Raising Federal Income Tax Rates Without Limiting Tax Deductions Benefits Liberal Democrats More Than Republicans

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Posted by Milton Recht:

Liberal Democrats tend to live in the higher tax states and they take bigger federal income tax deductions for state and local taxes. Raising federal tax rates makes the deduction for state and local taxes more valuable. The higher federal tax rates lowers the burden of high state taxes to high income earners, while raising the federal tax burden of low state tax residents.

The increase loss of federal income tax revenues from the deductions under higher income tax rates is borne by residents in low tax states, mostly Republicans, who take smaller deductions for state and local taxes. The net effect is that low tax state residents will pay a bigger part of the high tax state government employee salaries, benefits and pensions.

By not limiting deductions, while raising federal tax rates, Obama will unfairly increase the federal tax burden of low tax state residents for the higher spending of high tax states.

Raising the tax rates on the rich is not fair unless income tax deductions for state and local taxes are also limited.

From The Wall Street Journal, "Of Liberals and Loopholes: The current tax code favors high-tax states:"

Source: The Wall Street Journal

Since the affluent tend to itemize their deductions more than do average taxpayers, and since the affluent pay higher marginal tax rates, they tend to benefit more from deductions. Ergo, limit deductions and you raise the effective tax rate (not the marginal rate) of the affluent. (The effective tax rate is the share of total income paid in taxes, while the marginal rate is the tax on the next dollar earned.) Such a reform would help tax efficiency and equity, and the economy would benefit from fewer investment distortions.

But suddenly liberals are having second thoughts, and our guess is that this is because residents of high-tax Democratic-run states are about twice as likely to take advantage of tax loopholes as taxpayers in low-tax states. For example, 44% of Connecticut filers itemize their deductions, but only some 21% of North and South Dakota residents do.