Paul L. Caron

Friday, January 26, 2018

Hemel: States And Localities Can Offset Federal Tax Law's Impact On Their Residents

Daniel Hemel (Chicago), States and Localities Can Offset Federal Tax Law's Impact on Their Residents:

The federal tax overhaul signed into law by President Trump in December 2017 strikes a blow to households in high-tax states, with potentially negative ramifications for state and local government finances. First, the law imposes a new $10,000 cap on the deduction for state and local taxes (SALT)—well below the average amount claimed by residents of high-tax states such as New York, California, and New Jersey. Second, the legislation rolls the preexisting law’s personal exemptions into a much larger standard deduction, which will mean that most taxpayers who currently itemize their deductions will stop doing so and thus will lose any SALT benefit. Absent any response from states and localities, the net effect of the new tax law will be that the vast majority of households pay their state and local taxes with nondeductible dollars—which, in turn, will likely make it more difficult for states and municipalities to raise revenue for their schools, hospitals, police and fire departments, and other vital public services.

But state and local governments are not helpless in the face of the new SALT limits. One proposal, which the State of California and several towns in New Jersey are considering, would allow taxpayers to claim a state or local tax credit in exchange for donations to government-affiliated organizations. Because such donations are treated as charitable contributions rather than state and local tax payments for federal income tax purposes, these arrangements would allow taxpayers who hit the $10,000 SALT cap to satisfy their remaining state and local tax obligations with federally deductible dollars. A second proposal—which is the focus of this report—would involve state and local governments shifting from employee-side personal income taxes to employer-side payroll taxes, which remain fully deductible for federal tax purposes. This payroll tax shift would deliver benefits for workers in states with high income taxes regardless of whether those workers itemize deductions on their federal tax returns. Importantly, the two proposals are not mutually exclusive, and states and localities would be well advised to consider both.

Proposals for a payroll tax shift stand on solid legal ground. Moreover, the administrative challenges of such a shift would be relatively straightforward in flat-income-tax states such as Illinois and Massachusetts—and not insuperable in states with graduated income tax rate structures such as California, New Jersey, and New York. By fighting to preserve their residents’ ability to pay for public services with deductible dollars, states and municipalities can protect their revenue-raising capacity while prodding members of Congress to reconsider a tax law that was ill conceived from the outset.

Scholarship, Tax | Permalink


How do you get a bunch of law professors to promote shady tax avoidance schemes? Just say "it will undermine Trump's tax reform."

Posted by: GU | Jan 26, 2018 6:16:03 PM

In my view, a shift from income taxes to payroll taxes should work. But the charitable contribution to government in exchange for a credit against taxes otherwise due the same government scheme is ridiculous, and advocates should be ashamed.

Posted by: Mike Petrik | Jan 27, 2018 5:18:55 AM

#resistance, much? Substance over form.

Posted by: Anon | Jan 27, 2018 7:39:15 AM

Sadly, it is unsurprising to me that Blue States would consider passing harmful and regressive tax legislation just to stick it to the Trump Administration.

Posted by: Mike Petrik | Jan 27, 2018 7:56:06 AM

Really? Tax professors do your home work. Charity tax deductions are not deductible when donor directs where/how the 'gift' is to be used. More importantly, this tax avoidance scheme would be closed in a New York minute.

Posted by: Donna Witty | Jan 27, 2018 8:07:22 AM

The comment about the "charity tax" deduction is valid ,it's the amount less the benefit. The idea of he increased PR tax on employers only would work in the short run[which is what most if not all politicians care about], however it would only serve to drive out more business, until the only employers who remain are ;1- public entities, and,2- businesses that can't move.

Posted by: Paul Berg | Jan 27, 2018 12:26:56 PM

@ Donna, the good news is this is showing the true colors of many academics. They should be cheered by the simplification of the tax code. If the IRS is have a shot at doing its job, Schedule A has to go. However, their fear of Trump leads them to waste time on stupid ideas. Maybe that's not a bad outcome after all.

Posted by: Dale Spradling | Jan 28, 2018 6:01:50 AM

Charitable deductions are also not allowed when they are made with the expectation of any quid pro quo, for which an expected reduction in state tax liability certainly would be.

Posted by: Dr.Tax | Jan 29, 2018 5:59:58 AM

Mr. Berg: You misunderstand the payroll tax proposal. It does not involve an “increased PR tax on employers.” The change would not “serve to drive out more business,” because the proposal is simply a shift from the employer "withholding" income tax on behalf of the employee to paying the same amount as a tax on the employer. The employer pays the tax in either case in the same amount. The actual change is from payment into a “trust fund,” and from thence to the gubmint, to a direct payment in the same amount to the gubmint. As the author points out, in those states with flat income taxes (including IL, MA, PA) the change would be one of bookkeeping only.

Posted by: Publius Novus | Feb 1, 2018 7:42:50 AM

"[Blue] States And Localities Can Offset Federal Tax Law's Impact On Their [Wealthy] Residents"

That's better, puts the political considerations into perspective.

Posted by: MM | Feb 4, 2018 4:46:48 PM