Spillovers, Local Public Finance, and the Deductibility of State and Local Taxes

Things that make you go "hmmmm...":

Greg Mankiw's Blog: AMT Reform: The Washington Post reports that the new Democratic majority in Congress wants to focus on the Alternative Minimum Tax. The AMT is paid disproportionately by residents of Democratic states because those states tend to have high state and local taxes and the state and local tax deduction is disallowed under the AMT.

This raises the question: Is the state and local tax deduction justifiable in the first place? I think not. Suppose the residents of town A vote for high local taxes to finance, say, a municipal pool. The residents of neighboring town B keep taxes low, allowing people who so choose to join a private pool club. Because of the federal tax deduction, town A gets a federal subsidy at the expense of town B. This is neither equitable (it is violates the principle of horizontal equity) nor efficient (it encourages excessive provision of goods and services by states and localities over the private sector)...

When I took public finance from Richard Musgrave, the canonical examples on this question were somewhat different. They were things like:

1. Suppose Town A votes for high local taxes to finance, say, more law enforcement officers, who arrest criminals making their getaways after committing robberies in Town B...
2. Suppose Town A votes for high local taxes to finance, say, a better library, which inhabitants of Town B can wander into and use...
3. Suppose Town A is discouraged from raising taxes to the level that provides the efficient level of public services because it fears that businesses will migrate across the border to Town B...
4. Suppose Town A votes for high local taxes to finance, say, better schools which teach more things and, with Nash bargaining between workers and employers, raise the productivity and profits of firms in both Town A and Town B...
5. Suppose Town A votes for high local taxes to finance a high-quality emergency room in its public hospital, which treats heart attack patients from Town B...
6. Suppose Town A votes for high local taxes and spends the money on roads, which makes it easier for shoppers from Town C to get to Town B, and so boosts profits of and employment in retail stores in Town B...
7. Suppose Town A votes for high local taxes to finance improvements to its parks, while Town B sells off its public lands in order to temporarily lower its taxes...
8. Suppose Town A votes for high local taxes to provide free flu shots to all its inhabitants, reducing the risk that Town B inhabitants will catch the flu...
9. Suppose Town A votes for high local taxes to buy an extra fire engine and more fire inspectors, thus reducing the risk that Town B will be immolated in a wildfire...
10. Suppose Town A votes for high local taxes to buy and store emergency earthquake supplies that will be of use to Town B residents if the San Andreas lets go in a big way...

Plus there is the curious "the AMT is paid disproportionately by residents of Democratic states." I would have put it differently, and said that the AMT IS paid disproportionately by Republicans, many of whom live in states that usually give their electoral votes to the Democratic candidate.