High Tax Blue States and Tax Reform
From the scenes that played out at the end of last year as many residents in high property tax states rushed to try to prepay some or all of their 2018 taxes so as to fully deduct them on their 2017 tax returns to the continued search for ways to circumvent the SALT and property tax deduction cap imposed by tax reform, there is anger in New York, California, and New Jersey over the seeming unfairness of the new tax law.
Is the anger justified? Perhaps, but this anger might as well be played out in many other states, if not all. The Tax Reform law does promise benefits to many individuals and households and the numbers pan out, and not just in those states but generally, there are also some who stand to lose from tax reform, typically those who normally itemized a lot and who may not have dependents. I have addressed this in a previous blog.
It is entirely plausible to come away with the argument that the capping of the SALT and property tax deduction at $10,000 in a bid to keep the cost of tax reform low was achieved more readily because those who would be affected the most live in those states unlikely to turn red despite any GOP overtures. It is however not necessarily the case. Studies already show that in those states, as in other states, much more individuals and households also stand to gain from tax reform than those who might lose.
What is intriguing though are the options being considered by these states in a bid to circumvent the law. There are two that seem to lead the pack: Changing the state tax to a charitable contribution, which has no cap as an itemized deduction; and changing the legal placement of the state income tax to the business side (as a payroll tax), which should not change the incidence of the tax, but which avoids the cap as the tax is fully deductible as a business expense.
These ingenious moves however, while potentially undermining the intent behind the tax reform, might have possible perverse outcomes. In the first instance it is interesting why the tax would not then be avoided altogether as it is a voluntary act and not a mandatory one. Even if that problem did not occur such a move only helps to entrench making the rich richer as they stand to gain the most from such an interpretation. Also there is the sometimes forgotten fact that the individual AMT still is in place and especially for those with incomes above $200,000, the likelihood of being affected increases with higher itemized deductions.
In the second instance, there is an appeal here to trickle down, which is anathema to Democrats. Instead of the loss of the benefit, the benefit is captured by businesses. It is not clear how they are supposed to pass it on to the households discriminately that should have obtained those benefits. Besides why should they even want to?
I think the issue being raised by the governors in these states is just political brouhaha and rhetoric to trump (no pun intended) up support against the tax reform put in place by the GOP by highlighting and magnifying their potential weaknesses. Ultimately these alternatives will not come to any fruition as they stand to backfire however you cut it.
Politically, the real battle is on how well Tax Reform pans out especially in its supply side promises. On Tax Reform as a whole, I have offered an assessment of the new law here. I have also given a brief thought on supply side economic predictions in this context here.