform" to lower the burden of the tax receivers*, the cronies, is being sold. Again this is again because there are more people that can be convinced this benefits them than the number who know it will hurt them. And since government knows there isn't much more it can squeeze from people who can barely pay their bills as it is it aims to once again move against the prudent who save and avoid debt.

    *the crony class receives more from taxes and how they are spent than they pay. Effectively they don't pay taxes, they receive them. Any tax reduction for them simply increases their net gain.

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  2. As a someone living in the Republic of California I am confident that CA will lower its taxes when the Feds eliminate state tax deductions. I have already made plans to adjust my financial activity because I am sure state and local gunverments will lower taxes. Not only after the deductions have been eliminated, but before because these gunvernments are very concerned about the tax burdens they lay on "their citizens".

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  3. To think that Albany (New York's capital) will all of a sudden embrace common economics because the Feds shift the tax burden is an awful argument. If anything they (Albany) will just double down

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  4. "One of the main arguments for bringing in the income tax in the early twentieth century was that now, in contrast to the indirect tariff, everyone would directly feel such a tax, and therefore the public would rise up to keep taxes low. Obviously it didn’t work that way."

    Exactly!

    Even policies so bad that they usher in a new dark age would probably not straighten out most people's morality and economic thinking (probably do the oposite!), so why argue for more a little more pain for your neighbor? Why would anyone seriously consider policies which can only increase suffering? Sounds like kind of self-defeating, sadistic strategy to me.

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  5. Hi Bob -

    I'm interested in hearing your thoughts on the proper libertarian strategy analysis on the so-called Flat Tax. There are a few bits to the Flat Tax proposal but the key elements, from a libertarian point of view, are (1) it's a revenue neutral replacement tax on consumption (2) the expected cost of compliance is dramatically less than the current income tax. Let's assume that's true.

    If I understand yours and Rothbard's thoughts on advocacy and strategic alignment correctly, I believe the correct libertarian position is that we should not advocate the plan but we should support it. A libertarian certainly shouldn't advocate the tax because it's a tax and we need to focus our advocacy on eliminating taxation. But because the flat tax reduces the overall burden by dramatically lowering the compliance costs, we should be supportive.

    Of course, we can ruminate on how a flat tax would play out from a realpolitik perspective but I'm mostly interested in understanding the framework for applying the libertarian strategic analysis.

    Thoughts?

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    Replies
    1. Wow, there's a lot of marginal analysis missing in these comments!
      Also, it's pretty obvious that the people in the pro:SALT camp all live in high income tax states, like NY and Cali.

      Guys, I get that you want me to subsidize your SALT bill, but don't confuse that with economic analysis.

      It sounds like you guys might be upset to lose your subsidy. But notice that you've put your anger into some sort of action (starting with commenting on a blog, but perhaps next by writing your local politician? *begin marginal analysis*)

      If SALT goes but spending stays the same, then I guess you're just having an end-to-shifting-of-the-tax-burden-to-someone-else moment; welcome to the real state and federal burden the rest of us are used to!

      If SALT goes but spending stays the same and you are personally upset at all, it's just an acknowledgement that you'll get the same amount of "services" from the state and federal government but you'll pay more; which is exactly my point, viz, you've been paying less than your share up till now. That has meant, on the margin, you've been (at least complacently) allowing gov to grow without the rational resistance you would've shown (and that now you're beginning to show through your anger at the loss of SALT).

      Does anyone who reads this blog think that the mortgage deduction encourages home ownership over renting? Does anyone who reads this blog think that having childless people pay taxes toward public schooling is a subsidy from the childless to the childfull? Because if those are true...

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    2. Wow, there's a lot of marginal analysis missing in these comments!
      Also, it's pretty obvious that the people in the pro:SALT camp all live in high income tax states, like NY and Cali.

      Guys, I get that you want me to subsidize your SALT bill, but don't confuse that with economic analysis.

      It sounds like you guys might be upset to lose your subsidy. But notice that you've put your anger into some sort of action (starting with commenting on a blog, but perhaps next by writing your local politician? *begin marginal analysis*)

      If SALT goes but spending stays the same, then I guess you're just having an end-to-shifting-of-the-tax-burden-to-someone-else moment; welcome to the real state and federal burden the rest of us are used to!

      If SALT goes but spending stays the same and you are personally upset at all, it's just an acknowledgement that you'll get the same amount of "services" from the state and federal government but you'll pay more; which is exactly my point, viz, you've been paying less than your share up till now. That has meant, on the margin, you've been (at least complacently) allowing gov to grow without the rational resistance you would've shown (and that now you're beginning to show through your anger at the loss of SALT).

      Does anyone who reads this blog think that the mortgage interest deduction distorts the market by incentivizing home ownership over renting?

      Does anyone who reads this blog deny that funding public schooling through e.g. property taxes subsidizes the child-having by the child-less?

      So, therefor... A duck!

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    3. @Evan Smiley
      Sometimes semantics are important. Is there a part of the argument that you cannot follow due to the loose yet accurate-in-spirit use of the word?

      Also, do you have an argument? I see you post here, so I'm curious. I assume you're pro-SALT deduction from your comment.

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    4. The flaw with this this subsidy argument is that numerous high tax states are net losers on the federal level. That is more tax is paid to the federal government from them than what they get from the federal government.

      For the high tax state I live in, 74 cents comes back for every dollar. So how on earth are you subsidizing me through federal taxation? Unless you live in NJ, the only state with it worse than IL that's simply not possible. And NJ is another high tax state. CA is also a net loser and is a high tax state.

      http://www.keypolicydata.com/government/federal-taxes-and-spending/

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    5. Trying to discern what "money comes back" is a Sisyphean task. Is there some reason why the Federal Government needs to tax you and then return it? Any task that requires that the Feds rebate money to you locally should be handled locally in the first place.

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    6. If one is going to argue that the deduction of local taxes is a subsidy for those living in high tax states it needs to be shown that these people in high tax states are receiving the subsidy in some form or fashion. It's a call to support the argument, not an argument that there should be a 'return' of what is paid. Should be is not even considered.

      The person making a claim that he is subsidizing those in high tax states because he lives in a low tax state and has a smaller deduction needs to prove it or at least support it, somehow, by some measure. If the low tax state government can get its funding from people in other states through the federal government then that's probably a good deal of why that state has low taxes. A low SALT deduction means nothing by itself with regards to who is subsidizing who regardless of how accurately the flows of federal spending can be determined.

      Remember, "Government is the great fiction by which everyone endeavors to live at the expense of everyone else."

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  6. Sorry for the double post (thought it was lost and had to re-create the last part); and also, sorry about it being a reply to Mark A. It was meant as a general reply to the commenters.

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  7. One thing to remember is that typically state and local governments cannot finance their overspending with persistent deficit spending. The Federal Government can and does as we all know. We all assume that at some point the chickens will come home to roost. If I felt that the SALT somehow decreased spending at any level; local, state or federal, that would be one thing. But I doubt that it does. Forcing sub Federal Governmental entities to limit spending might be more beneficial in the long run but it is a difficult question. What is truly amazing is how special interests so clearly control our Government.

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