The Obama administration wants to raise $1.6 trillion in revenue over ten years and the Republicans have countered with a proposal to raise $800 billion through unspecified eliminations of deductions and loopholes. There is one deduction that can be eliminated that will raise the $800 billion and hopefully satisfy both constituencies and that is to eliminate the state and local income tax deduction which disproportionally favors the wealthy (which Obama would like), but also benefits people who largely live in blue states with big state governments, something Republicans should like. As a generalization this deduction is a net wealth transfer from Republican leaning states like Tennessee, Florida, New Hampshire and Wyoming to Democratic states like New York, California, Massachusetts and Oregon. Of course some states that voted for Obama also have no income tax like Nevada and Washington.
Obama might object because there are people who earn under $250,000 who benefit from this deduction. But as a public policy matter this is a far superior option to raising marginal rates. Because raising rates is a tax on success on often on the success of small businesses who are the job creators, whereby eliminating this deduction essentially penalizes state governments that simply spend too much and would create pressure to shrink the size of these state governments. It also empowers the people by saying, if you don’t like your taxes going up because of the elimination of this deduction, complain to Sacramento and Albany which is the real source of the problem – not the federal deductibility of state and local income taxes.
For similar reasons, Congress should end the tax exemption for municipal bonds that are not directly tied to capital projects. This does not mean that all GO (General Obligation) bonds would be taxable. It simply means the state and local governments would need to show the money was used to build a road or a school instead of plugging holes in the operating budget and paying for pensions and salaries of workers.