Question

Politics Question

Although government from the state to the local level is clearly unitary, local finance is very diverse, with many local levies and revenue streams. Should states abolish all local taxes and institute more efficient tax reforms? Why/why not?

Answer 1

State and local tax and interest exemptions from municipal bonds encourage higher state and local government taxes and debt. Through requiring higher marginal federal tax rates to replace lost income, the state and local tax deduction further removes the connection between taxes paid and benefits rendered, causing all federal taxpayers to partially pay for services given to citizens of other states. In contrast, state and local bond interest deduction distorts infrastructure spending decisions and makes it easier for states to accumulate debt that could damage state economies and lead to federal bailout demands.

The deduction of state and local taxes reduces the cost of such taxes and promotes the implementation of higher taxes and wasteful spending by the government. The deduction of municipal bonds allows government and local authorities to run deficits that could lead to insolvency and unnecessarily subsidize wealthy investors.

Since state and local taxes reduce individuals' after-tax income, it may make sense to exclude the income used to pay those taxes from federal taxation. Yet this was when the bulk of services were rendered by state and local governments and most taxes were collected. The reverse is true today, as the federal government receives more than 50% more income than the combined government and local authorities.

By fact, the tax deduction helps states to raise taxes higher than they would otherwise, which allows governments to provide services that are left to the private sector more adequately. The tax deduction also has major adverse effects on the distribution of income from the poor to the rich and from people in low-tax states to people in high-tax states.