Elections Have Tax Consequences

By Kevin D. Williamson

Sunday, January 29, 2017

If you have spent much time in the more rarefied corners of California, one thing will be obvious: The lifestyle associated with urban progressivism can be very comfortable — if you can afford it. If you can’t — well, the view from Santa Monica is very different from the view from Friant, just as the view from Tribeca is very different from the view from Elmira in upstate New York. Progressivism in the United States used to be a school of political action, but today it is mainly a highly refined lifestyle — one that Republicans may be on the verge of making a little more expensive.

It’s time for a blue-state tax hike.  

Congressional Republicans and the Trump administration will disagree about many things, but it is rare to find a Republican of almost any description who will turn his nose up at a tax cut of almost any description. As Robert Novak put it: “God put the Republican Party on earth to cut taxes. If they don’t do that, they have no useful function.” And tax cuts are coming. But there are two proposals in circulation that would constitute significant tax increases — tax increases that would fall most heavily on upper-income Americans in high-tax progressive states such as California and New York. The first is a proposal to reduce or eliminate the mortgage-interest deduction, a tax subsidy that makes having a big mortgage on an expensive house relatively attractive to affluent households; the second is to reduce or eliminate the deduction for state income taxes, a provision that takes some of the sting out of living in a high-tax jurisdiction such as New York City (which has both state and local income taxes) or California, home to the nation’s highest state-tax burden.

Do not hold your breath waiting for the inequality warriors to congratulate Republicans for proposing these significant tax increases on the rich. Expect lamentations and the rending of garments, instead.

Slate economics editor Jordan Weissmann, who is not exactly Grover Norquist on the question of taxes, describes the mortgage-interest deduction as “an objectively horrible piece of public policy that should be reformed,” and it is difficult to disagree with him. It distorts the housing market in favor of higher prices, which is great if you are old and rich and own a house or three like Bernie Sanders but stinks if you are young and strapped and looking to buy a house. It encourages buyers to take on more debt at higher interest rates than they probably would without the deduction, and almost all of the benefits go to well-off households in the top income quintile. It is the classic example of upper-class welfare. And it has a nasty side, too: Those sky-high housing prices in California’s most desirable communities serve roughly the same function as the walls of a gated community or the tuition at Choate: keeping the riff-raff out. Pacific Heights is famous for its diversity: They have all kinds of multimillionaires there.

Geographically, those mortgage subsidies are not randomly distributed. The mortgage-interest deduction is much more important to rich people in San Francisco, where the median home price exceeds $1 million, than it is to middle-class people in Tulsa, where the median home price is about $110,000. In San Francisco, the median home costs 10.2 times the median household income; in Houston, the median home costs 4.3 times the median household income, a fact that probably will be of some interest if the deduction is eliminated and housing prices readjust.

The current arrangement means, among other things, that taxpayers outside the expensive, Democratic-leaning coastal metros are much more likely to simply take the standard deduction than to itemize their taxes. Put another way, the mortgage-interest deduction is a lot more important to Nancy Pelosi’s constituents than to Mac Thornberry’s. Both Trump’s campaign tax plan and reforms under discussion in the House call for raising the standard deduction, which would make the mortgage-interest giveaway irrelevant to an even larger majority of taxpayers. Trump’s plan also calls for putting a cap on deductions — not just for mortgage interest but for all itemized deductions — at $100,000. (The mortgage-interest deduction already is capped at a very generous level, applying to interest on loans up to $1 million.) Eliminating or reducing deductions is intended both to simplify the tax code and to offset some of the revenue losses associated with other tax-reform ideas under discussion, especially reducing the number of brackets and lowering the rates in those brackets.

The best course of action would be to eliminate the mortgage-interest deduction entirely over a relatively short period of time, say five years. The National Association of Realtors (a.k.a. The Committee to Re-Inflate the Bubble), the members of which make their livings on sales commissions and which therefore favors higher housing prices at all times, will howl. But it is difficult to make a compelling case that subsidizing Lena Dunham’s mortgage on her $5 million Brooklyn apartment (or helping out whoever took that $4.2 million Trump apartment off Keith Olbermann’s hands) needs to be a top national policy priority.

The state-tax deduction is a slightly stranger beast.

In principle, there is something in state taxes that federalism-minded conservatives should like: Most of us would prefer if the main tax collectors in Americans’ lives were located in Austin or Tallahassee — or even Sacramento — rather than in Washington. Fifty states with 50 different tax regimes and 50 different ways of spending the money provide Americans with lots of choices, lots of interstate competition, and 50 laboratories of democracy in which to test different approaches to social problems. The question of the California model vs. the Texas model need not ultimately be an issue of right and wrong but simply one of different preferences: There are Oakland people and there are Odessa people, and there is no reason to think that they should have to live in the same way or that they should want to.

The problem is that allowing for the deduction of state taxes against federal tax liabilities creates a subsidy and an incentive for higher state taxes. California in essence is able to capture money that would be federal revenue and use it for its own ends, an option that is not practically available to low-tax (and no-income-tax) states such as Nevada and Florida. It makes sense to allow the states to compete on taxes and services, but the federal tax code biases that competition in favor of high-tax jurisdictions. There is a certain kind of partisan Democrat who likes to sneer that the rich blue states subsidize the poor red ones (which isn’t exactly true; there’s a reason that there isn’t a big, expensive Air Force base in Manhattan), but there is a great deal of cross-subsidy, too. Tax handouts such as the state-tax deduction and the mortgage-interest deduction interact in complex ways with state and local policies (the nice liberals in San Francisco practice utterly ruthless economic segregation) to partly shift the burdens of the progressive model away from the residents of our progressive metros.

The more you look at it, the more the parts of the Republican tax mantra not having to do with rates per se — simpler, fairer, flatter — appear to be wise. Of course, it would be wiser still to cut federal spending down to the level of federal revenue (my first choice) or to raise taxes enough to cover spending (second choice), but nobody is going to talk seriously about that until there isn’t another option.

For the moment, though, Republicans give every indication that they are loading up a big tax hike on the rich — one that the Democrats will not enjoy very much at all. As someone once said, “Elections have consequences.”