Trump’s tax reform limits the State and Local Tax (SALT) deduction to $10,000, disproportionately affecting high-tax states with progressive policies. These states can avoid the problem, though, by shifting to payroll taxes instead of income taxes. CEPR’s Dean Baker explains
GREGORY WILPERT: Welcome to The Real News Network. I’m Greg Wilpert, coming to you from Quito, Ecuador.
As citizens in the United States prepare to file their taxes for 2017, many are confronted with an uncomfortable fact that despite President Trump’s promise, they will probably have to pay slightly more in taxes this time around. The people that are most likely to see a tax increase are those who live in high tax states, such as those who live in California, New York, and New Jersey and who used to be able to deduct all of their state, and local taxes from their income for calculating their federal taxes. The state and local tax deduction, also known as SALT deduction, is now capped at $10,000. What will be the consequences, not only for the tax payer, but also for those states and cities with higher tax rates, and can they do anything about this?
Joining me to analyze the SALT deduction, and what states can do about it, is Dean Baker. Dean is Senior Economist at the Center for Economic and Policy Research and is the author of <i>Rigged: How Globalization and How the Rules of Modern Economy were Structured to Make the Rich Richer.</i> Welcome back, Dean.
DEAN BAKER: Thanks for having me on.
GREGORY WILPERT: So why, briefly, is limiting the SALT deduction to $10,000 a problem? Isn’t the main effect to raise taxes for those who are more able to pay more taxes, that is for higher income people?
DEAN BAKER: Well, it certainly generally hits higher income people. The basic story, if you put the cap at $10,000, most people will be under it. But it’s not hard, particularly in a higher tax state, and a state also with higher property taxes like California and New York, that even a fairly middle income person could be above that. So it’s totally plausible in those states that someone has a home that’s worth 8, 900,000, maybe they bought it 20 years ago and it cost half or a third as much. They could have $10,000 in property tax alone, which means that whatever they pay in state income taxes, they’re gonna lose the deduction on that. But obviously, higher up you are, higher up you go, the more impact it is. On the one hand, I’m not troubled by higher income people paying more money, but the reality is that these people have a lot of power.
So there’s two issues from the standpoint of a state like California or New York. One is that you could simply have people move, now that’s exaggerated. People have … A lot of Republicans were sort of gleeful saying, oh, okay, all these people are gonna move from high tax states to Texas or other lower tax states. Well that’s not gonna happen en masse. Surely they’ll be some and that is somewhat of an issue; they exaggerate that but it’s not zero. They could also play games. Someone could say they live in Texas. They have a house in Texas and they’re living there, and use that to try to avoid paying some of their taxes in California or New York. So you will see some of that.
But the other thing is that, obviously this costs them more money, and these are powerful people. They will use their political power to, at the very least, prevent any further tax increases. But they will try to have their taxes rolled back. Because now, in effect, they’re paying 40% more. If you could deduct this against the old 39.6% tax rate, 40% of your state and local taxes were paid by the federal government. Now 100% is paid by yourself. So there would be pressure to lower the taxes.
Reason why I’m so concerned about that is that these are the places where you see progressive policies. You see in New York or California looking to expand Medicaid coverage, other healthcare coverage, looking to extend free college. Their ability to do that is gonna be seriously limited, if this were to stay in place as the Republicans have proposed it.
GREGORY WILPERT: So you recently published a fairly detailed proposal for how states could get around the SALT deduction and the limit. That is by turning income taxes into a payroll tax. How would this work and how would it help states and taxpayers?
DEAN BAKER: Well basic story is you take some portion of the state income tax, and you reduce the state income tax by roughly that amount. Let’s say five percentage points; in New York their tax is roughly 5 percentage points. It’s somewhat progressive so for higher income people, it’s more than that. But suppose you had a state employer side payroll tax of five percentage points and you have a zero bracket so everyone doesn’t pay it. You have to earn above say $15,000. Governor Cuomo has actually just proposed something along these lines, and he has it at $40,000. But whatever, you have some zero bracket and then your employer paid five percent of your wages above 40,000, in the case of what Cuomo’s proposed. Well you’re reducing your state income tax by that amount, so if you are subject to a five percent state income tax, basically you pay zero. The higher income people might have paid an eight percent tax. In the case of New York, they’d instead pay a three percent tax. What that would mean is that the bulk of the tax that they’re subject to for the state, would still be deductible because the employer side payroll tax would be deductible for them.
The conventional view among economists, let’s stick with the five percent number, we’ll just say it comes at zero dollars. It starts at your first dollar of your paycheck. Suppose you’re into $100,000 and we tell your employer they have to pay a five percent tax on your wages. What we would expect to happen is that over time, they’ll reduce your wages accordingly. So that they’re paying five percent tax on your wages, instead of you getting paid 100,000, you’ll get paid 95,000. Now that leaves you in the exact same spot relative to the state government because before you used to get 100,000 and you had to send a check for 5,000. Now you’re getting 95,000.
The difference is at the federal level, you’re only being taxed on 95,000 not 100,000. So in effect, you preserved the deductibility of the income tax that gets paid to the state. As I said, Governor Cuomo seems intent on going this route, which to my view, is a very good idea.
GREGORY WILPERT: So let’s turn to some of the complications of this proposal. First, how realistic is it to expect taxes to completely rewrite their tax laws on such a fundamental level. I mean you mentioned that Governor Cuomo’s considering and of course, this would have to pass the legislature. I mean, wouldn’t this require a pretty fundamental rewriting of state tax code?
DEAN BAKER: Yeah, of course we’re rewriting. In many case, I believe New York’s in this situation. But most states already had their tax code tied to the federal tax code, which would require rewriting in any case. So the federal government doubled the standard deduction, so states that tied their standard deduction to the federal one will have to change that.
They got rid of the personal exemption so many states had the personal exemption tied to the federal government’s personal exemption. So many states, most states I’m sure, have to redo their tax code anyhow. In terms of the complexity, it really isn’t that complex. I mean people can make it sound complex. If I just sat down with someone and said, hey, do this, it would take most people a while to figure out. But the reality is, from the standpoint of people who do withholding schedules for companies, this is fairly straightforward. You just have to give them the formula, they plug it in. From the standpoint of you as tax payers, it’s very simple. This is not some incredibly complex story and again, since redoing the tax code anyhow, this isn’t a huge further complication.
GREGORY WILPERT: Another issue that has perhaps been raised is that currently most high tax states have a progressive income tax. Wouldn’t introducing a payroll tax like this be regressive, in the sense that it’s a flat tax?
DEAN BAKER: Not at all, cause you’re leaving the progressive aspect in place. So an example I did before, New York State, which has for most people, they’d be looking at roughly a five percent income tax. Higher income people would be paying eight percent. I think it peaks out at like eight four or eight five. What you would do is you would leave in that tax for higher income people. So for more middle income people, basically the payroll tax would substitute five percent payroll tax for five percent income tax. For higher income people, they would pay the five percent payroll tax and then they would also pay three percent income tax on top of that. So you haven’t changed the progressivity at all. There’s no reason to. I mean, obviously, if the state’s reconsidering its tax code, they can do whatever they want. But there’s no reason why this should be any less progressive and it could even be made more progressive than the current structure.
GREGORY WILPERT: But then the other issue is not only would state tax laws have to be written, but employment contracts basically, so that employers wouldn’t carry all the tax burden. Wouldn’t both employers and employee resist such a change?
DEAN BAKER: Two things, one is you would look to phase it is. Cuomo’s looking at phasing it in over three years, which is what I had recommended. I mean not that they’re taking their advice from me, but I mean that would be a reasonable time frame. The second point is that in contracts … I’m saying three years. Many contracts will expire there. But also people typically are getting wage increases currently about two and a half percent a year on average. What that would mean is you’re not looking at cutting anyone’s pay or at least not for the most part. What you’re basically talking about is people would get somewhat lower pay increases. Again, it’s being offset by paying less taxes to the state. But instead of someone looking at say, two and a half percent pay increase, they’re looking at a half percent or one percent pay increase this year and next year, with the difference being made up by paying lower taxes to the State of New York.
GREGORY WILPERT: Finally, your paper points out that since employers are paying the tax directly, their payroll tax, then employees would be paid less and therefore would have to pay less in Social Security and Medicare. But wouldn’t that mean that their Social Security benefits would be lower when they retire?
DEAN BAKER: Well, you could see it as a bonus or cost to it. Not only does this increase their exemption for federal income taxes, it also in effect makes their state taxes deductible from the standpoint of Social Security and Medicare taxes. So they’ll pay less on those taxes as well. The downside is, as you suggest, it does mean somewhat lower Social Security. Now realistically, when you try to do some calculations, you say for someone earning $50,000 a year, $60,000 a year, you’re talking about lowering their Social Security payment maybe a few hundred dollars, if this were in place for their whole working career. So it’s a relatively small impact on people’s Social Security. And again, I’m not a fan of seeing Social Security cut, but you are seeing a relatively small impact.
But the other point I’d make on that is my expectation would be that, suppose New York does this, certainly Governor Cuomo’s looking to. He’s putting it on the table ,and he’s gonna try to push it through the legislature. I assume he’s serious about it, he’s not wasting his time and other states follow. They’ll be pressure for more states to do it, cause I suspect most people would rather pay less tax than more, and since your legislature could do this fix and have you pay less tax.
As more states start to do it, it makes pressure on the federal government to say, okay, this was stupid. Let’s go back and rewrite it. So my hope would be that, let’s say New York state does something like this, California’s looking in a similar direction, some other states go. Then in Washington, whether it’s still a Republican Congress or if you get Democrats there, let’s rewrite this. It’s stupid to have states doing this. It’s costing us revenue in a way that doesn’t make sense. Let’s go back and put back something like the pre-existing rules, where the state and local taxes were deductible against people’s income tax. That would be my expectation.
GREGORY WILPERT: Well we’ll leave it there for now. I’m speaking to Dean Baker, Senior Economist at the Center for Economic and Policy Research. Thanks for having joined us today Dean.
DEAN BAKER: Sure, thanks for having me on.
GREGORY WILPERT: And I’m Greg Wilpert for The Real News Network.