Why GOP tax compromise is the worst of all worlds

Republicans have managed to craft a tax plan that incurs all the political liabilities of a tax cut and almost none of the policy and political advantages of actually passing one. In fact, they are getting hit with headlines that their plan raises taxes on some.

In the process of getting rid of broad-based and ubiquitous tax deductions, the GOP is going to anger many constituencies and lobbies. But at the same time, as we’ve explained, the rates are not coming down enough for many families — and some will actually get a tax increase. Some will get a slight increase and others, although they might secure a minor cut, will have the political perception of losing out because of eliminated deductions.

The core of the problem revolves around the GOP change to the state and local tax deduction (SALT). There are two conservative counterarguments for and against getting rid of this deduction, and the way Republicans dealt with this debate secured the liabilities of both and the benefits of neither.

On the one hand, we should never have crafted a federal tax code that incentivizes states to be shielded from the political backlash of high taxes. Allowing individuals to deduct all state and local income and property taxes distorts the tax “market” among the states and helps fuel the tax bubble of liberal states.

On the other hand, given that the deduction has been in place for many years, we don’t want to raise taxes on anybody without a clear across-the-board tax cut. This is especially true of most home-owning families in most every major metro area. They are paying a lot in taxes, even after SALT; these are not the people on Medicaid or getting Obamacare subsidies. They are getting hosed by Obamacare.

The second problem with getting rid of SALT is that once families can no longer deduct local taxes, in conjunction with the doubling of the standard deduction under the new plan, the deductions for charity and home ownership are essentially gone.

For all but those with massive mortgages on large homes, most upper-middle-income families will consequently take the standard deduction. Thus, even though the charitable deduction is not directly touched and mortgage interest is only tweaked for future homes with a fairly generous cap of $500,000, they will become irrelevant.

Do we really want to go after charity … of all the things we socially engineer through taxes and statute?

And while most conservatives believe the mortgage interest deduction is an odious market-distorter that should never have gotten off the ground (I personally think it would be better to incentivize the down payment, not debt), it is politically perilous to go after it, particularly without a massive tax cut.

In other words, the rate cuts must be so advantageous that it’s worth the political liability of going up against these constituencies. As we’ve noted before, the chained CPI, the bait-and-switch on different provisions, and the fact that the personal exemption (which is abolished) is worth more over time than the expanded child tax credit all make the attack on these deductions not worth the benefit.

But it gets worse.

In come the Republicans and the worst possible plan. Had they simply abolished SALT, we’d be better off. Instead, they cap SALT at $10,000, but in a very uneven way. Absolutely no state income or sales taxes may be deducted, but the real estate tax can be deducted all the way to $10,000.

Remember, except for a few states, almost everyone pays income or sales taxes. And some are quite high (not just in states like New York and California). The red state of South Carolina, for example, has a seven percent income tax.

On the other hand, most people only pay between $3,000 and $6,000 in real estate taxes. The lavish $10,000 max deduction for real estate taxes was a shout-out to the parochial and outrageous real estate taxes of New Jersey and Long Island, N.Y. But by completely abolishing the much more broad-based state income tax deduction, the GOP plan will cause many people — not just residents of New York and California — to pay more in taxes, while ruining itemization of charity and mortgage.

I would pay $169 more in taxes under this plan. While my home state of Maryland has an above-average income tax, it’s not as high as California, and my real estate taxes are very reasonable. Yet by abolishing SALT, it will force me into the standard deduction and void out any tax cut. And I have a very middle-of-the-road home of $350,000 with a very low mortgage interest rate.

My family pays $9,300 in state and local income taxes but only $4,700 in real estate taxes. Under the GOP plan, the larger number cannot be deducted. I would surmise that more people are in situations similar to mine — wherein they pay more in state income taxes (which, again, cannot be deducted under this plan) than they pay in real estate taxes.

The better solution would be a flat cap of $10,000 on SALT, which could be used for any mix of income, sales, and property taxes. This would curtail any subsidization of runaway state taxes but at the same time ensure that there is no net tax increase on a broad array of individuals throughout the country.

Also, many more people would still be able to take the full $10,000 in deduction and still itemize, thereby saving the current level of incentives for charity. The GOP is now raising taxes while also subsidizing the most out-of-control property tax jurisdictions.

This is why Rep. Tom MacArthur, R-N.J., said he is “thrilled” with the deduction compromise and found that “of the 151,000 people in his district that benefited from the state and local deduction last year, all but 3,000 of them would fit under the $10,000 cap, and most were subject to the [alternative minimum tax] anyway.” Yet people in my home state of Maryland or in South Carolina — where income taxes are at least average and property taxes are reasonable — will lose out.

This system also creates a massive market distortion with housing and charity. The only people among those earning under the AMT level who will itemize are those living in high real estate tax areas. At present, many families who own a home itemize their deductions. This will essentially distort the entire incentive of charitable giving toward those in random locations rather than on income level.

To review, with this tax reform plan, the GOP will anger the housing industry, dismay charitable foundations, and raise taxes on many families (and not just in New York and California), while still keeping the parochial handouts for New York and New Jersey — all for a muddled tax plan that is, at best, a wash.

Congratulations, GOP: You have now messed up the only remaining issue on which Republicans have always been righteous. And while they continue funding every penny of Obamacare, Medicaid, and Planned Parenthood, they have a message for middle-income families seeking to adopt children: Save your money.

Editor's note: This article has been updated to note that the author's state and local taxes are $9,300, not his state taxes only.

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