After State Deduction Cut, Blue States Panic To Hide Spending Binges With Crazy Tricks

After State Deduction Cut, Blue States Panic To Hide Spending Binges With Crazy Tricks

In Democratic-majority states across the nation, state legislators are flailing blindly to find a way around the reduced federal tax deduction for state and local taxes.
Kyle Sammin
By

Democrats have been running around with their hair on fire since the Tax Cuts and Jobs Act of 2017 was enacted last month, but some of the latest ravings in high-tax states show the damage may be penetrating to their brains.

In Democratic-majority states across the nation, state legislators are flailing blindly to find a way around the reduced federal tax deduction for state and local taxes, a tax code provision that previously masked the effects of the high taxes those same legislators have enacted.

They have mulled all manner of half-clever workarounds, schemes that look, maybe, if you squint, like a way to make a tax not a tax, but still something that everyone has to pay to the state government. State legislators often do not represent the highest strata of intelligence in a society, but some of these so-called fixes are so absurd that even the dimmest bulb in the state house could not have offered them with a straight face. What these fake solutions are, instead, is a sad attempt for state legislators to dodge accountability for having made their state’s taxes so high.

Give to Charity—Or Else!

The most ridiculous idea along these lines comes out of Sacramento, where a Democratic supermajority controls California’s legislature. That state, which has some of the highest taxes in the country, will find its residents particularly aggrieved once they have to pay all of them without a federal deduction. The solution, according to State Senate leader Kevin de León, is to pretend a tax isn’t a tax. Instead, it’s a charitable donation to the state government. Problem solved!

De León, who hopes to bring ideas like this to the U.S. Senate in 2019, proclaimed in a recent statement that “our hard-earned tax dollars should not be subject to double-taxation, especially not to line the pockets of the Trump family, hedge fund managers and private jet owners.” You might think he was proposing that one of the two income taxes (federal or state) be repealed. You would be wrong.

Instead, he wants only to restore the deduction from one tax for the amount levied by the other. Your dollars would still be taxed twice, but some people would reduce the federal tax they pay by a fraction of the amount paid to the state. (To actually avoid paying taxes on income used to pay state taxes, you would need a credit, not a deduction. The deduction only saves the marginal rate on the income devoted to state taxes—the fraction of the fraction.)

Although he chooses to hide it, de León probably knows the difference between a credit and a deduction. He also probably knows that pretending a tax is a charitable donation will not fool anyone. But no one ever got far in politics by telling people hard truths, even when math is involved. Instead, we get magical thinking and willful blindness.

In the proposed law, California lawmakers would create a tax credit of 100 percent for charitable contributions to the state, thereby allowing people to replace their entire tax bill with a donation they would freely give to the state. If they choose not to make this “donation,” the state would still require them to pay taxes. See the trick? Just give the money, and the state won’t take it. With a wink and a nod, de León and his Democratic majority think they can create some fake deductions and keep the people happy.

Any tax lawyer who proposed such a scheme to his clients would need to make sure his malpractice insurance was paid up, but malpractice in politics a sadly so common as to be uninsurable, even if it could be defined. The Internal Revenue Service and the courts are not nearly as dumb as de León thinks they are. If the government is forcing you to give them money—which is what taxation is—then whether you hand it over as a donation or as a payment makes no difference. In the end, you have to pay. That makes it a tax.

For de León’s argument to be sound, we would have to believe that people who voluntarily hand over money to the state are not paying a tax, but simply offering the state their money out of the kindness of their hearts. If that is true, then we have almost all been doing exactly that for our entire working lives.

After all, if you let the government take taxes out of your check, or paid them at the end of the tax year without being hauled into court, you gave if freely, right? Similarly, if a mugger demands your wallet and you give it to him without making him stab you, it must be a gift!

The logical hole in the scheme is big enough to throw the tax code through. “Give it to me or I’ll take it” is not the plea of a charitable fundraiser. The IRS and the courts have dealt with far cleverer schemes to avoid taxes in the past, and they win most of the time. California can try all the lexicological legerdemain it wants, but a tax by any other name is still a tax.

New Jersey, New York, and Others Scramble

California is not the only home to would-be tax-dodgers. Democratic governor-elect Phil Murphy of New Jersey told CNBC that his state plans a legal challenge to the law in federal court. Murphy, who ran on a platform of raising taxes, was thin on the details of the suit, failing to explain how choosing to limit a deduction would violate the Constitution.

He did offer the less-than-reassuring statement that he’s “not a constitutional attorney,” and added that the bill may fail to hold up because when last-minute amendments were added before passage, “a lot of them [were] handwritten.” Nobody tell him how they wrote the Constitution!

Schemes being proposed in the New York legislature are more realistic, but still will not achieve the results legislators there are hoping to see. New York, like many high-tax states, recently allowed residents to pre-pay their 2018 property taxes in 2017, the last year in which amounts over $10,000 will be deductible. That may work, but only if the taxes have actually been assessed already—estimated prepayments of notional taxes are not likely to qualify. But even if it works, it is a one-year fix, putting off the inevitable.

More permanent ideas are also on offer. As The New York Times reported last week, legislators in the Empire State are also considering shifting the tax burden from individuals to corporations. By taxing employers on their employees’ wages, the incidence of the tax would shift to the corporation, which could deduct it, while leaving the actual amount of tax collected unchanged.

This idea has some merit. It is legally sound, unlike the California proposal. Also, New York’s corporate taxes are surprisingly low now—the Tax Foundation named New York the seventh-best state for corporate taxes (it ranks 49th-best in individual taxation). So there is room to grow, and the shift may be equitable. But there are also unintended consequences to raising taxes on corporations that state legislators seem desperate to ignore.

We have already seen that corporations shift manufacturing overseas when federal taxes and regulations become too onerous. How much easier would it be to shift to a low-tax neighbor of New York, like Pennsylvania? Workers have to live where the jobs are, but companies can move where they please, and the people will follow. The New York tax shift may be revenue-neutral, but it switches the tax to the party best able to avoid it by moving.

There Must Be One Weird Trick!

There is another, simpler way to fix the problem that even the Times was obliged to point out: cut taxes. As the article notes: “‘I suppose the rational response for us is to lower our taxes,’ said Benjamin Barnes, who heads the Connecticut Office of Policy and Management, ‘but we have a public that has shown again and again that they expect high levels of service.’”

Barnes is right: people want everything without having to pay for any of it. At some level, it is a natural human response. Who doesn’t love a bargain? But thinking taxpayers must admit that the party had to end sometime.

Shifting the pain of state taxes to the federal government only added to the federal deficit, and made the whole country responsible for the spendthrift habits of a few rich states. The federal government, unlike the states, can legally run deficits. But the laws of economics carry even greater force: someday, the debt must be paid.

State governments must face up to the reality that they are living beyond their citizens’ means. Now that the people are becoming aware of just how much government is taking from them, they have to pony up the cash or act like adults and recognize that there is no such thing as a free lunch. For now, their legislators are doing their best to keep endless buffet going, but sooner or later, the bill will come due.

Kyle Sammin is a lawyer and writer from Pennsylvania. Read some of his other writing at kylesammin.com, or follow him on Twitter @KyleSammin.

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