There’s an old line that the definition of a liberal is someone who won’t take their own side in an argument. The line certainly describes the response of many liberals to the new Republican tax scheme. By capping the deduction for state and local taxes, the Republican tax bill raises taxes on higher income people in liberal states. Many liberals seem to think this is just fine.
The basic logic of the “this is just fine” gang is that higher income people have been the winners in the economy over the last four decades. Insofar as we need more revenue for the government, they should be the ones to provide it. Therefore we should not be upset about a provision in the Republican tax plan that means higher taxes for people with money.
But this provision is not raising taxes for all wealthy people; it is raising taxes for a subgroup of higher income people. That is a very different story. Presumably we would not think it’s okay if the bill just raised taxes on higher income people of Polish or Italian ancestry, even though as high income people they may be able to afford a larger tax burden.
In this case the subgroup of high income people who face higher taxes are people who live in relatively liberal states that provide better services to their population. The reason that states like California and New York have higher taxes is that they have relatively good education and Medicaid systems and try to provide some income support to their poor.
The Republican plan is to make higher income people pay a higher price for living in liberal states. In many cases, this relatively powerful group will put pressure on state and local governments to reduce their tax burden, which will force cutbacks in services. Needless to say, they will certainly object to any efforts to raise their state and local tax burden further to meet new needs going forward.
There are several routes that have been proposed to circumvent the cap on the deduction for state and local taxes. One being seriously considered in California is to set up state-run charities to which people can contribute and get a 100 percent credit against their state taxes. Since charitable contributions are still fully deductible under the new law, this would effectively preserve the deductibility of state income taxes.
There is a debate among tax experts as to whether this sort of set up would be legal, but it does maintain a certain symmetry in how tax law treats different types of contributions. Under the new law, a high income person can give to the charity of their choosing and effectively get the government to kick in 37 cents of every dollar.
This means if a rich person gives $1 million to the “Religious School for the Education of White Nationalists,” the taxpayers will chip in $370,000 for the cause. In that situation it certainly seems reasonable that a $100,000 payment by a high income person to support Los Angeles public schools should at least get the same 37 percent subsidy.
If that route doesn’t pass legal muster there is an alternative route that is not legally suspect. This involves substituting an employer side payroll tax for a portion of the state income tax.
To take a simple case, suppose that a state has an income tax of 5 percent. The state could get rid of the income tax and replace it with an employer side payroll tax of 5 percent.
The conventional view among economists is that an employer side payroll tax comes out of wages, which means that employers will eventually reduce workers’ pay by the amount of the tax. So a lawyer who had been getting $200,000 a year will see her wages lowered $10,000 as a result of the 5 percent tax.
This leaves the worker with the same amount of money as she would have had after paying her state taxes, but instead of paying federal income taxes on $200,000 in wages, she would only pay it on $190,000 in wages. This effectively preserves the deductibility of her state income taxes.
A neat side benefit of going this route is that it effectively makes the tax deductible on income taxes even for people who don’t itemize. That would be a pure gain for people in states like California and New York. We can also leave a portion of the income tax in place for very higher earners and have a lower cutoff under which the tax is not collected to preserve progressivity.
There will be complicating factors in making this switch, but no system, including the current one, is perfect. The key point is that liberal states have the weapons they need to fight back against this pernicious Republican tax plan. The question is whether they will try and just accept yet another massive defeat without a battle.