Jim Geraghty at National Review says that if taxes must be raised, lets structure the tax hikes to impose maximum burden on “blue” states. Specifically, he wants to leave the capital gains tax rate in place, raise income taxes on the very top tax bracket, eliminate or scale-back the mortgage interest tax deduction, and eliminate or scale-back the deduction for state and local taxes.
The higher rates are, of course, already part of Barack Obama’s plan. And essentially any plan to tax the rich has the feature of disproportionately taxing blue states in order to subsidize red ones. That’s the general structure of the American fiscal union—high productivity states tend to vote for Democrats and subsidize the low productivity states where most people vote Republican. But Geraghty is right that the state and local tax deduction primarily benefits residents of blue states since blue states have high taxes, and so does the mortgage interest tax deduction because blue states have expensive houses.
I think this is a fine idea, but I’m especially enthusiastic about the mortgage part. Suppose homeowners in expensive coastal cities couldn’t deduct their mortgage interest, what would happen? Well, what would happen is that prices would fall. But nothing more dramatic than that. All the deduction does is encourage further bidding up of the price. In a normal market, that bidding up of the price might lead to additional construction. But the main reason those blue metro areas have such expensive houses is that zoning doesn’t allow demand to be matched with supply. No matter how expensive Georgetown or Harvard Square or Park Avenue gets they’re not demolishing the existing structures and replacing them with much larger ones. So you’d get some extra tax revenue this way with no real change in the amount of underlying economic activity.
