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## Additions for My State Tax Paper: Reciprocity, Sullivan, and Pease

For: Getting Around the State and Local Tax Deduction Limit (January 9, 2018). Available at SSRN: https://ssrn.com/abstract=3099296.

(1)  Suppose we accept that fairness (or whatever) means that state taxes should be deducted from income for federal taxation, because they pay for public goods just like donations to private charities.  Suppose John Doe has an income of \$1,000,000, West Dakota has a tax rate of 10%, and the US has a tax rate of 30%, so West Dakota tax is \$100,000 and US tax is \$300,000 sans deductibility.  Then if we add deductibility  of state taxes from federal income, 30% of \$900,000 is just \$270,000 and John Doe saves \$30,000 on his federal taxes.

But suppose, instead, that we don’t do that. Instead, we add deductibility of federal taxes from state income. The result is that since 10% of \$700,000 is \$70,000, John Doe saves \$30,000 on his state tax bill.

If we add both kinds of deductibility, then there’s an algebra problem to solve. Let I be income, S be state tax, and F be federal tax.

S = .1(I-F)

F= .3(I-S)  = .3(I – .1(I-F)) = .3(I – .1I + .1F) = .3I – .03I + .03F = .27I – .03F

1.03F = .27I

F = (.27/1.03)I = .3I –  .3I+ (27/1.03)I = .3I –  ( .3(1.03) – .27)/1.03)I

F = .3I – (.039/1.03) I

S = .1 (1-.(.27/1.03)I) = .1I –  (.027/1.03) I

Thus,  if I got my algebra right (doubtful), federal taxes fall by about  \$38,000 and state taxes fall by about \$26,000 as the result of reciprocity. Thus, the state will lose a lot of tax revenue from reciprocal deductibility, but it does come out ahead vis a vis the federal government.

Some states do in fact allow deduction of federal taxes (will they continue to do so?)

From the existing draft: \href{https://itep.org/wp-content/uploads/pb51fedinc.pdf}{Six states} do allow the deduction. These states, with their rank in state and local taxes as a fraction of state income \href{https://files.taxfoundation.org/legacy/docs/State-Local_Tax_Burden_FY2012.pdf}{in 2012}, are Alabama (39), Iowa (31), Louisiana (45), Missouri (29), Montana (38), and Oregon (10).

(2) I should incorporate insights from Martin Sullivan’s July 2017 Tax Notes, “Economic Analysis: Repeal of SALT Deduction More About Politics Than Policy”.

Good tables. Argues for tax credit scheme. Table 5 should be redone with the \$10,000 limit that was actually enacted.

(3) Remember Pease phaseouts for very rich taxpayers. It is just 20%  I think, and so does not change the number of taxpayers affected, only the amount of dollars.

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