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California, Other Blue States, Look To Circumvent Federal Tax Change

  

California, New York and other large, left-leaning states are pushing back against the federal tax overhaul signed by President Trump last month, particularly a provision that puts them on the hook for a greater share of federal revenue. Put simply, they don’t want to pay.

“As Washington has shot an arrow aimed at New York State’s economic heart, the best plan is to get out of the way before it hits,” New York Gov. Andrew Cuomo said in his annual State of the State address on Wednesday. “So, we are exploring the feasibility of a major shift.”

The new law no longer allows taxpayers to write off more than $10,000 of state and local income and property taxes from their federal returns. New York — along with California, Massachusetts and other large, blue states — has some of the highest taxes and property prices, so they will feel the brunt of the loss of state and local tax deductions, also called SALT deductions.

Democrats in these states say Republicans in Washington intentionally targeted their states.

“They went out of their way to really penalize our taxpayers,” said California Assembly budget chairman Phil Ting, a Democrat from San Francisco. “So, we’re really looking at ways we can mitigate that for our tax base, and we’re looking at a variety of proposals.”

Many of these proposals are based off an analysis by 13 tax law professors, which explores ways individuals, businesses and states could look to take advantage of loopholes in the new tax law. Some might sound pretty zany.

In California, state Senate leader Kevin de León has a proposal for taxpayers to give to a new state-run charitable fund, called the California Excellence Fund, in exchange for a refund on income taxes. Californians donate to the charity and receive a credit that wipes away their state income tax liability. The charitable contribution is then federally deductible.

UCLA professor Kirk Stark has championed this idea. He says the Internal Revenue Service has sanctioned similar arrangements on a smaller scale, including when taxpayers give to the Cal Grant program for low-income college students.

“There’s no limitation whatsoever indicating that the donation or contribution has to be targeted to some specific program or something like that,” Stark said.

But Stark also acknowledges the IRS could react to the measure by trying to impose a limitation.

In New York, Cuomo says the state is looking to shift from income taxes to a new payroll tax — which businesses could still deduct, but would probably require employees to take lower pre-tax salaries.

David Kirk, a partner at accounting firm Ernst & Young, says that proposal comes with other problems.

“It’s payroll, which is inherently regressive,” Kirk said. “The billionaires, regardless of what state you’re in, have a relatively small W-2, relative to their overall wealth and income.”

California Republican state Senate leader Patricia Bates says the state has another option.

“I think that the best idea is for our Legislature to take a long, hard look at the tax rate that we put on Californians,” Bates said. “We can do a lot with that, because we have the power here to reduce taxes.”

She says Democrats are looking for any reason to clash with the Trump administration.

“That has certainly been the MO for the last year that we’ve been up here, since President Trump was elected,” Bates said. “It’s not the best way to go.”

Who really pays?

Most Californians do not use SALT deductions. Only about a third of filers have typically claimed them, and many of those still do not get the deductions, because they must pay the Alternative Minimum Tax.

And, because of other cuts in the tax overhaul targeted to wealthier income brackets, Kirk says most households will not pay more next year as a result of losing the deduction.

The ones who will pay more are “the individuals with the higher amounts of income — maybe over $600,000 — what you might call the working wealthy [with] large W-2s,” Kirk said. “What you’re probably going to end up seeing is a break-even for a vast majority of people.”

“It’s just that relative to someone in a low-tax state, their tax cut might be smaller,” said Frank Sammartino, a senior fellow at the Tax Policy Center.

In other words, with the loss of the SALT deduction, a state like California is now even more costly for higher-income taxpayers in comparison to a bordering state like Nevada, which has no income tax.

Economic analysts have said it could also make it more difficult for local and state governments in higher-tax states to gain public support for new taxes.

“It will blunt the effect of lower federal rates for many taxpayers,” Moody’s Analytics reports. “Public resistance to tax increases will likely rise, and that in turn will constrain local governments' future revenue flexibility. In addition, if larger federal deficits caused by the tax cuts result in attempts to cut entitlement spending, states will be pressured to backfill cuts to federal funds from their own budgets.”

Some California Republicans are weighing whether they would support Democratic proposals to avoid the hit. State Sen. John Moorlach doesn’t rule it out.

“We’re going to benefit those we really need to keep here, because if we lose any of our top 1 percent, we lose a portion of about 50 percent of our income taxes,” Moorlach said.

A former accountant, Moorlach’s main concern is that the proposals being floated are “too cute.”

“I just wonder if it’s really something that should be pursued, because it will be squashed [by the IRS],” he said.

States are considering one other tactic to fight the loss of the SALT deduction — one that brought Cuomo a long ovation during his State of the State speech: Sue it as double taxation.

“We believe it is illegal, and we will challenge it in court as unconstitutional,” Cuomo said.

New Jersey has also threatened a lawsuit, while California Attorney General Xavier Becerra says he’s reviewing legal options.

Ben Bradford

Former State Government Reporter

As the State Government Reporter, Ben covered California politics, policy and the interaction between the two. He previously reported on local and state politics, business, energy, and environment for WFAE in Charlotte, North Carolina.  Read Full Bio 

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