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At the end of 2017, President Trump signed into law the Tax Cuts and Jobs Act with among other things eliminated the federal tax deduction for state taxes paid.

Essentially, the federal government allowed taxpayers to remove whatever they already paid in state taxes, from their federal taxes owed.It is explained in this article.

My first question is, why did the federal government ever do this? Isn't this just another way of transferring money to states?

My second question is, under this regime, why would any state in their right mind not impose state taxes (9 states don't) ? Their residents aren't saving money anyways, as whatever they would have paid in state taxes goes to the federal government.

closed as off-topic by quid, Nathan L, JoeTaxpayer Jan 10 at 23:09

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    You're wrong about all of state income taxes going to the federal government. It's a deduction from income, not a credit. Say you paid $1000 in state taxes, and are in the 20% tax bracket. You deduct the $1000 from your income, which means you pay $200 less to the IRS. – jamesqf Jan 8 at 19:15
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    Nine states don't have income taxes. I believe that many of the other taxes these states do have (e.g., property tax) used to be deductible from federal income tax. – Adrian McCarthy Jan 8 at 19:45
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    I live in a state without state income tax and instead relies mostly on higher property tax and sales tax rates. When there is an economic downturn and people start losing their jobs this prevents a big loss in tax income since the income people receive will drop yet property taxes are still owed. – user1723699 Jan 8 at 20:44
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    @JAB, it does, especially when the property taxes are ~3% of the value of your property, calculated based on what similar properties are selling for. – shoover Jan 8 at 21:30
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    It might help to realize that many of the states that 'benefited' from the SALT deduction fund the federal government more than the low tax states i.e. the money already flowed from high tax states to low tax states. Then consider that people in already low tax states got a tax cut while many high-earners in high-tax states are getting an increase due to this change. – JimmyJames Jan 8 at 22:51
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At the end of 2017, President Trump signed into law the Tax Cuts and Jobs Act with among other things eliminated the federal tax deduction for state taxes paid.

The state and local tax (SALT) deduction was not eliminated, it was capped ($10,000 for 2018). ~90% of the people that benefited from the deduction had income over $100k. So capping it limits benefits for people with higher incomes, and with the new standard deduction far fewer people will be itemizing deductions. It will hit high income earners in high-tax states the most. This cap is probably the most unpopular aspect of the new tax law.

Essentially, the federal government allowed taxpayers to remove whatever they already paid in state taxes, from their federal taxes owed.It is explained in this article.

This is a deduction, not a tax credit. Deductions reduce the amount of your income subjected to tax, but you're right that it does decrease federal tax revenue to some extent. Historically ~30% of people itemized deductions, itemized deductions are only beneficial to the extent that they exceed the standard deduction, so for a lot of people who itemized the actual impact of the SALT deduction was far less than their marginal tax rate applied to their SALT payments.

My first question is, why did the federal government ever do this? Isn't this just another way of transferring money to states?

The deduction helps limit double-taxation, that was probably the main motivation initially. Also, the people writing tax laws are elected officials who have incentive to keep their constituents happy.

My second question is, under this regime, why would any state in their right mind not impose state taxes (9 states don't) ? Their residents aren't saving money anyways, as whatever they would have paid in state taxes goes to the federal government.

The states that don't have state income tax still have taxes, they may have property tax, sales tax, ownership/use tax, gas tax, cigarette/vice taxes, etc. Those other types of tax typically fall into the SALT deduction. Typically states without income tax will have higher property tax rates or sales tax rates, so you have to compare full tax picture not just income tax.

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    @RonMaupin I'd argue that it's disingenuous to say Texas doesn't have property tax just because it is assessed at the city/county level, the average property tax in TX is ~1.86% of home value. Colorado is similar in that property tax is assessed at the county level, but at a lower average rate than in TX. Texas has gas tax, franchise tax, maybe others. The point is just that states choose to collect tax revenue in different ways, but they all collect it, so not having one type of tax doesn't necessarily mean much. – Hart CO Jan 8 at 20:01
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    The state does not get any revenue from the property taxes. The franchise tax has been called an income tax for businesses, but it is only charged on the business. Back before the state ad valorem tax was repealed, the state did have a property tax, but that was eliminated during the oil embargo when the state collected a lot of money from oil taxes when the price of oil went up a lot. It takes a state constitutional amendment to change the state taxes, so it is very unlikely to get an income or property tax. – Ron Maupin Jan 8 at 20:06
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    Another consideration for why a state would choose higher sales taxes over property/income taxes is how property and income taxes tax the state's residents, whereas higher sales tax rates will tax both residents and tourists/visitors. – ps2goat Jan 8 at 20:10
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    @RonMaupin Each state handles things differently, if your county collects property tax, then it is to pay for things the county has responsibility for that the state does not, if it were a state property tax, ostensibly the state would pay for those things rather than each county. The franchise tax to a business is ultimately paid by the consumers and/or employees. The important part for comparison between states is not what the state collects specifically, but the total tax burden to the residents (which still doesn't paint a perfect picture). – Hart CO Jan 8 at 20:16
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    Not only did they cap SALT, they turned it in to yet another marriage penalty as the cap does not double if you are married. – Dev Jan 8 at 20:45
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The state tax deduction lets you deduct state taxes paid from your taxable income for calculating the federal tax that’s due, not from the federal tax paid. Suppose you pay state taxes of $2,000 and your marginal federal tax rate is 30% — your deduction from the amount paid in federal taxes is $600, not $2,000. The justification is that money paid in state taxes isn’t actually part of your income, so you shouldn’t be taxed as if it was.

  • Thanks for that clarification. Even so, by allowing you to deduct the tax from your income, the federal government still loses out. – CodyBugstein Jan 8 at 17:00
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    @CodyBugstein The federal government is at the mercy of Congress. If Congress wants to turn state tax payments into a deduction, they pass a law and the IRS obeys. – pboss3010 Jan 8 at 17:12
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    @CodyBugstein I don't understand the intent behind your comment. Are you saying that's a bad thing? It wouldn't make sense for taxpayers to have to pay income taxes on money that is not income, so the people passed laws to prevent that. That's what we want. – only_pro Jan 8 at 20:28
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    @CodyBugstein Maybe you're arguing that it should be the other way around: that federal taxes are a tax deduction for state taxes? Or maybe split in some more even way? Whatever you choose, some entity is going to "lose" out: the federal government, the state government, or the taxpayer (via double taxation). – jamesdlin Jan 8 at 21:18
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You have many questions in this question; try to focus down to one question and it is more likely to be answered.

To address your question:

why would any state in their right mind not impose state taxes

Presumably you mean state income taxes. I live in Washington State, which has no state income tax. There are many ways to measure characteristics of tax systems on a spectrum; one is that a tax system is said to be "progressive" if the tax burden falls more on rich people, who can afford it, and "regressive" if the tax burden falls more on poor people, who cannot.

Due in large part to Washington State's lack of an income tax, we have the most regressive state taxation system in the United States. The 20 percent of families with the lowest incomes pay nearly 17 percent of their income on state and local taxes, while the 1 percent of families with the highest incomes paid only 2.4 percent of their incomes in state and local taxes.

You may wonder how state and local governments are funded at all; it is a combination of regressive sales taxes and property taxes that are legally prohibited from growing by more than 1% in nominal dollars. (Exercise: what is the effect of nominal revenues being prohibited from growing faster than the rate of inflation over time?)

As a result, Washington State is a "low tax, low service" state. Schools are underfunded to the point where the judiciary is holding the legislature in contempt because they have failed in their constitutional mandate to fund education.

Why, you ask, would any sane legislature not collect a state income tax in this situation? Well, it has come up for a vote eleven times in the past hundred years. Most recently, in 2010, a measure was put to the general population for a vote; the proposal would put a small state income tax on income in excess of $200000 per person or $400000 per couple. This measure was defeated by a 2-1 margin, and the vast majority of those voting against make nowhere even vaguely close to $200K a year.

Why would the residents of the state with the most regressive tax system in the country, where there are high sales and property taxes borne disproportionately by the poor, and deeply underfunded state services that poor and middle class people depend upon, vote 2-1 against a progressive tax on the wealthiest? There were two main arguments made by opponents. First, that an income tax would drive away jobs -- because of course, we all know how high-tax-high-service states like California and New York have no jobs, I guess?

But that wasn't the real argument against. The real argument against was "if you give the legislature an inch, they'll take a mile". A tiny income tax on high earners in Washington State will quickly become a high tax on everyone, so we cannot allow any tax increase whatsoever, the argument went. That argument was successful.

So, income taxes are a complete non-starter in Washington State; you ask how any state "in their right mind" could make this decision; I leave it to you to conclude whether or not Washington voters are in their right mind.

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    I don't see a problem with low tax, low service. The problem is that low tax low service can quickly become high tax low service. Btw, I think another reason it may have gotten defeated is because people - even, or perhaps especially the poor - value simplicity. – CodyBugstein Jan 8 at 22:22
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    @CodyBugstein: You have thoroughly missed my point. Think like someone in the 20% percentile of income. Those people effectively do live in a high tax, low service state. They're paying 17% of their already-low incomes in taxes, and receiving services that are literally unconstitutionally illegal, they're so crappy. It is only the rich in Washington who live in a low-tax, low-service state, and they send their kids to private schools. – Eric Lippert Jan 8 at 22:29
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    Your last point is true everywhere. High tax California is ranked 44th nationally for pre-k through 12 schooling (far lower than Washington state). In fact, Washington state is ranked higher than New York and California. – quid Jan 8 at 23:15
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    @quid: Indeed, California's k-12 school funding system was completely messed up by attempts at tax reform in the late 1970s, from which they have yet to recover. As you note, things are bad all over. The existing, entrenched political system does not incentivize politicians to make long-term investments in education, regardless of whether that is in the best interests of the country or its citizens. – Eric Lippert Jan 8 at 23:46
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    Sure, there are lots of ways to explain an outcome. But, I would argue that California is not a high-tax high-service state, as you mention. It's certainly a high-tax state (and the taxes and non-tax-government-imposed-mandatory-fees come from every conceivable direction) and services are expensive, but expensive doesn't equate to well managed or high-outcome. There are a lot of reasons to vote against instituting an income tax, I'd certainly have voted against it. Also, Washington state has corporate B&O tax on gross receipts, of which Amazon pays about a quarter billion each year... – quid Jan 9 at 0:06
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The original idea was this: The federal government taxes your income, but if you send your income on to somewhere else that is in the public interest, you wouldn't need to be taxed on that money, as you were already giving it to somewhere that benefited society. This was the thinking not only of the State and Local Tax deduction, but also of the Charitable Contribution deduction. State and local governments are tax-exempt organizations, as are charities, because the work that they do is considered a public benefit. In essence, you could funnel your income to those places instead of the federal government, and, ideally, the federal government wouldn't need as much money, because these organizations were doing some of the work that the federal government wouldn't have to do.

Unfortunately, because state and local taxes are not voluntary, this gives an incentive to those governments to tax as much as possible. Among other reasons, the new limit is an attempt to even the playing field between high-tax and low-tax states, so that the federal government does not lose so much money to the high-tax states at the expense of the low-tax states.

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    It's hard to understand what is even about the playing field, when high-tax states such as California and New York are net contributors to the Federal Treasury, and many low-tax states are net recipients. It sounds, instead, like making even more of a transfer from the wealthy to the less wealthy. – Andrew Lazarus Jan 8 at 19:53
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    I am also confused by your last sentence. Can you explain? – Azor Ahai Jan 8 at 23:31
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    @AndrewLazarus It's almost as if those high-tax states are ON to something, huh? Provide benefits and services to your population, even if it requires taxation, and people and businesses might actually THRIVE there... – jaypops96 Jan 10 at 0:13
  • @AzorAhai It seems highly likely that the cap on deducting State and Local Tax (SALT) will result in relatively more Federal tax paid by residents of high-tax states like California, compared to low-tax states like West Virginia. The high-tax states also tend to be more prosperous, so the effect is to further subsidize states that rely on the Federal government for money instead of raising their own taxes. (Admittedly, in the case of some states, there may not be much wealth to tax.) – Andrew Lazarus Jan 10 at 0:18
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    @AndrewLazarus Oh I see, thanks for the explanation. The use of "at the expense of" confused me. – Azor Ahai Jan 10 at 0:22
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My first question is, why did the federal government ever do this? Isn't this just another way of transferring money to states?

There's also a purely mathematical reason for the federal govt to allow deduction of state and local taxes (ESPECIALLY SALT income taxes) from your federal tax income: in theory if tax rates were high enough, and no SALT deduction was allowed, you could end up owing more in taxes than dollars earned.

For example, say your state had a super high tax bracket of 40%. And let's imagine federal income taxes were closer to the levels seen in the 1950s-1960s USA, where the top marginal rates were 70-90%. If you paid 40% on SALT taxes, but couldn't deduct them, then you paid an additional 70% on federal taxes, you'd end owing 110% of your income!! (at least income in the higher brackets).

The US Bill of Rights (especially the 10th amendment) was designed to give significant power to the states rather than the federal govt., so giving states the power to levy their own taxes without having to worry about double taxation on every dollar was an attractive feature.

  • While I understand that owing more in taxes than you made in income would be a very bad situation, what does this have to do with the Federal government? The federal government would just say "too bad. lower your state tax". You could just as easily argue that states should allow for the deduction of federal taxes paid. – CodyBugstein Jan 9 at 16:00
  • Also the situation you described already happens, in the case of US citizens living in foreign countries. The US federal government demands full taxation even if the combined local and US tax exceeds all of a citizen's income! – CodyBugstein Jan 9 at 16:01
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    @CodyBugstein The govt basically DID just say "too bad. lower your state and local taxes". That was the effective message of the 2017 bill. But many of the republicans who supported this tax bill have previously argued vociferously that the federal govt should be LESS powerful and have LESS authority to regulate and tax heavily, because they claim states should retain more of the power (including the power to tax). By eliminating the SALT deductions, the fed govt is in some sense infringing on the power of states and localities to tax. – jaypops96 Jan 9 at 21:55
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    @CodyBugstein Could you list which countries you have lived in with double taxation? Generally speaking, even in the absence of tax treaties, the USA lets expatriates subtract off tax paid to their country of residence. Where were you that had an exception, or did you hire poor tax preparers? – Andrew Lazarus Jan 10 at 0:23
  • @AndrewLazarus Depends on what you call double taxation. Most countries in Europe tax everything multiple times - e.g. you pay a non-deducible tax when you sell a house, based on the total value of the house (needless to say, this reduces people's willingness to move). To get the house in the first place, you needed some income, which was taxed. And everything you buy is further taxed on top of that. And that of course includes investment taxes - you invest money that was taxed, which earns money (income after taxation) which is taxed, and when you use that to buy something, it's taxed. – Luaan Jan 10 at 8:28
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I'm writing this answer to try and cover the question "why did the federal government ever do this [allow deductions of certain state taxes]?"

Simply put, the IRS's taxes on income are (were) intended to tax actual income received, which might be less than the theoretical amount earned. State income taxes are money that is never actually seen by the tax payer, if someone earns $50,000 and their state takes 5% of that they will never see or receive that $2,500. It seems reasonable that earnings which someone would never receive are not taxed.

For a good example of why this made sense, compare this to "theft and casualty losses". If someone earns $50,000 but is then robbed of all but $5,000, they do not have to pay taxes on all $50,000. In fact they would probably not even have enough money to pay the taxes on the full $50,000 if it was demanded of them.

Another more tenuous analogy would be the deduction on IRA contributions. Money one places in an IRA they are not actually earning as income, they cannot do anything with it or use it (without penalties). Instead the money is taxed in retirement when the person actually receives the money (in a form they can spend and use). Again, this taxes income one actually sees and has access to.

This follows the same principle of income taxes normally being based on the money you in some sense actually get.

No longer allowing an unlimited state tax deduction in a sense changes this principle and allows money the tax payer never got to be taxed again. I shaln't go into who this may benefit or hurt but in essence that is the difference.

  • Downvoting because this is not true. There are many situations in which a taxpayer is expected to pay tax on money that they have not seen. For example in the case of a legal judgement. Even if the lawyer skims off 30% of it, the taxpayer is still taxed on the full amount (Source) – CodyBugstein Jan 9 at 16:04
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    @CodyBugstein If one hires a lawyer that is their prerogative. They were not obliged by law to hire a lawyer any more than they hire anyone else and the costs are thus up to them. I was referring to money one could not possibly see while following the law, not money someone could decide to spend on something. That is an entirely different matter. I do not deduct the money I spend on food shopping either, because I decided to spend that money. – Vality Jan 9 at 17:20
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    TCJA also eliminates (at least until 2025) nonbusiness theft and casualty deductions except those occurring in a Federally-declared natural disaster. – dave_thompson_085 Jan 10 at 2:02
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My second question is, under this regime, why would any state in their right mind not impose state taxes (9 states don't) ? Their residents aren't saving money anyways, as whatever they would have paid in state taxes goes to the federal government.

This is not true.

  1. Not everyone could deduct state and local taxes (SALT) on their federal income tax under the old system, only people who itemize. Since most people don't itemize, they get zero deduction from SALT. It is probable that fewer will itemize under the new system, but under the old system only about 30% did.
  2. Even among people who did itemize, it did not reduce their federal taxes by the amount of the SALT. First, it's a deduction in the taxable income, not the taxes. Second, part of that is lost to itemization for most people.

Consider a simplified federal system (old). The standard deduction is $5000 (perhaps this was a while ago). The tax rate is 20% (for simple arithmetic). You paid $4000 in mortgage interest and $4000 in SALT. No other itemized deductions.

If you don't itemize, you take the $5000 deduction, reducing your taxes by $1000 (20% of $5000). If you do itemize, you take an $8000 deduction, reducing your taxes by $1600 (20% of $5000). So for a $4000 payment of SALT, you save $600. That's only 15% of the SALT you paid. You still had to pay the other 85%.

It gets worse. What if you didn't have the $4000 in mortgage interest? Then you take the standard deduction. You get 0% savings from your SALT "deduction" that you couldn't take.

Now, let's look at someone with a higher tax rate, say 40% (because 39.6% is too much arithmetic). That person may have no mortgage, but pay $40,000 in SALT. That's well over the $5000 standard deduction. So that person saves $16,000 in SALT deduction (40% of $40,000). That's $14,000 more than the $2000 from the standard deduction (40% of $5000).

Now, go back earlier in the history of the SALT deduction. Tax rates are up to 94%. The rich person can deduct almost all the SALT paid. Most people can't. And those that can, are only paying a small amount of tax anyway. They get little benefit from the deduction (still $600 if their tax rate and standard deduction are the same).

And that's why SALT was deductible. It was a big assist to rich people at a modest cost for middle class people. Poor people get no help at all. Since politicians have a lot of reasons to make rich people happy, it's unsurprising that tax policy was often made to help them. Especially when it also helps other politicians (those in state and local government).

You might think that capping the SALT and mortgage interest deductions fixes this. But it doesn't. Rich people can easily afford a mortgage on a $500,000 house and generate more than $10,000 in SALT. But middle class people often can't. Remember that in our example, the deductions were $4000 and $4000. So the middle class gets only part of the benefit while rich people get the full amount.

On the bright side, very few middle class people will take the $10,000 SALT deduction rather than the $12,000 standard deduction. It really only makes sense in the first few years of a mortgage. And it may not then, as many won't use close to the cap. Hopefully this will cause support for this regressive deduction to erode.

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Double taxation of income is viewed as immoral. Imagine you earn 1$, and 3 different levels of government apply a 40% income tax on it.

All together you owe 1.2$ for every 1$ you earn. Earn 100,000$, owe the government 120,000$.

If you avoid double taxation, the 0.4$ you send to level of goverment 1 reduces your taxible income to 0.6$. Then you owe 0.24$ to goverment 2, leaving you with 0.36$. Then you owe 0.144$ to level of goverment 3, leaving you with 0.216$.

Still expensive/bad, but not ridiculous.

Taxing income on income not recieved warps incentives. This is why you can deduce the cost of earning your income as a general rule.

State taxes are a cost of living in a state, and hence a cost of earning the income in that state. So you can deduct it from your income.

It does not permit you to deduct it from your taxes. So paying 40$ in state taxes does not reduce your federal taxes by 40$. If your marginal federal tax rate is 20$, then it reduces your federal taxes by 8$.


As for why state income tax, or why not; income tax permits both progressive taxation (taxing people earning more money more than people earning less), and it tends to be taxation that is hard to avoid and relatively easy to assess and collect.

Now, on the other hand, sales tax acts like a tarrif.

Suppose you have two states. In state 1 you have a 20% flat income tax; in state 2, a 25% sales tax.

Suppose you have a widget that costs 100$ in labour, before taxes.

In state 1 to pay your employees (or yourself) 100$ you need to spend 125$. 25$ goes to the state, 100$ to the employee. So you sell the widget for 125$.

In state 2 you pay your employees 100$ for them to get 100$. When you sell the widget, you have to sell it for 125$, and the state gets 25$.

So far so good.

Now what happens when you produce your widget in state 2 and sell it in state 1?

You pay employees 100$. They get 100$. You ship to state 1. You sell it for 100$, 25$ cheaper than local producers can.

How about make it in state 1 and sell it in state 2?

You pay employees 100$ after tax, which costs 125$. You ship to state 2. You sell for 125*1.25=156.25$. 25% more.

If state 2 had an income tax like state 1, but subsidized all exports by 20% and had a tarrif on all imports of 25%, the math would be the same.

Thus, having your government tax base be sales taxes instead of income tax act like tarrif barrier.

The downsides -- harder to tax, easier to cheat, massively regressive that loads taxes on poorer people -- remain. But the ability to effectively place tarrifs and subsidies on imports and exports make it very tempting.

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