Senate Plan to Fully Repeal State Tax Break Stokes Raging Battle

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By Che Odom

Groups representing governors, state lawmakers, mayors, teachers, and others are hoping Republican senators will consider their perspective on the deductibility of taxes paid to state and local governments.

They may need to be prepared for disappointment. After days of public debate and compromise on the House tax reform bill (H.R.1), the Senate Finance Committee’s tax plan, released late Nov. 9, jettisons the whole federal deduction for state and local taxes (SALT deduction) for individuals.

Under the House plan, individuals would only be able to claim the SALT deduction for property taxes up to $10,000 a year. Currently, the federal code allows people to deduct the cost of sales, income, and property taxes paid to state and local governments.

“The nation’s mayors strongly oppose the Senate’s proposal to eliminate the State and Local Tax (SALT) deduction in their tax reform bill,” New Orleans Mayor Mitch Landrieu (D), president of the United States Conference of Mayors, said in an email to Bloomberg Tax. “The Senate repeal of SALT violates the promise that tax reform would provide relief for middle class families. Instead the proposal would tax these families twice on the same income.”

Elimination of deductions is a way for the federal government to broaden the base of what is subject to tax and raise revenue to pay for cuts in individual and corporate rates, features of both Senate and House plans. Democratic and Republican members from higher tax states, such as California, Connecticut, New Jersey, and New York, are pressing to preserve the deduction in some form.

House Ways and Means Committee Chairman Kevin Brady (R-Texas) is pushing back against the Senate’s plan, saying that the House won’t accept a bill that kills the entire deduction.

“I’m committed to it,” Brady said Nov. 12 on “Fox News Sunday.” With the preservation of a deduction for $10,000 in property taxes, combined with a new family tax credit and a deduction for mortgage interest for new purchases that would be capped at $500,000 of debt, the House bill “gets the job done,” Brady said.

Americans Against Double Taxation, a coalition of state and local government groups, realtors, education groups, and other organizations, said that it soon would begin a national radio advertising campaign to alert the public about Congress’ plans to “kill” the deduction for individuals but not businesses. The radio buy will cover a dozen states and reach more than 35 Republican-led congressional districts in suburban areas that would be hard hit by the tax plan, the coalition said.

Passthrough Deduction

The House and Senate plans preserve the full deduction for corporations and passthrough entities. Brady clarified Nov. 9 that passthrough entities, such as partnerships, limited liability companies, S corporations and some trusts, would be able to claim the deduction—but their individual owners wouldn’t be able to do so.

In passthrough entities, the tax liability passes directly to the individual owners, such as partners in the case of partnerships—though some states tax passthrough entities directly.

“Businesses organized as passthrough entities for tax purposes are still businesses,” Joe Crosby, a principal with state and local government consultant MultiState Associates, told Bloomberg Tax.

Like any business, passthroughs should be able to deduct “legitimate business expenses,” including taxes and fees paid to state and local governments, Crosby said.

“It doesn’t make sense from an economic perspective to conflate state and local taxes that businesses pay—for example, tangible property taxes on machinery or sales taxes on computer equipment—with those that individuals pay,” he said.

“Income,” whether defined from an economic perspective, an accounting perspective, or for tax purposes, is necessarily different for businesses and individuals, he added.

Double Standard

Allowing businesses to take the SALT deduction is a double standard, according to state and local groups campaigning to save the full tax break for individuals.

“It is a little hypocritical for Congress to take away the SALT deduction for hardworking middle-class taxpayers and yet let corporations and now passthrough entities get the benefit of the SALT deduction,” Jake Lestock, policy specialist with the National Conference of State Legislatures, told Bloomberg Tax. “Why are they consistently putting the weight of tax reform on the backs of the middle class?”

However, the deduction’s repeal is actually a necessary part of lessening the burden on taxpayers, Rachel Greszler, a research fellow in economics, budget, and entitlements at the Heritage Foundation, said during a Nov. 6 event sponsored by the Heritage Foundation. A supporter of full repeal, Greszler predicted that state and local property taxes would increase if the House compromise becomes law because local officials will use the deduction as a way to sell hikes in that area.

She said the benefits of the deduction flow to the “high-tax states” and those with high incomes.

‘A Great Reform’

Those urging repeal of the deduction said that whatever tax bill finally passes Congress will have other base broadeners that could benefit state and local governments. States that conform to the federal tax code could leave their rates unchanged but still see increased revenue because a wider range of activities would be subject to tax.

Karl Frieden, vice president and general counsel of the Council On State Taxation, said that some important changes could be made to the Senate bill’s language that might affect how states react to the proposals.

“It really depends on not just are they similar or different, but did they write it in a way that states would normally conform to,” he told Bloomberg Tax.

But many states will have a difficult time swallowing the repeal because doing so puts “further fiscal pressure on many taxpayers,” Lucy Dadayan, a senior research scientist at the Rockefeller Institute of Government, told Bloomberg Tax in an email. “It’s hard to say who are the winners, but the losers are cash-strapped taxpayers.”

Still, it is a “great reform to include in the Senate plan,” Nicole Kaeding, an economist with the Center for State Tax Policy at the Tax Foundation, told Bloomberg Tax in an email.

“Less than 30 percent of tax filers take the deduction, and almost 90 percent of the benefits accrue to tax filers making more than $100,000,” Kaeding, said. “The $1.8 trillion deduction can finance a large portion of the Senate’s proposed tax rate decreases.”

With assistance from Alex Ebert in Columbus, Ohio

To contact the reporter on this story: Che Odom in Washington at COdom@bna.com

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

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