Special Report

Save the Country! Tax the Rich!

They all live in the bluest of states.

By 12.3.12

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There's one tax benefit for the rich that I can't see why anyone would possibly want to defend. That's the deduction of state and local taxes on your federal income tax.

This is a racket perpetrated by the bluest of blue states -- the whole Northeast and California -- in order to foist their profligacy on the rest of the nation. Nearly all the beneficiaries of this deduction are high-income people living in New York, New Jersey, Connecticut, Massachusetts, Maryland (i.e., the suburbs of Washington) and California. And you can bet the vast majority vote Democratic and spend their days congratulating themselves on how progressive they are. Meanwhile, they end up foisting the bill onto the financially responsible Republican states that have nothing to deduct because they have no income tax at all! Try Texas, Florida, South Dakota, Wyoming, Nebraska, Tennessee, and Alaska for starters.

The theory is that the deduction of state taxes prevents citizens from being taxed twice for the same government services. Whoever thought that one up? There is no overlap of services in high tax states that doesn't exist in every state. All the exemption does is allow politicians in profligate blue states to tell their constituents, "Don't worry about our high taxes. You can always deduct it from your federal income tax." (I know, I live in one.) In other words, you can stick it to the rest of the country. If you don't believe it, just listen to Chuck Schumer howl the next time anyone mentions eliminating the deduction.

Charles Lane of the Washington Post has calculated that the exemption cost the federal government $67 billion in 2011. Is that anything to sneeze at? Moreover, an incredible 30 percent of all deductions came from residents in two states -- New York and California. And wouldn't you know, they just happen to be the most highly taxes states in the nation. New York ranks #1 overall and California #2. Others ranking near the top -- Connecticut (3), Massachusetts (5), New Jersey (7) and Maryland (10). Moreover it is the richest people in these states -- and only they -- who benefit. According to the Congressional Budget Office, 73 percent of the deductions went to taxpayers with incomes over $100,000 and 20 percent to people making over $1 million. What more surgically targeted strike on tax breaks for the rich could you possibly ask?

More than that, it's important these people feel the full weight of their spending habits because they are on the verge of heading off a fiscal cliff and taking the rest of the country with them. Predictably, the states with the highest tax rates are also those that are in the deepest debt. Massachusetts leads the pack with $11,000 per capita. Rhode Island, Connecticut, Delaware, New Jersey, New Hampshire, New York, and Vermont are all in the top 10. And the New York State figure is misleading because it doesn't include New York City, whose $8,700-per-head debt is greater than every state except Massachusetts and Alaska ($9,500).

What states have been most prudent about borrowing? Try Tennessee, which only taxes interest and dividends and has an unbelievably low debt burden of $773 per capita. Texas (no income tax), Georgia, Nebraska, Arkansas, Nevada (no income tax), Alabama, Minnesota, Arizona, and Kansas round out the bottom ten. None of these states are run entirely by Democrats (although Minnesota just voted to go that route). The 18 states with all Republican legislatures and a Republican governor have an average debt of $2,874 per capita and a median rank of 36th. The 14 states that were all Democratic before the last election have exactly twice as much debt -- $5,744 -- and a median rank of 11th. There could hardly be a more dramatic contrast.

There is yet another way that high-spending states use the tax code to shift the burden onto the more financially responsible states. That is through the exemption on municipal bonds. Walk into any financial advisor's office in New York City and they will immediately try to steer you into "triple-tax-exempts." That means New York State or New York City bonds, whose interest income is exempt from federal, state, and New York City income taxes, which can add up to more than 40 percent. Holders of municipal bonds in every state are exempt from federal taxes but the exemption only works really well in states with high income taxes. The whole system is designed to steer money away from the private sector and into the government. Given this advantage, states and cities are encouraged to borrow even more money. It also shows how governments at all levels work in concert, favoring each other. After all, they are all in the same business -- extracting more money from taxpayers.

All this is soon going to come to a head. Keep in mind, Europe didn't hit its financial woes because the whole European Union overspent. It was undermined because one country -- Greece -- dug itself too deep a hole. Things then cascaded and soon Germany was being asked to bail everyone out.

That's the way it will happen here as well. It won't be the entire U.S. government that runs into trouble, just one or two states that finally go over the edge. Illinois is the prime candidate. The state ranks only 12 in general obligation debt ($4,424 per head) but has been raiding its pension funds since the feckless administration of Governor Rudy Blagojevich and now has unfunded liabilities of $83 billion. Only 45 percent of its pension obligations are covered, the worst performance of any state. Only California has a lower credit rating and Illinois is now borrowing $8 billion to cover unpaid bills, many of them to small businesses. Observers predict the state could be asking for a federal bailout before Obama finishes his second term.

So what happens then? Will Obama turn his back on his home state? Or will Republicans be demonized for not allowing him to rescue Illinois taxpayers? And if the federal government assumes Illinois' pension burdens, how many other states will quickly be in line?

So there are rough times ahead. And it's the liberal blue states that are dragging us down the chute. There's only one way to go. Wealthy liberals in the Northeast, California, and the Chicago suburbs who congratulate themselves on their "progressive" voting patterns have to be shown there's a price to be paid for all this profligacy. Tax the rich! It's the only way to head off the crisis.

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About the Author
William Tucker is news editor for RealClearEnergy.org.