High-tax states such as New York, California, and New Jersey are spending significant time and resources trying to concoct ways for their high-income residents to evade federal taxes.
This strategy is in direct response to the newly enacted Tax Cuts and Jobs Act, which caps state and local tax deductions from federal income taxes at $10,000 per taxpayer. But legislators in high-tax states who wish to prevent the wealthy from fleeing to lower-tax states should lower the cost of local and state government instead of ducking federal taxes.
The $10,000 cap in the state and local deduction is irrelevant for most taxpayers.
For starters, 70 percent of taxpayers don’t itemize their deductions when filing their federal income taxes. These taxpayers benefit instead from the standard deduction.
Since the Tax Cuts and Jobs Act nearly doubles the standard deduction, The Heritage Foundation estimates that about 85 percent of taxpayers will not itemize deductions. And the state and local tax deduction is worth nothing to taxpayers who don’t itemize.
What’s more, the cap won’t limit many taxpayers’ state and local tax deductions because only about half of those who currently claim the deduction pay more than $10,000 in state and local taxes.
It’s primarily high-income taxpayers in high-tax states who will be affected most by the change in federal tax law. And that’s why lawmakers in those states are trying to find ways around the law.
Instead of trying to pass the buck of their big-government costs to federal taxpayers in lower-tax states, policymakers in high-tax states should just reduce their own state taxes.
As U.S. Rep. John J. Faso, R-N.Y., aptly said: “The solution is to lower the cost of government in New York and make our state a place where businesses can create jobs so our people don’t have to flee.”
While a dollar in additional state and local tax deductions could save taxpayers as much as 37 cents in federal taxes (depending on their marginal tax rate), a dollar in state and local tax cuts would put 100 cents back into most taxpayers’ pockets.
Rather than address New York’s own high-tax problems, Gov. Andrew Cuomo, a Democrat, is proposing a new payroll tax on employers that would be deductible at the federal level.
But a new payroll tax on employers—one that would be in addition to existing income taxes—could hurt workers, businesses, and government revenues by discouraging companies from locating in New York. Such a tax would be extremely complicated and have disparate impacts on workers and businesses across the state, creating big boons for some and losses for others.
New York already has experienced the largest outmigration of residents of any state in recent years. State officials don’t need to exacerbate that with higher or more complex taxes.
Another idea being considered by states such as California and New Jersey is to circumvent the new cap on state and local tax deductions by setting up state-run charitable institutions to fund the government. Taxpayers who make donations to those institutions would receive a dollar-for-dollar reduction in their state tax bills.
But federal tax law specifies that donations providing a direct monetary benefit for the donor do not qualify as charitable deductions. It’s hard to contest the direct monetary benefit of a dollar-for-dollar reduction in state tax liability.
Rest assured, even if states such as New York and California manage to circumvent new federal limits on state and local tax deductions, the IRS will implement new rules to enforce the intent of the cap. Instead of reducing total taxes for residents, the result could be higher taxes because high-tax states may not fully abandon their newly generated “workaround” revenue sources.
Additional sources of tax revenues are the last thing residents in high-tax states need. Taxpayers who live in New York and who make between $75,000 and $100,000 already pay an average of $9,950 in state and local income taxes. And the average millionaire in New York pays $502,000 in state and local taxes.
These highly taxed residents don’t need their governments spending more time and resources trying to evade taxes or create new, hopefully deductible taxes. Instead, they need state policymakers to make their governments more efficient and accountable; to limit nonessential government services; and to cut out waste and redundancies.
If states reduce government costs to more reasonable levels, residents will have more money in their pockets and fewer will be affected by the new cap on state and local tax deductions.
And, as economic studies show, states with lower tax burdens have significantly better economic outlooks, including higher growth in incomes, employment, population, gross state product, and even state and local tax revenues.
It’s time for lawmakers in high-tax states to throw in the towel on their efforts to shift their high-tax burdens onto federal taxpayers in other states, and instead focus on reducing the taxes they charge their residents.