How federal taxes affect state taxes

The Badger Institute (the former Wisconsin Policy Research Institute):

The House Republican tax reform bill unveiled last week offers a $1.5 trillion (that’s trillion, not billion) tax cut, most of which redounds to the benefit of businesses. The top corporate tax rate would be slashed from 35 percent to a flat 20 percent rate, whereas small businesses would see their pass-through income taxed at a maximum 25 percent, down from 39.6 percent. Also, the tax structure for companies doing business abroad would be completely revamped — for the better.

For individuals, the bill is more of a mixed bag, with winner and losers. It would reduce the number of tax brackets from seven to four, increasing the income range within each bracket. At the same time, several tax breaks that taxpayers in high-tax states such as Wisconsin have come to rely on would be eliminated or reduced.

The real showstopper is that state income taxes would no longer be deductible. That’s fine for people who live in states that exact no or very little income tax. But what about here?

Consider that Wisconsin’s top state income tax bracket is 7.65 percent, among the highest in the country. According to Urban Milwaukee’s analysis of Internal Revenue Service data, in 2015, more than 800,000 Wisconsin taxpayers claimed deductions for state income taxes, totaling $6.22 billion. You don’t have to be a CPA to understand the effect that denying such deductions could have on Wisconsin’s taxpayers.

That’s not all. The reform bill also would cap real property tax deductions at $10,000. Although the Milwaukee Journal Sentinel notes that across the state there are relatively few homeowners with property tax bills in excess of $10,000, a closer county-by-county analysis tells a different story. For example, Milwaukee County ranks 42nd out of 3,143 counties nationwide for property taxes imposed as a percentage of median income.

This means a lot of Milwaukee County residents do pay over $10,000 per year in property taxes. Residents of Dane County and certain other Wisconsin counties also feel the brunt of high property taxes. Up until now, being able to deduct all of one’s property taxes has served as a palliative of sorts for many homeowners in these counties.

But perhaps not so much in the future. The consequence of capping property tax deductions, along with eliminating the state income tax deduction, would effectively punish a large swath of Wisconsin residents just for living where they do.

To be sure, the House bill would almost double the standard deduction. That would reduce the number of people itemizing deductions (including state income and property taxes), since the only reason to do so is if those deductions combined exceed the standard deduction. Nonetheless, there is no question that Wisconsin taxpayers who continue to itemize (and there will be plenty of them) would get dinged.

The first impulse might be to contact House Speaker Paul Ryan (R-Wis.) or one’s congressman to make a plea for putting things back to the way they have been. Before doing that, however, we should ask ourselves whether the answer lies there or, instead, with our own state tax system.

As already noted, several states have little or no income tax, and most have property taxes far below our own. Why should the federal government continue to subsidize Wisconsin taxpayers via the tax code because we can’t figure out a more equitable way to raise revenue — or cut spending?

Instituting open-road tolling on major highways as a way to fund roads, instead of resorting to income taxes, or consolidating local government as a belt-tightening measure are both worth a closer look than they have been given so far.

Almost everyone agrees that simplifying federal tax laws is necessary, and eliminating state income tax deductions and capping deductions for property taxes are small steps toward that end. As Todd Berry, president of the nonpartisan Wisconsin Taxpayers Alliance, told the Journal Sentinel the other day, “I hope people realize there are … good reasons to try to clean up and simplify a pretty hard-to-justify tax system.”

There is a ways to go before the House bill or anything like it becomes law. Still, the smart money says that change is a coming and Wisconsin better be ready.

Whether or not one agrees with all the particulars of the House Republican tax bill, give Congress credit for at least starting to fix a longstanding problem. Wisconsin ought to “clean up and simplify” its own tax system.

If it does, that could help make our state more competitive in the marketplace — and help a lot of its residents who otherwise might take a hit under federal tax reform. The moment is upon us to act.

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