Nation’s Most Irrational Tax Break Falls Out of Favor

A constant refrain among advocates for tax reform is that there are too many special breaks built into our nation’s tax system.  While some tax breaks are worthwhile, far too many are ineffective, unfair, complicated, or politically motivated.

But even the most flawed tax break typically has some kind of rationale—however flimsy—that its supporters can trot out in its defense.  Without a rationale or purpose, why would a tax break ever be enacted in the first place?

The answer is that sometimes tax breaks get enacted by accident.

Last week, the Oklahoma legislature sent Gov. Mary Fallin a bill—at her request—eliminating just such a break: a state income tax deduction for state income taxes paid.  Oddly enough, Oklahoma taxpayers who happen to claim itemized deductions can currently write off their state income tax payments when calculating how much state income tax they owe.  This bizarre, circular deduction did not come into existence because of its policy merits (there are none), but rather because Oklahoma accidentally inherited it when lawmakers chose to offer the same package of itemized deductions made available at the federal level.

The federal deduction for state income taxes paid exists primarily as a way for the federal government to aid state governments.  In effect, by letting taxpayers write off their state income tax payments, the federal government is indirectly providing states with a portion of the income tax revenue they collect.  Since a state obviously cannot provide aid to itself, however, this rationale is thrown out the window at the state level.  Accordingly, state deductions for state income taxes paid have been described as irrational, absurd, (PDF) and lacking “economic justification” (PDF).

Making matters worse, these purposeless tax breaks actually exacerbate the unfairness built into state and local tax systems.  According to an ITEP analysis, over half (58 percent) of the revenue lost through Oklahoma’s deduction flows to just the wealthiest 5 percent of taxpayers.

The good news is that this deduction seems to be on its way out.  New Mexico and Rhode Island both repealed their state income tax deductions in 2010 and Vermont followed suit in 2015.  Now, after years of urging from the Oklahoma Policy Institute, it appears that the Sooner State will join this group as well.

Once Gov. Fallin signs Oklahoma’s repeal into law, only four states will offer the deduction in full: Arizona, Georgia, Louisiana, and North Dakota.  A fifth state, Hawaii, allows the deduction only for taxpayers earning under $100,000 per year (or under $200,000 for married couples).  These nonsensical deductions may not last long, however, if tax reform advocates (PDF) in the remaining states are successful in their efforts (PDF).