Local Governments Prepare for a Federal Fight Over ‘Double Taxation’

WASHINGTON — Mayors and county officials are among those preparing to defend a longstanding federal tax deduction for money people pay in state and local taxes.

They anticipate the deduction will be on the chopping block as the Trump administration and GOP members of Congress forge ahead with plans to revamp the U.S. tax code. More details are expected about the pending Republican tax plan in the days ahead. It’s tentatively slated to involve up to $1.5 trillion in tax cuts over 10 years.

Local leaders and public finance experts say nixing the state and local deduction, which dates back to 1913, could make it harder for some states and localities to raise their own tax rates.

And supporters of the deduction argue that eliminating it would result in double taxation, because people would have to pay federal taxes on income put toward state and local taxes.

“The federal government will basically be forcing taxpayers, that make up the backbone of our community, to pay taxes a second time on the same income,” said Mayor Elizabeth Kautz, of Burnsville, Minnesota.

But curtailing deductions is one way to make up for lost revenue from tax cuts, and to avoid adding to federal budget deficits or the national debt, which now totals about $20 trillion.

The state and local, or SALT, deduction is an attractive offset—one that was also in the crosshairs during the last major tax code overhaul finalized in 1986.

Estimates included in a Congressional Research Service report issued in May show the combined amount of state and local deductions in 2017, for property, income and sales taxes, totaled about $102 billion.

“They need it to balance their plan,” Matt Chase, executive director of the National Association of Counties, said during a call with reporters Thursday, referring to SALT and Republicans driving the tax rewrite.

But counties are ready to push back. “We’re not just going to be an offset for a federal revenue grab,” Chase said.

Opposition Against ‘Double Taxation’

On Thursday, a newly announced coalition, Americans Against Double Taxation, vowed to fight for SALT. The group’s members include local government organizations like the National Association of Counties, National League of Cities and U.S. Conference of Mayors.

The coalition mirrors one that successfully advocated to preserve the deduction during the rewrite of the tax code that took place in the 1980s, under then-President Ronald Reagan.

Governors want to see the deduction preserved as well.

Scott Pattison, executive director and CEO of the National Governors Association, said at a Route Fifty event earlier this week that the state executives are supportive of SALT. “There are taxpayers in very, very red states, like Texas, who will pay a lot more,” he noted, as he discussed the potential effects of a roll back of the deduction.

Natalie Cohen, managing director of municipal research with Wells Fargo Securities, offered a similar take. "The common thinking is that it's a rich, blue state issue,” she said.

"But if you look at a state like Texas, which does not have an income tax, a lot of the sale of homes there, the selling point is you can deduct not just your mortgage interest, but also your property taxes,” she said. “And property taxes are much higher than in other places.”

Cohen flagged another related issue that could come into play with a SALT repeal. “It's indirect, but it would have some effect on home values in the states where the property tax is high.”

Implications for State and Local Finances

Dan White, an economist at Moody’s Analytics, who works on fiscal policy research, emphasized that eliminating SALT will not cause any direct costs for state and local budgets. “It’s not decreasing the amount of revenue they’re already seeing,” he explained.

“But what it does is, it’s going to make it more difficult for states and local governments, especially those that are very high-tax places already, to increase taxes,” White said. “Or it could potentially make it more difficult for them to increase taxes in the future.”

The idea is that without the deduction in place, the federal tax burden on people would rise, leaving states and local governments less room to levy taxes of their own.

“What it boils down to is: are there certain constituencies out there who are going to say ‘no, you cannot increase my taxes because I’m not able to deduct my state and local anymore,'” White said.

John Hicks, executive director of the National Association of State Budget Officers, previously worked 25 years in Kentucky’s Office of the State Budget Director.

He pointed out that during that time, there were not many instances when state lawmakers took action to raise individual income taxes. When the state did, it was to address critical costs tied to education.

“The issue of, ‘oh, can I deduct it on my federal income tax was not a concern,’” Hicks said. “There were way bigger fish to fry.”

He added: “I think the larger question is whether or not there is a stimulative effect to whatever comes out of tax policy changes here in Washington—as to the impact on state revenues.”

But Mark Stodola, mayor of Little Rock, Arkansas, and the first vice president of the National League of Cities, does see the elimination of the exemption as a threat to municipal finances. “Cities would face tremendous pressure to lower local tax rates,” he said.

“Coupled with the declining federal support in cities,” Stodola added, “removing the SALT deduction would only further strain our already stressed municipal budgets.”

‘Wealthy Person’s Tax Break’

House Speaker Paul Ryan, at an event The New York Times held Sept. 7, made his case for getting rid of state and local tax deductions.

But first he indicated that Republican tax-writers were looking at more-or-less doubling the “standard deduction,” commonly used by people who do not claim itemized deductions like SALT on their federal tax returns.

“When you effectively double the standard deduction, you take care of middle-income people,” he said. At that point, according to Ryan, SALT becomes a “wealthy person’s tax break.”

A report the Government Finance Officers Association prepared and recently updated with 2015 data provides some perspective on who claims the state and local deduction.

It notes that nearly 40 percent of taxpayers making between $50,000 to $75,000 annually, and more than 70 percent of taxpayers earning from $100,000 to $200,000, use SALT.

About 42 million tax returns, roughly 28 percent of the total filed, included itemized state and local tax deductions in 2014, the Congressional Research Service report says.

Ryan also suggested that the state and local deduction mainly benefits states with higher costs and budget problems.

The thinking here would be that taxpayers receive some relief from the burden of covering these costs with the state taxes they pay, because they can claim the federal SALT deduction.

“You’re having basically states that don’t have fiscal problems cross-subsidizing states that do, through the federal tax code,” Ryan said. “What it is, is a fairness issue. And so, let’s let people see their true cost of government. Let’s not have this cross-subsidization.”

‘Don’t See Ourselves as a Loophole’

Evan Liddiard, a senior policy representative for federal taxation with the National Association of Realtors, said that at first glance a higher standard deduction, like the one Ryan described, might appear to make up for the loss of the state and local deduction.

But there are other factors to consider with the forthcoming GOP tax plan.

Liddiard said that a previously released House Republican tax blueprint calls for a repeal of the personal and dependency exemptions that individuals and families can claim.

“Taking those away means that the standard deduction does not really go up very much at all,” he said. “For some families,” he added, “the amount of exempted income would go way down.”

Chase pushed back on the idea SALT is a subsidy for certain states.

He said states like New York and California, two places with higher percentages of taxpayers claiming SALT deductions, “contribute far more to the federal Treasury than they get back in federal payments.”

“High-tax states,” Chase said, “are actually subsidizing federal spending for those so-called low-tax states.” He added: “And states that are lower tax tend to get far more in federal subsidies, that allow them to have lower taxes at the state and local level.”

Chase said the coalition was not about to get “steamrolled” on SALT.

“We don’t see ourselves as a loophole,” he said. “We aren’t like the other tax expenditures.”