The Republican chief of a congressional panel looking to rewrite the U.S. tax code suggested on Tuesday that a federal tax deduction claimed by individuals for state and local taxes paid is encouraging some states to keep their taxes high.

Dave Camp, chairman of the House of Representatives Ways and Means Committee, spoke at a hearing focused on the merits of the state and local tax deduction, as well as the tax exemption for municipal bond interest income.

Taxpayers in California, New York and New Jersey claimed more than one-third of all deductions taken for state and local taxes paid in 2010, Camp noted, also pointing out that these states have among the steepest state and local tax rates.

“Those findings, and many more that have been uncovered over the years, raise significant concerns,” the Michigan lawmaker said.

Those states are also among the most populous and tend to vote Democratic. Advocates for keeping the provisions noted that those states are largely urban with higher costs and higher tax payments paid back to the federal government.

“We’re big givers and we don’t complain about it,” said New York Democratic Representative Charles Rangel.

The hearing is the latest in a series held by tax-writing lawmakers hoping to overhaul the tax code this year. Doing that will be tough, given party rancor and the power of perk-protecting lobbyists, but Camp and Democratic Senate Finance Committee Chairman Max Baucus of Montana pledge to introduce legislation this year.

Scott Hodge, president of the Tax Foundation, which advocates lower taxes, estimated that scrapping both benefits would produce enough federal revenue to lower individual tax rates by 5 percent.

“Reducing the rate would have all taxpayers being treated more similarly,” Camp said, referring to that analysis.

Both provisions date to the tax code’s creation in 1913, setting them apart from what some call tax loopholes. They are also among the largest tax benefits.

In fiscal year 2011, the U.S. government missed out on about $30 billion in revenues because of the muni-bond interest tax exemption and about $67 billion from the state and local tax deduction, the Congressional Budget Office said this month.

That total of nearly $100 billion a year roughly equals the amount of revenue forgone by the federal government because of another popular tax break – the mortgage interest deduction.

President Barack Obama, a Democrat, and some Republicans have suggested limiting these tax breaks, but the provisions are politically popular, fervently defended by state and local officials, and embedded in the financial markets.

LOCAL RULES RULE

Municipal bonds allow states and local governments to tap capital markets more cheaply than private sector borrowers to fund public projects such as schools and roads.

Lawmakers from both parties defended the tax exempt status of municipal bonds at the hearing.

“All we’re going to be doing is passing that tax onto a different level,” said Representative Kenny Marchant, a Texas Republican who said he had been swamped with concern from local officials in advance of the hearing.

Lawmakers were largely in agreement on the need to examine so-called private activity bonds, which fund private-public projects such as airports and private colleges. A recent New York Times article pointed out that the bonds have been used to finance private projects such as a Goldman Sachs office.

Experts noted that these particular private activity bonds were issued as part of onetime disaster recovery programs, which have looser regulations.

Both Camp and the committee’s top Democrat, Representative Sandy Levin of Michigan, suggested looking into the rules on these bonds.

(Reuters)