One of the most important lessons I learned in law school is that legal rules are often less ideological than the context from which they emerge. It is a lesson I’ve thought about repeatedly this past year, as questions about state standing to sue the federal government and the validity of nationwide injunctions are raised by new parties against a new administration. I hadn’t, however, seriously considered the way such lessons might apply to substantive tax law.
Of course, it was foolish to think that tax law would be immune from this larger trend. In response to the 2017 tax legislation’s dramatic curtailment of the state and local tax deduction, several scholars and policymakers have been exploring the possibility that high tax states might want to offer state tax credits for charitable donations made to the state. As someone long skeptical of my state’s use of charitable tax credits, I’ve find this sudden progressive interest in state tax credits bemusing and intriguing.
In an impressive joint effort, several tax professors make a compelling case for the validity of such tax credits under current federal tax law, at least for credits equal to less than 100% of the deduction. In so doing, they also pulled together a very useful chart of currently available state tax credits. According to the authors, current tax law has taken an approach they term the “Full Deduction Rule,” which allows taxpayers to deduct the full amount of their charitable contribution even if they receive a state tax credit for the same contribution. The authors’ thorough consideration of court cases exploring state tax credits suggests that this approach has been consistently adopted by both the courts and by the federal government.
The paper, however, goes beyond the descriptive, making the normative case for this rule. They argue that any other rule would significantly increase administrative difficulties with the deduction because it would require taxpayers to value their charitable deduction only after have they determined its effect on their state tax liability. Further, they suggest that reductions in tax liability have never been considered taxable income, a position consistent with the Full Deduction Rule. Finally, they argue that the Full Deduction Rule is supported by federalism as it makes federal tax law neutral toward these state policies. Of these three justifications, I’m most compelled by the administrative argument. Federalism doesn’t have to mean the federal government should be neutral with respect to state fiscal choices, and it usually doesn’t.
Of course, such conclusions will be contested. Eric Rasmusen, for one, is less convinced of the validity of this whole enterprise, and he recently posted a short response to the co-authored paper on SSRN. Rasmusen’s chief concern is that the proposed credits allow an exchange of value between the state (as the recipient of the charitable contribution) and the taxpayer (a reduction in tax liability), and thus would fail to qualify as a charitable contribution under the substance-over-form doctrine. He suggests policy concerns about the Full Deduction Rule in this context.
As Dan Shaviro’s recent blogging on this issue has suggested, much of what matters here will be the specifics of the state program. Certainly, states can craft state charitable tax credits that would seem to offer taxpayers more than simply the benefit of a reduction in state taxes. But the more they do that, the more questions they raise about the distributive effects of such proposals.
Living in Arizona and observing the effect of our various school tax credit programs, I confess I have at least some hesitance about other states rushing to embrace tax credits, though my concerns are less about the legal validity of the proposals. Of course, perhaps better-drafted state laws (and perhaps better enforcement of quid pro quo rules) would alleviate some of these concerns. For example, it seems some private schools in Arizona condition scholarship dollars on parents supporting that school’s tax credit program.
Other concerns are more structural. Arizona also has a school tax credit program for public schools. Unsurprisingly, money from that tax credit program flows unevenly. The richest school districts—and the richest schools within those school districts—get the lion’s share of the aid. Allowing wealthy taxpayers to use tax credits to do an end-run around the SALT limitation raises its own considerable distributional concerns, especially if such tax credits are designed to support specific state functions.
Of course, states like California and New York are without Option A (the full SALT deduction), and tax credits may still be preferable to severe cuts to state taxes and spending. To that end, I appreciate this joint effort to timely address an important topic in many statehouses.