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Why Higher Taxes from the Tax Cut?

It’s the beginning of tax season, and many upper income earners are discovering that their tax bill will be higher, not lower, after the highly touted Republican\Trump tax cut.

And that includes many supporters of the tax cut!

We sympathize with folks who may feel betrayed by getting a higher tax bill from a tax cut they supported, but let’s explain: There are really two factors behind the tax cut/tax reform that are driving this phenomenon.

First, while the tax reform slashed the business tax rate, on the individual side it was carefully designed to benefit lower and middle income earners, not the wealthy. This was in keeping with President Trump’s stated populist intention to focus on the working class, and to rebut charges that Republicans only care about the wealthy. In fact, polling from the last several election cycles suggests that upper income voters today are more likely to support Democrat candidates than Republican candidates, so the design of the tax cut may simply reflect the new political reality that the wealthy are diminishing as a Republican constituency, and a desire by Republicans to enhance their appeal to the working class.

And of course, the dramatically lower corporate tax rate directly benefits upper income earners, as they tend to be owners, investors, and managers in companies with now lower tax burdens.

But more important was the intention to stop subsidizing high state and local taxes through the federal tax code, which has been a goal of center-right tax reformers for decades.

Because of unlimited federal tax deductions for property taxes and state and local income and sales taxes, the previous tax code effectively subsidized high tax jurisdictions. Essentially, taxpayers in low tax states were subsidizing the high taxes of states like New Jersey, New York, Illinois and California. What motivation would voters in high tax states have to complain when they could just deduct state and local taxes from their federal taxes?

By capping the state and local tax deduction at $10,000, federal tax reform has thrown the issue of high state and property taxes into sharp relief, and the states are already being forced to focus on taxes in their current legislative sessions. And this is a good thing.

Even in states like Texas, where overall taxes are low but property taxes are high, middle class taxpayers face the prospect of not being able to deduct all of their property taxes, either now or at some point in the near future. They are pressuring their state legislatures for caps on property tax increases and even for property tax reductions, and this is a good thing.

Subsidizing high state and local taxes through the federal tax code was always a bad idea. May a thousand state tax revolts bloom!