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Democrats should support lower taxes — not wacky workarounds

Democrats should support lower taxes — not wacky workarounds
© Greg Nash

Two months after Republicans passed the Tax Cuts and Jobs Act, blue-state Democrats are still fighting the law. This historic tax package is delivering tax cuts for more than 80 percent of Americans. At least 3.5 million Americans are receiving special tax reform bonuses. Utility companies are using reduced tax burdens to slash utility bills for millions more.

In response, Democrats are concocting complex schemes to circumvent the tax law and several states are actually suing the federal government to halt their implementation.

The irony of their efforts is that Democrats argued that only “the wealthy” benefited from tax reform. With their announced legal and legislative strategies to undo the law, however, Democrats are centering their resistance effort on the trimming of the State and Local Tax deduction (SALT), which overwhelmingly benefits upper income earning households.

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SALT allows taxpayers who itemize their deductions to deduct the full amount owed in state and local taxes from their federal income tax bill. Upper income earning taxpayers disproportionately benefit from the formerly uncapped SALT. Lower-income taxpayers rarely deduct state taxes from federal income taxes because they take the standard deduction instead. Because SALT reduces the impact of high tax rates on high earners in high tax states, SALT essentially serves as a tax subsidy to upper income taxpayers paid for by average citizens in low tax states.

 

The size of this tax burden cost-shift is fairly large. In 2014 for example, taxpayers with an income exceeding $1,000,000 received an average deduction of $260,500 under SALT, compared to a deduction of $11,900 for the average taxpayer. More than 90 percent of taxpayers with an annual income exceeding $500,000 took the deduction. People earning less than $100,000 a year received only about 12 percent of the total amount in SALT deductions.

The tax law’s new $10,000 cap on SALT significantly reduces this subsidy. As a result, it has created significant political pressure on Democrats in high tax states to cut taxes, as the SALT deduction no longer shields their abused taxpayers from the harmful effects of their states’ ridiculously high taxes. Rather than reduce rates, Democrats in states like California, New York, New Jersey, and Connecticut have begun taking extreme steps to maintain their iron grip on taxpayer dollars, including announcing a joint lawsuit and proposing nonsensical schemes that treat obligated tax payments as charitable contributions.

In California, Sen. Kevin de Leon (D) has proposed legislation to create a fake charity, the “California Excellence Fund,” for wealthy taxpayers to theoretically “donate” to in lieu of paying state taxes. The theory undergirding this shell game is that these donations are “charitable” and thus fully tax deductible, unlike paying state and local taxes.

However, the scheme violates the IRS definition of what constitutes a charitable donation, according to IRS Publication 526. The rule states that a donation is tax deductible to the extent donors don’t benefit from the charitable act. There can be no quid pro quo. Since the entire purpose of this charade is to benefit “donors,” it violates IRS rules.

In New York, Governor Cuomo (D) is considering a far more harmful workaround. His proposal would partially replace the state income tax with an equally costly payroll tax. Under this plan, employers would cut employees’ paychecks by the amount they pay in state income taxes to fund the payroll taxes. Since payroll taxes are fully deductible, this workaround essentially preserves the SALT cap without reducing after tax pay.

However, for the payroll tax rates to match current income tax rates, an unprecedented and untested graduated payroll tax would have to be created and administered. The tax would be incredibly difficult to collect and would make a convoluted tax system that much worse.

Unfortunately, wacky workarounds aren’t the only tactic being deployed to fight the tax cuts. On Jan. 26, New York, New Jersey, and Connecticut, a collection of states with the three highest combined state and local tax burdens, announced a joint lawsuit against the federal government on still-to-be-announced grounds. It should be noted that in 2016 alone, more than 2.5 million net taxpayers with a collective income of $151.2 billion fled these states, almost exclusively to migrate to lower taxed states.

Instead of fighting to protect taxpayers from their harmful policies, Democrats in high tax states should fix the root of the problem: uncompetitive tax burdens on all taxpayers. Not only would reducing taxes staunch the exodus of tax refugees from these states, it would create jobs, boost wages, and provide much needed relief to struggling households. However, Democrats are just as likely to take this path as their creative schemes for their high-income constituents are to succeed.

Tyler Tate is a state affairs associate for the nonprofit Americans for Tax Reform.