Federal Changes to State Tax Deduction May Threaten State Budgets

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By David McAfee

State budgets could take a hit if the federal government eliminates or limits the ability of taxpayers to deduct state and local taxes, according to a representative from the National Conference of State Legislatures.

Congressional Republicans are poised to restrict the deduction as they put the finishing touches on tax reform bills that passed the House in November and the Senate Dec. 2. Republican leaders from both chambers are meeting to reconcile differences in their respective tax bills with the goal of getting a tax bill for President Donald Trump to sign by year’s end.

By eliminating or capping the deduction for taxes paid to local and state governments (SALT deduction), few people will have enough in deductions to itemize, according to Americans Against Double Taxation, a coalition of state and local government advocates, Realtors and other organizations.

That could, in turn, make homes less affordable and even bring down property values, some argue. Property taxes, which are indexed to property values, are a large source of funding for local and state spending on education.

Realtors believe elimination of the deduction would cause a 10 percent drop in home prices, but even if that number is less, it will affect local property tax revenue, according to Max Behlke, director of budget and tax for the NCSL.

“If property value goes down by 10 percent, or 5 percent, that means local property taxes go down by 5 percent, then you have a hit to them,” Behlke said Dec. 11 during NCSL’s Capitol Forum conference in Coronado, Calif. “There’s going to be less money going to schools, or they’re going to be going to the state going, ‘We need more money.’”

Behlke added that it’s an “indirect hit to revenues,” but it will “constrain the ability of lawmakers at the state and local levels to adjust their tax rates.”

Impacting New Taxes

The current House and Senate bills would preserve an individual deduction for state and local property taxes—capped at $10,000—but not for income taxes. However, lawmakers may be considering a potential compromise—letting taxpayers deduct state income taxes in addition to property levies, up to the $10,000 cap.

Kim S. Rueben, a senior fellow in the left-leaning Tax Policy Center, said that the SALT deduction “may affect your ability to raise money.”

“The SALT is much more about what does it mean to what you can and cannot do in terms of casting new taxes or being able to raise the money,” she told conference attendees.

Supporters of the deduction, many from high-tax states such as New York, California, and New Jersey, say its repeal could impact everything from home prices to education budgets. And supporters of the tax break argue that residents of their states will be less likely to support attempts to raise revenue if they can’t deduct the taxes on their federal returns. The deduction, in one form or another, has existed since inception of the Internal Revenue Code in 1913.

Blue-State Politicians

However, those pushing for repeal argue that the deduction serves as a subsidy to high-tax states, and they acknowledge that repeal may force New York and other wealthier states to reconsider their spending.

Noah Wall, vice president of advocacy at the conservative advocacy group FreedomWorks, slammed states that oppose Republican attempts at tax reform. He said in a written statement that lawmakers from high-tax states are worried they “won’t be able to continue raising state taxes even higher.”

“The state and local tax deduction forces lower-tax states to pay the federal taxes of the states with terrible tax policy,” Wall said in a statement. “Politicians in these blue states are worried that if this special break is overturned, they’ll get thrown out of office.”

With assistance from Che Odom in Washington

To contact the reporter on this story: David McAfee in Los Angeles at dmcAfee@bloomberglaw.com

To contact the editor responsible for this story: Cheryl Saenz at csaenz@bloombergtax.com

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