Economy & Business

Four Blue States Protest Tax Reform with a Frivolous Lawsuit

New York Gov. Andrew Cuomo speaks to guests during the National Action Network (NAN) Dr. Martin Luther King, Jr. Day Public Policy Forum in New York City, New York, January 15, 2018. (Eduardo Munoz/Reuters)
The Constitution doesn’t mandate a deduction for state taxes.

Four high-tax blue states — New York, Connecticut, Maryland, and New Jersey — have filed suit against the federal government over the recent tax reform. Specifically, they object to its limitation on the deduction for state and local taxes (SALT).

Under federal tax law, filers are allowed to deduct property taxes (the local part) and either state income or sales taxes. But under the Tax Cut and Jobs Act (TCJA), the SALT deduction is now capped at $10,000. This deduction had been particularly valuable in high-tax, high-house-price states such as California and the four now suing the federal government.

Republicans limited the deduction for two reasons. First, doing so helped to offset some of the lost tax revenue from lower rates. And second, the deduction distorts the economy, acting as a subsidy for high-tax (and, yes, Democratic-leaning) states. When a state raises its taxes, the federal government ends up assuming part of the burden, because residents are able to deduct their higher payments from their federal taxable income.

Unsurprisingly, high-tax blue states have been fighting tooth and nail against this reform. This latest argument might be the silliest yet, as it makes no sense economically or legally. The four states claim that limiting the SALT deduction violates both the Tenth and 16th Amendments, as well as Congress’s Article I taxing powers. The Tenth Amendment reserves unspecified powers to the states, while the 16th Amendment provides the federal government a wider ability to charge income taxes. In Article I, meanwhile, Congress is given certain taxing powers but limited in what it can force on states.

The four states are claiming, at the most basic level, that the TCJA damages their ability to levy high taxes on their residents by limiting the federal deductibility of those taxes, thereby infringing on rights reserved for the states. Unfortunately, the lawsuit makes no sense on legal or economic grounds. It is purely pandering to Trump-hating voters.

On the legal side, the TCJA in no way limits what taxes states may levy; it simply caps the deduction for those taxes. Nowhere does the Constitution mention tax deductions, and there is clear evidence against the idea that a SALT deduction has always been seen as constitutionally mandatory.

Federal payroll taxes for Social Security and Medicare are levied on workers’ total income, for example, with no deductions allowed for state (or even other federal) taxes. A similar argument could be made from the fact that only one of state income and sales taxes is deductible, or the fact that the alternative minimum tax (AMT) has long taken the SALT deduction away from certain taxpayers. Even the standard deduction would seem to be a problem for the states’ case, as filers using the standard deduction get no reduction in federal taxes when state taxes go up.

This lawsuit has little merit other than to serve as a clear signal that political leaders in these states have joined the anti-Trump Resistance.

Indeed, if one takes the states at their word — that they are entitled to levy taxes first and the federal government may tax only the remainder — then the only logical conclusion would be that SALT should be a fully refundable credit, not simply a deduction.

On the economic side, high-tax states are worried that if residents don’t get to deduct their state and local taxes, they will complain more about the high tax burden their state and local politicians have imposed on them. However, the TCJA lowered the overall tax burden for about 95 percent of taxpayers. Residents of the suing states are somewhat more likely to receive a tax increase, but on average their taxes are still being cut. Taxpayers are more able to pay high state taxes after a federal tax cut, not less.

The Tax Policy Center estimated that 84 percent of the benefit of the SALT deduction before the TCJA went to households in the top 20 percent of income earners. Blue states that might be expected to favor a tax reform that increased the progressivity of the tax code (meaning it tilts the tax burden toward the rich) are instead busy inventing ways to preserve this deduction for their rich residents. This lawsuit has little merit other than to serve as a clear signal that political leaders in these states have joined the anti-Trump Resistance.

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