States Sue to Overturn $10,000 Cap on SALT Deduction
States Sue to Overturn $10,000 Cap on SALT Deduction
Four blue states have sued the U.S. Government in Federal District Court seeking an injunction to stop the IRS from enforcing the allegedly unconstitutional cap on itemized deductions under the new tax law. The Complaint seeks “declaratory and injunctive” relief because it claims the $10,000 cap on Schedule A state and local (“SALT”) taxes imposed under the Tax Cuts & Jobs Act (“TCJA”) violates the Tenth Amendment to the U.S. Constitution, which vests all powers not specifically delegated to the federal government in the states.
While the states make some compelling arguments, on balance, there is little chance the lawsuit will be successful.
David Carl Kamin, a professor of law at my alma mater, New York University, who focuses his scholarship on tax budget and policy, and who worked in the Obama administration, sees little chance of the lawsuit’s success. He told the New York Times that the courts had given broad discretion to Congress “on what deductions are allowed and not allowed,” citing the Alternative Minimum Tax. “I think the policy is poorly designed for a number of reasons, and I think Congress should revisit it,” he said of the tax law. “But it seems a situation in which the courts are unlikely, and probably shouldn’t, intervene.”
The lawsuit is State of New York, State of Connecticut, State of Maryland and State of New Jersey v. Steven T. Mnuchin et al (S.D.N.Y., Civil Action No. 18-cv-6427, July 17, 2018). New York, New Jersey, Maryland and Connecticut have all joined in the suit.
The Complaint and associated exhibits alleges that “the SALT deduction is essential to prevent the federal tax power from interfering with the States’ sovereign authority to make their own choices about whether and how much to invest in their own residents, businesses, infrastructure, and more—authority that is guaranteed by the Tenth Amendment and foundational principles of federalism.”
The argument goes that “double taxing” income that goes to basic state services by disallowing a deduction increases the power of the federal government, creates a federal monopoly on tax receipts, and reduces the power of state governments by impermissibly cutting off their source of revenue. In support of their position, the plaintiffs point out that “[a] SALT deduction has been a part of every federal income tax law since the first federal income tax was enacted in 1861.” As the Tax Foundation points out in a poignant article on the topic, the SALT deduction is even older than that.
The SALT tax deduction originated with the Civil War-financing Revenue Act of 1862, and was carried over into the Revenue Act of 1913, the post-Sixteenth Amendment legislation creating the modern individual income tax. The rationale for the original SALT deduction arose out of a fear that high levels of federal taxation might “absorb all [the states’] taxable resources,” a concern first addressed in the Federalist Papers, appears to have held sway. Alexander Hamilton, Federalist No. 31, in The Federalist Papers, ed. Clinton Rossiter (New York: New American Library, 1961), 189-192. Hamilton warned against a federal “monopoly” on taxation that would freeze out and lead to the “destruction of state governments.”
On the other hand, with the SALT tax deduction, citizens of states with high SALT taxes receive additional state benefits which are effectively paid for by other states who are more frugal and keep the state and local tax burden low. The Urban-Brookings Tax Policy Center has observed, state and local governments, “are able to raise revenues from deductible state and local taxes that exceed the net cost to taxpayers of paying those taxes, in effect allowing those jurisdictions to export a portion of their tax burden to the rest of the nation.” Frank Sammartino & Kim Rueben, “Revisiting the State and Local Tax Deduction,” Tax Policy Center, March 31, 2016, http://www.taxpolicycenter.org/sites/default/files/alfresco/publication-pdfs/2000693-Revisiting-the-State-and-Local-Tax-Deduction.pdf
The exhibits to the Complaint point out that the 3.3 million New York taxpayers filing returns took an average SALT deduction of $21,943 in 2015! But, New Yorkers take SALT deductions that are 28 times as much as Alaskan residents who had an average SALT deduction of just $791 in 2015.
The states make a compelling argument that the SALT cap will artificially depress home values in their states, which is a virtual certainty, but it is not clear that this rises to a constitutional issue. The New York State Division of the Budget projects that the new cap will result in a loss of tens of billions of dollars in home equity value.
"New York will not be bullied," New York Attorney General Barbara Underwood, said in a press release announcing the lawsuit. "This cap is unconstitutional — going well beyond settled limits on federal power to impose an income tax, while deliberately targeting New York and similar states in an attempt to coerce us into changing our fiscal policies and the vital programs they support. We will not allow partisans in Washington to hurt our people or interfere with our policies. We’ve filed suit against this unconstitutional attack on New York and our state’s fundamental rights – because we won’t stand by and let Washington pick the pockets of New Yorkers."
States claim the cap "violates bedrock principles of federalism enshrined in the Tenth Amendment."
What is the 10th Amendment?
What is the 10th Amendment? Glad you asked. The 10th Amendment is often used to prevent the U.S. Government from imposing an obligation that states regulate a certain activity reserved for state sovereignty (i.e., voting laws, minimum wages, waste disposal, handgun background checks, etc.) in a federally mandated manner. The federal government cannot “intrude on state sovereignty” or “commandeer the legislative process” because to do so would violate principles of federalism. For example, in the recent case of Shelby County v. Holder, 570 U.S. 2 (2013), the Supreme Court struck down a section of the Voting Rights Act as unconstitutional because it gave the federal government the right to overrule state voting laws based on a formula that exceeded the scope of the U.S. Government’s interest in enforcing equal voting rights under the 14th and 15th Amendments and challenged the “equal sovereignty of the states.”
You may have heard about the Federal government using “legalized bribery” to circumvent the 10th Amendment. The way this works is Congress offers federal funding to the states as a “bribe” for something like highway upkeep and construction. A given state can reject the funding. But, if it accepts the funds, the state must also accept the “strings” that accompany them, so long as they are rationally related. In a highway bill, the states might need to agree to a speed limit of 55 mph to reduce “wear and tear” on roadways. Some areas where “strings” are prevalent are infrastructure spending, education spending, healthcare spending, environmental spending, gun laws, drug enforcement and labor standards.
While many Connecticut taxpayers do not itemize their federal deductions, the average state and local tax deduction overall in 2015 was $19,664, according to the legislature’s nonpartisan research office. Among those earning more than $1 million per year, the deductions are among the highest in the nation, at nearly $330,000. If there are no changes in the tax law, officials say, the average taxpayer, including millionaires, will pay $3,846 more in federal taxes in 2018.
Taxpayers earning between $75,000 and $100,000 per year would pay additional taxes, on average, of only $19 per year, the research office said. Those earning more than $1 million per year would pay an additional $118,000 per year, boosting the overall average.
Connecticut was tied with New Jersey in 2015 for the second-highest percentage of taxpayers claiming the deduction — at 41 percent of federal tax returns. In Maryland, the rates are even higher with 46 percent of federal tax returns itemizing.
“Perhaps most concerning, this law discriminates against Connecticut taxpayers, who stand to lose over 10 billion dollars in state and local tax deductions,’’ Gov. Dannel P. Malloy said Tuesday. “Hundreds of thousands of residents could see a tax increase even as their property values decrease. I am proud to stand with my colleagues across the country in fighting against the discriminatory impacts of this shortsighted and damaging Republican law on our states."
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