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If states want high tax rates, states should bear the burden
States battling tax reform’s limitation on state tax deductibility hope to hide their guilt behind outrage. These governments were already doing the same thing and targeting the same “wealthy.” Their problem is of their own making, so their solution must be too: Lower your taxes.
The recent tax reform changed the previously unlimited ability to deduct state and local taxes (SALT) when determining federal taxable income. Instead it placed a $10,000 limitation for those choosing to itemize, and roughly doubled the standard deduction for those choosing not to. The result: People in high SALT areas and/or with high incomes, find these tax payments now increasing their federal taxable income and potentially their federal tax bills.
The prior federal tax treatment made high SALT payments more affordable to both the paying individuals and the assessing states and localities. Obviously, there are other expenditures — such as personal ones — that are nondeductible; however, there also some — such as charitable ones — a government wants to encourage. The previous unlimited SALT de facto encouraged these too.
{mosads}Broadly, recent tax reform took the approach government should not play favorites when it came to deductibility. Better to double the standard deduction, lower tax rates, and allow individuals flexibility and keep more of their money. For most taxpayers, this is a good deal.
Where this is not a good deal is those states with high taxes. Because these states’ high tax rates push many residents above the new SALT threshold, their rates are more clearly outliers than they already were. So too are the governments which enacted those high levels.
Two things in particular define those governments: Democratic and outraged.
Last October, Kiplinger compiled their top 10 least tax-friendly states: California, Connecticut, Hawaii, Illinois, Maine, Maryland, Minnesota, New Jersey, New York, and Vermont. All ten are dominated by Democratic state governments. Democrats control nine of ten state houses, six of ten state senates, and six of ten governorships — directly opposite Republicans’ dominance in all three nationally.
Their outrage has been tremendous. New York’s Democratic governor Andrew Cuomo called the limitation “economic civil war.” These states have threatened taking the SALT limitation to court and devising other creative ways (California and Connecticut are examining setting up a way for taxes to be “charitable contributions”) for their citizens to avoid it.
Interestingly, one thing these states have not talked about: They have been doing the same thing. Not one of Kiplinger’s ten allows the deduction of federal income taxes for determining their state income tax burden.
They have been using the federal tax code’s prior ability to deduct SALT to subsidize the cost of their high taxes. Also by denying their citizens deductibility of federal taxes, they have further raised SALT receipts and taxed their citizens — creating an even bigger expense they cannot now deduct.
Tax reform’s SALT limitation does not require these states to change either practice, it simply mimics both and no longer subsidizes them. Tax policy is now more consistent at the state and federal level in these high SALT states. These states wanted “the wealthy” to pay more in taxes, that’s why they set their own tax systems up this way. Tax reform’s SALT limitation now does that too.
By not allowing federal tax deductibility, these states took aim at their “wealthy.” Many blue state politicians have called for higher taxes still on “the rich.” And because their “wealthy’s” nondeductible federal tax bill goes up, these governments could possibly see their state tax take go up too — for example, if it shifts these citizens’ expenditures from deductible ones such as charities.
Suddenly high SALT states have gotten their desire: Their “rich” are paying more, just not to them. And the method is the one these states have been using. Yet tax reform’s copying of their target and method is an outrage.
To quote Shakespeare: “The lady doth protest too much, methinks.” It is not surprising. Tax reform’s policy change has laid bare high SALT states’ policy. They complain all the louder because of their complicity. The means was theirs. The end was theirs. And they fear the cost will now be theirs: Political retribution for it and economic loss from its dismantling.
Just as the problem is entirely one of their making, so is the solution. Simply cut your excessively high taxes. According to the Federation of Tax Administrators’ November 2017 compilation, California’s top rate is 12.3 percent, Minnesota’s 9.85 percent, New Jersey’s 8.97 percent, and New York’s 8.82 percent. Even a cut could leave high taxes and citizens unable to deduct their federal taxes — as these states have been doing and desperately desire continuing. And one more thing: Stop hypocritically protesting what you are guilty of doing.
J.T. Young served under President George W. Bush as the director of communications in the Office of Management and Budget and as deputy assistant secretary in legislative affairs for tax and budget at the Treasury Department. He served as a congressional staffer from 1987-2000.
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