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Proposal Would Hit Blue State Taxpayers

Some conservatives want to kill the U.S. deduction for state and local taxes. Californians and New Yorkers would feel the strongest sting.

December 05, 2004|Warren Vieth | Times Staff Writer

WASHINGTON — As President Bush lays the groundwork for a possible overhaul of the U.S. tax code, one option under consideration would deal its biggest financial blow to citizens of blue states such as California and New York.

Some conservative activists are urging the Bush administration to scrap the federal deduction for state and local taxes as part of a broader plan to revamp the nation's tax system.

Although the proposal would hurt some taxpayers in nearly every state, it would hit hardest in states with higher-than-average income levels and bigger-than-average state and local tax burdens. High on the list are a number of blue states -- those that were carried by Democrat Sen. John F. Kerry in last month's presidential election.

Taxpayers in California and New York, for example, which have top state income tax rates of 9.3% and 6.5% respectively, would be highly affected; residents of Florida and Texas, which have no state income taxes, much less so.

"There's no question this effort would punish blue states," said Rep. Robert T. Matsui (D-Sacramento), a member of the tax-writing House Ways and Means Committee. Over time, he said, it could force state and local governments to cut expenditures.

That could happen if taxpayers, stung by the higher tax burden that would come from losing the deduction for state and local tax payments, demand a cut in local and state tax rates and become unwilling to approve any increases.

Supporters of the change insist the disproportionate effect on blue states is a coincidence, but they acknowledge that the proposal could hurt most in states that voted against Bush.

"Let me put it like this: It certainly isn't something that's a discouragement," said one prominent conservative. "Yes, we talked about this. The fact that it hits blue states is not something that's been missed among Republicans."

But in a political complication, some blue states that would be hit hardest by the tax change are led by Republicans. If the White House adopts the proposal, it could create a rift with some of the GOP's biggest stars in those states, such as Gov. Arnold Schwarzenegger and New York Gov. George E. Pataki, among others.

Schwarzenegger's office declined to comment on the proposal. But California State Controller Steve Westly, a Democrat, said it would amount to a hidden tax increase for millions of California taxpayers, who already pay $58 billion a year more to the federal government than they get back in services.

"Simply put, it would be yet another poke in the eye from the federal government to California," said Westly.

It remains unclear whether the administration will adopt the proposal. Some administration and congressional advisors said they believed the idea had been floated as a trial balloon to see how much support or opposition it attracted.

If the administration did move to eliminate the deduction, it might partially offset the costs to blue state residents by adding other elements to the tax package, such as a reduction of top tax rates or a repeal of the increasingly broad Alternative Minimum Tax, which also hits blue states hard.

Bush has said one of his top second-term priorities is to revamp the tax code so that it is simpler, fairer and more pro-growth. He also has said he would be guided by the recommendations of a bipartisan commission he planned to appoint by the end of the year.

White House and Treasury officials say all overhaul options are on the table. "The president has yet to even name the advisory panel, so we're not going to rule things in or out at this point," said White House spokeswoman Claire Buchan.

Bush has hinted strongly that his proposal would preserve two popular tax breaks: the deductions for mortgage interest and charitable contributions. That he has not mentioned preserving the state and local tax deduction has been interpreted by some as a signal that it is fair game as the administration looks for ways to finance other tax changes.

"This is very real," said one congressional staffer close to the tax discussion. "They need the money desperately.... It's one of the only things they can attempt to do to finance tax reform."

The deduction for state and local taxes is one of the biggest tax breaks claimed by households. This year, the deduction is valued at $46 billion. That compares with $70 billion for the mortgage interest deduction and $30 billion for charitable contribution deductions, according to the Office of Management and Budget.

"The people who are going to be disproportionately penalized by this are high-income households, especially those in states with relatively high or progressive income taxes," said Kim Rueben, a research fellow at the Public Policy Institute of California.

Last year, 5.5 million California households, or 37% of all tax filers in the state, claimed deductions for state and local income taxes. In New York, 3.2 million households, or 37%, did.

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