The Deductibility of
State and Local Taxes
February 2008
Numbers in the text and tables may not add up to totals because of rounding.
Unless otherwise indicated, all years mentioned in this report are calendar years.
The Joint Committee on Taxation’s estimates of the budgetary effects of the alternatives for changing state and local tax deductibility are calculated on a fiscal year basis.
Preface
Since the inception of the federal income tax in 1913, federal taxpayers have been allowed to deduct certain state and local taxes in calculating their taxable income. In its final report, in 2005, the President’s Advisory Panel on Federal Tax Reform recommended elimination of the state and local tax deduction, which provides a federal subsidy for some of the taxes levied by state and local governments. That subsidy is of substantial personal benefit to residents of the states and localities that receive it, but it is not shared equally among all federal taxpayers. In addition, the individual alternative minimum tax (AMT) increasingly eliminates the benefit of the state and local tax deduction for many middle-class taxpayers.
This Congressional Budget Office (CBO) paper, which was prepared at the request of the Ranking Member of the Senate Budget Committee, examines the arguments for and against the state and local tax deduction; how the benefits from the deduction are distributed among different groups of taxpayers and different governments; how the deduction and the AMT interact; and how modifying or eliminating the deduction would affect the federal budget, the finances of state and local governments, and federal taxpayers. In accordance with CBO’s mandate to provide objective, impartial analysis, the paper makes no recommendations.
Kristy Piccinini of CBO’s Tax Analysis Division wrote the paper, under the supervision of Tom Woodward and Frank Sammartino. Juan Contreras, Robert Dennis, and Theresa Gullo of CBO commented on early drafts, as did Donald B. Marron, formerly of CBO. Jim Cilke, Karl Russo, and John Navratil of the Joint Committee on Taxation also commented on the paper. (The assistance of external reviewers implies no responsibility for the final product, however, which rests solely with CBO.)
Leah Mazade edited the paper, and Loretta Lettner proofread it. Maureen Costantino designed the cover and prepared the report for publication. Lenny Skutnik produced the printed copies, Linda Schimmel coordinated the print distribution, and Simone Thomas prepared the electronic version for CBO’s Web site.
Contents
Background on the State and Local Tax Deduction
Rules Governing the State and Local Tax Deduction
Current Issues in State and Local Tax Deductibility
Rationales for the State and Local Tax Deduction
Distribution of the Benefits from the Taxes-Paid Deduction
Analysis of Alternatives: Effects on State, Local, and Federal Governments
Description of the Alternatives and Their Cost
The Options’ Interaction With the Alternative Minimum Tax
Distributional Analyses of Changes in Tax Liability in 2010 and 2011 Under the Options
Effects of Deductibility Options on Tax Liability and Tax Simplification, by Income
Effects of Deductibility Options on Tax Liability, by Region
Effects of Combining Deductibility Options with Changes in the Alternative Minimum Tax
1. Estimated Cost of Federal Aid to State and Local Governments, by Aid Source
2. Sources of Revenue for State Governments, 2004
3. Sources of Revenue for Local Governments, by State, 2004
4. The Taxes-Paid Deduction, by Taxpayers’ Adjusted Gross Income, 2004
5. Selected Measures of State and Local Tax Deductibility, 2004
1. Percentage of Taxpayers Who Itemized and Who Claimed the Taxes-Paid Deduction, 1985 to 2004
2. Types of Taxes Claimed Under the Taxes-Paid Deduction, 1993 to 2004
3. Federally Subsidized Shares of Tax Revenues in 2004, by State
4. Federally Subsidized Shares of Income in 2004, by State
