Democrats in states such as California and New York are considering legislation that would subvert a new limit on the amount individuals can deduct from their federal tax liability for what they’ve paid in state and local taxes.
If the state legislation works as intended, it could cost the federal government hundreds of billions of dollars that Republicans had counted on to offset the revenue loss from the corporate and individual tax cuts in the bill they passed last month. But Republicans don’t seem to be sweating it, or even thinking about it.
“I don’t know much about what their conditions are, so I hesitate to comment,” Sen. Orrin Hatch (R-Utah), chairman of the Senate Finance Committee and the Senate’s lead author of the new tax law, told HuffPost on Tuesday.
Other senators who’d been closely involved in writing the tax bill, including Tim Scott (R-S.C.) and Susan Collins (R-Maine), were similarly unprepared to comment on developments in the coastal states, which have been the subject of national news stories since last week.
“I’m not really familiar with what they’re doing,” Collins said.
What they’re doing is this: Legislation by California Senate leader Kevin de León (D-Los Angeles) would allow Californians to “donate” to a state fund in the amount they would have paid in state taxes, receive a credit for their state taxes for that donation and then, because the federal tax law still allows households to deduct charitable donations from their adjusted gross income, they could write off the amount they’d charitably “given” to the state.
Essentially, de León’s bill would let state residents dodge a new $10,000 limit on the state-and-local tax deduction, thus allowing the state to continue collecting revenue from its relatively high taxes rates. His office said roughly 6 million California households claim the deduction, reducing their federal taxable income by an average of about $18,000.
“What we’re doing as leaders of blue states,” de León said in an interview, “is being creative and as innovative as possible to provide tax relief to Californians who are going to refuse to foot the bill for these wealthy corporations that are going to benefit from this tax boondoggle.”
De León’s measure is the kind of reaction Republicans might have forestalled if they’d spent more than a few weeks writing their bill. Experts warned in December that states could hack the law through a scheme like the one de León has proposed, but Republicans had already completed the final bill after unveiling it the previous month.
Policymakers in New York and Connecticut are considering a different sort of end-around that experts had also suggested might work: shifting state income taxes onto business payrolls, which are still fully deductible under the new federal law.
“I think this is something [Republicans in Congress] should have seen coming,” Larry Zelenak, a tax professor at Duke University School of Law, said in an interview.
But Zelenak said de Leon’s plan would not necessarily succeed. Though the Internal Revenue Service has previously said it’s OK for states to trade tax credits for donations to state funds, Zelenak said there’s nothing to stop the IRS from reversing that decision if states start exploiting it.
“It’s just an administrative interpretation, and a new administration is entitled to try a new interpretation,” Zelenak said. “I am not at all sure it would win in the end.”
Several Republicans told HuffPost the same thing.
“If there is an intent to get around it in that respect, I think they’re going to find it more difficult than they might imagine,” Sen. Mike Rounds (R-S.D.) said.
“I think they’re going to have a hard time doing it,” Sen. Ron Johnson (R-Wis.) said.
Nevertheless, Johnson suggested it was regrettable that the situation had come to pass, saying he would have written the bill differently, particularly its provisions on business taxation.
“This was not my approach to how we should have dealt with things,” he said.
Initially, GOP leaders wanted to eliminate the local tax deduction altogether but preserved it in order to win support from Republicans in high-tax states. Capping the deduction will increase revenue by $668 billion over 10 years, according to the congressional Joint Committee on Taxation.
Rep. Kevin Brady (R-Texas), chairman of the House Ways and Means Committee and lead author of the tax bill on the House side of the Capitol, said state lawmakers should simply allow their constituents to benefit from increased economic growth brought about by the tax law rather than interfering with its implementation.
“They need to understand the era of tax-to-the-max is over because we’ve pulled the curtain back and now families and workers in those states now clearly see just how high a tax burden and how much their paychecks are being taken,” Brady said.
When HuffPost asked Brady what would happen if states didn’t take his advice, he repeated the advice.
De Leon, for his part, isn’t exactly going out on a limb with his proposal. His office pointed out that California already provides tax credits for donations to state education funds and that 17 other states have similar schemes essentially creating government subsidies for private education. He scoffed at the suggestion, which several Republicans have offered, that states should simply lower taxes in response to the federal change.
“Where would the money come from to pay for our schools, to pay for higher education to invest in human capital? Money doesn’t just materialize off the sky,” de León said. “It’s an absolutely ludicrous and irresponsible statement.”
CORRECTION: An earlier version of this article incorrectly attributed Mike Rounds’ quote to Sen. John Kennedy (R-La.).