President Obama understands that to govern well one needs a vision and principles and a willingness to accept 80% as a win. However, on tax policy, his team is, frankly and scarily, clueless. Worse they so little understand taxes that they are on the verge of hurting the strongest Democratic states to spare the Republican ones. Where is our Democratic Grover Norquist?
If you live in a Demoratic state, you are usually in a community with progressive values paid for with an income tax and education paid for by property taxes. Your home is likely within 100 miles of a city, increasing your home value and its mortgage. Grover Norquist and the Republicans understand this; the Democrats are apparently bewildered.
We all have to wise up and battle in this tax policy arena just like in every other political arena.
How did the Republican tax writers cut the revenue loss from the steep income tax rate cuts in 2001? They allowed the alternative minimum tax (AMT) to apply to more and more middle class Americans over the ten year projection period. The Republicans did not index the AMT exemption for inflation causing it to more and more individual taxpayers due to inflation. Which taxpayers? Those with high state income and property taxes that are non-deductible under the AMT. Can anyone say Blue State taxpayers?
When the Republicans wanted to cut the estate tax in 2001 and its stated 55% rate, they did not cut the rate in reality, they eliminated the state death tax credit. A little more tax education than anyone wants apparently including Congressional Democrats. The state death tax credit gave the states the option of collecting a portion of the federal estate tax otherwise collectible by the IRS. By enacting a "pick up" estate tax, the states could impose an estate tax that did not cost their taxpayers anything, because otherwise the IRS would collect the tax. Every state has an estate tax equal to this tax, contributing to uniformity among the states. In estates over $10 million the state death tax credit was 16%.
A little math. If the stated federal rate was 55% and the state death tax credit rate was 16%, then every $100 of additional estate would result in a tax paid to the state of $16 and to the IRS of $39, for a total estate of $55, 55/100=55%. When the state death tax credit was repealed and the federal estate tax lowered to 45% (over time), how much will the IRS collect now? 45% of a $100 equals $45. So for every $100 of estate the IRS collected $6 more than it had before, while the Republicans were able to claim an estate tax rate cut. Moreover, the revenue loss that the Republicans imposed on the states, they claimed as a revenue gain to offset their increase in the estate tax exemption. Of course, in reaction many blue states reenacted an estate tax to replace the lost revenue and more taxpayers to flee to Florida and other states who did not reenact a tax.
Out of ignorance or desire to play along with the winners, Blue State Republicans went along with this shift of the tax burden from Red to Blue States. The Democrats even went along with the idea of allowing either income or sales tax to be deducted as a matter of equity for the states without any income. This is not a fairness issue! State income tax is deductible because the tax base, income, is the same for both federal and state purposes. The sales tax nor the property tax have this trait.
Now I hear that the President's budget limits tax deductibility. Are they nuts? It is bad policy and bad politics. If the income tax is to be fair, the tax and AMT need to be computed after all state income taxes are deducted. Especially now we cannot afford an attack on the income tax benefits of ownership of a principal residence.
I will tackle separately how to pay for health care reform fairly. I also will tackle the question of limitations on charitable deductions. Unlike the state income taxes and residence expenses, the charitable deduction is voluntary and does not impact fairness. The only question is how much should taxpayers subsidize charities.