Wednesday, December 6, 2017
Eugene Volokh (UCLA), Now That State Income Taxes Aren’t Going to be Deductible, Will States Switch to Payroll Taxes?:
[S]ay California replaces the state income tax (at least for employment income) with a state payroll tax that’s paid by the employer, and that it comes in at the same amount per employee. As I understand it, the payroll tax — like most other business expenses, such as salaries paid to employees — is deductible by the employer; and it’s not taxable income for the employee, because it’s not the employee’s income. ...
That’s how I understand the thinking of University of Chicago professor Dan Hemel, who wrote about this last month: ...
States like New York and California could impose an employer-side payroll tax pegged to the top marginal rate in the state and allow individuals to claim a refundable credit against state income taxes equal to the payroll taxes paid on their behalf.
The key point here is that a state, through a relatively straightforward legislative maneuver, could entirely negate the effect of the House or Senate proposal with respect to state and local income taxes paid on wage income (which is more than two-thirds of all household income). And given that this maneuver would make state taxes excludible for non-itemizers as well, the net effect could even be to lose money for the federal government.
One might ask why states don’t do this already. Even under current law, there are several advantages to states if they raise revenue through payroll taxes rather than personal income taxes: lower Social Security and Medicare taxes for all wage-earners; avoidance of the alternative minimum tax and the effects of the Pease provision for high earners; and exclusion of state taxes for workers who take the standard deduction. While it’s a bit of a mystery, the best explanation is probably that the benefits aren’t yet enough to motivate states to rearrange their tax systems, given that the people who pay the lion’s share of state income taxes are itemizers who can claim the SALT [that’s state-and-local-tax] deduction. Take away the SALT deduction for income taxes, though, and suddenly the motivation to shift away from a state income tax and toward a state payroll tax becomes much more powerful.