Republican Tax Plan Quickly Hits First Hurdle

By Richard Rubin and Siobhan Hughes Features Dow Jones Newswires

A day after announcing their ambitious tax plan, Republicans debated scaling back one of their largest and most controversial proposals to pay for lower tax rates: repeal of the individual deduction for state and local taxes.

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Faced with the potential for defections by House Republicans from high-tax states such as New York and New Jersey, Republicans are exploring ways to satisfy those lawmakers without backing off the lower tax rates they promised.

"The members with concerns from high-tax states have to be accommodated. This has to be dealt with," said Rep. Peter Roskam (R., Ill.), a senior member of the House Ways and Means Committee whose district outside Chicago ranks 37th out of 435 in use of the deduction. "So, you can imagine a soft landing on this that creative people are putting much time and energy into."

The fight over the state and local deduction, with more than $1 trillion at stake over a decade, is an early signal of the bruising battle ahead for Republicans trying to pass a tax bill that hasn't garnered Democratic support and that faces narrow GOP margins in the House and Senate. It is the most obvious case of a bloc of pivotal lawmakers holding a specific concern, but it won't be the only one.

"The notion that you fix this and then it's smooth sailing?" Mr. Roskam said. "How naive."

If Republicans from high-tax states all oppose repeal and stick together, they have the clout to force a change. The top nine states for the deduction, measured as a percentage of income, are represented by 33 House Republicans. With one vacancy in the House, the party can lose no more than 22 GOP votes on legislation if all Democrats remain opposed.

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The dispute over the state and local tax break echoes back to 1986, the last time Congress revamped the tax system. Then, too, House Republicans from New York fought against their own party's plan to repeal the tax break. Aided by Democrats, who controlled the House, they prevailed, and taxpayers can now deduct their property taxes, along with either their income or sales taxes.

More than 90% of filers with incomes over $200,000 claim the deduction, according to the Tax Policy Center. Overall, 38% of the deduction's value goes to California, New York and New Jersey, which have 21% of U.S. households, the center said.

Rep. Kevin Brady (R., Texas), the chairman of the House Ways and Means Committee, said he is listening to lawmakers from high-tax states and is open to further discussions.

"It's crucial that we deliver tax relief for every American regardless of where they live, including in those states that have high state and local taxes," said Mr. Brady, whose suburban Houston district ranks 328th out of 435 in use of the deduction, according to the nonpartisan Tax Policy Center. "We will have a choice between keeping that deduction for a few, or lowering tax rates for every American."

New York Republicans said Thursday that they were concerned that without that deduction, many of their voters might end up paying more in taxes under the GOP plans, and they were waiting for details about tax brackets and other breaks to determine how they would fare.

"I'm also worried that it would exacerbate New York's status as a donor state to Washington, where we send many more dollars to Washington than we receive back," said Rep. John Faso (R., N.Y.), whose district is largely in the Hudson River Valley.

Rep. Peter King (R., N.Y.) said that taking away the state and local tax deduction would squarely hit his middle-class constituents on Long Island, whose property taxes can average $15,000 a year and who wouldn't tend to benefit from other tax breaks contained in the House GOP plan.

"It doesn't add up," Mr. King said. "Even under the best interpretation, maybe a majority of my constituents would break even. So, if the rest of the country is getting a tax cut, the most I can tell my constituents is: It could have been worse for us."

Republicans don't intend to produce a detailed plan for weeks. A high-level framework released Wednesday was the product of six top negotiators from the House, Senate and Trump administration, and top policy makers said the state and local tax provision was one of the main deductions they were targeting for elimination.

Possible options under discussion include allowing the break for property taxes but not income taxes, or else converting the deduction into a smaller credit. The plan could also adopt a more general cap on itemized deductions.

Repealing the break would free over the next decade more than $1 trillion that the party plans to use to lower tax rates. Politically, it would be good for most Republicans, shifting more of the federal tax burden from states they represent onto states they don't and to Washington, D.C.

Repealing the state and local deduction while increasing the standard deduction would also limit the value of other deductions. Fewer people would get over the new, higher threshold to itemize deductions of $12,000 for individuals and $24,000 for married couples, meaning that fewer people would have an incentive to take deductions for home mortgage interest and charitable contributions.

Many higher-income households already have their state and local tax breaks curtailed under the alternative minimum tax. But about three-quarters of taxpayers who owe AMT and deduct state and local taxes would see a net increase if both provisions were repealed, as is the case under the GOP plan, according to economist Frank Sammartino of the Tax Policy Center.

Republicans argue that the deduction lets states raise taxes with fewer consequences, because the federal deduction subsidizes part of the cost. If New York wants higher taxes, they say, New Yorkers should pay.

Democrats and blue-state Republicans say the change would punish their states.

"Republicans used to say that the best decisions are made locally, and now they want to tax local decisions," said Sen. Chris Van Hollen (D., Md.).

The deduction's fate in the Senate isn't clear, either, even though Republicans there don't represent any of the top nine states for the deduction.

"Chairman [Orrin] Hatch recognizes that every major provision within the tax code has an important constituency and consequence," said Julia Lawless, a spokeswoman for Mr. Hatch, who heads the Senate Finance Committee. "He will work with members to examine these provisions and make appropriate decisions."

The fight over the state and local deduction highlights the backlash every decision in the tax debate will bring -- a reality glossed over when Republicans described their tax plan Wednesday, said Sen. Bob Corker (R., Tenn.). He said he supports repealing the state and local deduction but was "almost aghast" at the lack of clarity about tax breaks that would have to go away.

"They're throwing sugar out on the table," he said. "You haven't even begun to deal with the spinach part. Not even a little leaf of spinach was thrown out on the table."

--Kristina Peterson and Laura Saunders contributed to this article.

Write to Richard Rubin at richard.rubin@wsj.com and Siobhan Hughes at siobhan.hughes@wsj.com

(END) Dow Jones Newswires

September 28, 2017 18:57 ET (22:57 GMT)