Dude, how much did that car cost? Or why the federal offset matters

Chuck Sheketoff

Let’s say that someone named Jack goes to a car dealership and pays $20,000 for a new Ford. Someone named Fred goes to the same dealership and pays $20,000 for a new Toyota.

Ford, however, is offering a $5,000 rebate, and Jack will get it.

Who paid more? Fred, the one who did not get a rebate, of course.

The federal government offers a rebate on state and local income taxes for taxpayers who itemize their tax deductions. Tax policy wonks simply call it the “federal offset.”

Because the federal offset affects how much state and local taxes ultimately cost taxpayers who itemize — disproportionately higher income taxpayers — it affects the calculation of whether state and local income taxes weigh more heavily on the poor than on the rich.

One such calculation recently published by the Institute of Taxation and Economic Policy (ITEP) shows that Oregon's poor pay a higher percent of their income in state and local taxes compared to wealthy Oregonians. Some criticize ITEP’s analysis for including the federal offset, calling it “double counting” or "misleading." These critics are wrong.

Taxpayers in states that have income taxes can deduct state income taxes on federal returns if they itemize on their federal return. Sales taxes historically have not been deductible for itemizers, though a temporary law that allows sales taxes to be deductible in lieu of income taxes (you can't deduct both) is in effect through 2013.

As the Congressional Research Service noted in a report last fall, "[t]he federal deduction for state and local taxes results in the federal government paying part of these taxes through lower federal tax collections."

In other words, like the car dealership that gets paid in full by the buyer, the state gets the full payment from taxpayers who claim the federal offset. The itemizing taxpayer, however, gets a partial rebate from the federal government — just like Jack got from the car manufacturer.

Just as you would take into account a rebate in calculating how much a car costs you, you need to take into account the federal offset in determining the cost of state and local taxes. Critics who say otherwise are wrong.

---

Chuck Sheketoff is the executive director of the Oregon Center for Public Policy. You can sign up to receive email notification of OCPP materials at www.ocpp.org.

By Chuck Sheketoff Feb. 07, 2013 Posted in open discussion.