Another reason new federal law should prompt Wisconsin tax reform

Many taxpayers will no longer benefit from state and local tax deduction

By JAY MILLER | July 26, 2018

A whole lot more Wisconsinites are about to feel the sting of high state and local taxes (SALT) in ways they never have before — a fact that will lead either to a whole lot more dissatisfaction with elected officials or to substantive tax reform in Madison.

Here’s why:

Enactment of the new federal tax law means that unless you’re among the most successful Wisconsinites, you’re probably not going to have an incentive to itemize on your federal tax return.

The Center for Research on the Wisconsin Economy (CROWE) projects that, because of the doubling of the standard deduction, “only those with incomes above $500,000 will find it worthwhile to itemize.” (According to the Tax Foundation, in 2010 less than one-half of 1 percent of Wisconsin tax filers had adjusted gross income in excess of $500,000.)

Even the very few taxpayers in Wisconsin who continue to itemize probably will bump up against the $10,000 SALT deduction cap, losing at least part of the tax benefit they previously enjoyed.

The good news is most taxpayers will see an overall federal tax cut. The bad news is hardly any taxpayers who got a tax deduction from paying state and local taxes in the past will get one now, making them more aware of the actual cost.

The result: Pressure for local tax reform will be high, especially in states like Wisconsin, where income and real estate property tax rates remain particularly painful.

Whereas some states have high income taxes but low property taxes, or vice versa, Wisconsin weighs in on the high side for both, putting us in the unenviable “elite” category.

Other high-tax states (New York, New Jersey, Connecticut and Maryland) are lashing out at the SALT deduction cap by filing a lawsuit in federal district court to challenge the cap’s constitutionality.

A Wall Street Journal editorial described this ploy as a “sure legal loser.” And the Internal Revenue Service has cast severe doubt on legislative attempts by these states to circumvent the cap’s impact. One can’t help but notice the rich irony in having officials in these states scramble to save a federal tax break for their wealthiest residents, only to continue to punitively tax them at the state and local level.

Fortunately, Wisconsin appears to be taking a different approach by looking at whether the source of the problem lies with state, not federal, policies. The Wisconsin Assembly Committee on Ways and Means’ website signals that state tax reform may be on its way by noting that the committee “will examine each part of our state’s tax code and present a plan that will make our tax code fair, low and easy.”

One would be hard pressed to overstate the importance of this undertaking. As the committee website continues, “[N]ow is the time to develop a revenue neutral tax code that will unshackle Wisconsinites potential and allow our proud citizens and businesses to thrive in the 21st century and beyond.”

A key component of any tax reform ought to be a dramatic shift from the disproportionate reliance Wisconsin places on state income and property taxes. The new federal tax law offers a perfect rationale for doing so.

Of course, a cut in state income and property taxes would need to be offset by more government belt-tightening and/or increased funding from other sources. Despite some progress on cutting expenses, the fact remains that Wisconsin still spends far more per capita than most states.

Insofar as other revenue sources are concerned, a recent U.S. Supreme Court decision provides the prospect for modest relief. The Supreme Court in South Dakota v. Wayfair, Inc. overturned existing precedent that prohibited states from collecting sales taxes from online retailers unless they had a physical presence in such states. That means Wisconsin might be able to collect an additional $120 million per year from out-of-state vendors, according to a recent memo from the Legislative Fiscal Bureau.

If it is coupled with other changes, such as tolling to pay for maintenance of our highways, the case for lowering our state property and income taxes becomes even more compelling.

The idea is not to leave our state bereft of funds to operate on an efficient basis. Rather, it is to reform our taxes so we can maximize the benefits of federal tax relief, unshackle our potential and “thrive in the 21st century.”

Jay Miller of Whitefish Bay is a visiting fellow at the Badger Institute. He is also a tax attorney and an adjunct professor at the University of Wisconsin-Milwaukee’s Lubar School of Business.