Federal Deduction for State & Local Taxes Eyed for Elimination

The Bush Administration and Congressional allies have sent signals that they want to wipe out the federal tax deduction for state and local taxes. Ostensibly, they need to recover tax revenues that will be lost as the Alternative Minimum Tax (AMT) is abolished.

Initiated at the end of the 1960s, the AMT was instituted to ensure that wealthy Americans had to pay some federal tax regardless of the extent and effectiveness of the tax shelters they used to shield their income from taxation. It has been claimed that, in recent years, the AMT has been hitting upper-middle income individuals and families just as hard as, if not harder than, it has been hitting the wealthy. Because the AMT has not been indexed adequately to inflation, taxpayers whose incomes have not risen extraordinarily in "real" (constant dollar) terms have nonetheless seen their incomes rise sufficiently in nominal terms to fall within the provisions of the AMT.

Although certified public accountants who prepare personal tax returns have indicated that they are seeing this more and more, some opponents of the Administration argue that, instead of eliminating the tax, it should merely be recalibrated so it again serves its original purpose of making the rich pay their fair share of taxes. Abolishing the tax, critics point out, will benefit the truly wealthy far more than it will help the upper-middle class; and such a restructuring of the tax code is yet another expression of the Bush Administration's long-suspected interest in promoting policies—especially tax policies—that benefit the rich.

Furthermore, eliminating the federal tax deductibility of state and local taxes will have considerable adverse impact on upper-middle income taxpayers, who are very likely to claim this deduction when preparing their Form 1040s. Some observers have pointed out that high-income Americans sometimes don't even pay state and/or local taxes, so eliminating the deduction would have no impact on them. President George W. Bush, who for years lived most of the time in the state of Maine, stayed in Texas long enough each year to meet that state's minimum residency requirements and therefore enjoyed the benefit of the Lone Star state's absence of a state tax.

A few of the harsher critics of the Administration have also pointed out that the elimination of the federal tax deduction for state and local taxes will have a considerably higher incidence of adverse impact in those states that went to Bush's challenger in the 2004 Presidential Election. Upper-middle income taxpayers are far more concentrated in so-called "blue" states like New York, Massachusetts, and California than they are in so-called "red" states like Alabama, Kansas, and Wyoming.

A spokesperson for the Treasury Department, which is considering the changes to the Internal Revenue Code, denied any malevolent, punitive motivations behind the plan to eliminate the deduction. He further denied any ulterior motive to benefit wealthy supporters of Republicans behind wiping out the Alternative Minimum Tax. Despite such official denials, skeptical observers remain unconvinced.