New federal tax law should prod Wisconsin to enact tax reform

Residents in high-tax states like ours are stung harder by cap on state/local tax deduction

By JAY MILLER | Feb. 20, 2018

We have heard very little from Wisconsin’s governor, Scott Walker, or legislative leaders about Congress’ recently enacted tax reform legislation, known as the Tax Cuts and Job Act. But that has not been the case with leaders from several other high-tax states.

Governors from California, New York, New Jersey and Connecticut are howling. Much of their outrage stems from the prospect that a large swath of their residents may be paying higher federal taxes because of their own, well, high taxes. A brief explanation is needed.

Through the end of tax year 2017, taxpayers who itemized could deduct all of their real estate and state/local income taxes for federal tax purposes. By allowing this benefit, the federal government in effect lessened the sting these taxpayers suffered at the state and local levels.

That has changed with the new federal law. Starting this year, the amount of state and local taxes (SALT) that itemizing taxpayers can deduct at the federal level is capped at $10,000. Taxpayers in low-tax states, including ones that have no income taxes at all, won’t feel the pinch nearly as much, if at all.

What that means is that residents of a high-tax state could be paying much more in overall federal and state taxes than they would if they lived in a low-tax state but were otherwise in the same economic position.

High-tax states in the Northeast and elsewhere already are losing residents to lower-tax states, mostly in the Sun Belt. That taxes play a role cannot be doubted.

The effect on high-tax states

This holds true for Wisconsin, which qualifies as a high-tax state. Its individual state income taxes rank eighth-highest in the country, according to the Tax Foundation. Additionally, homeowners in the Madison and Milwaukee area labor under punishing real estate taxes.

In the Tax Foundation’s 2018 State Business Tax Climate Index, the individual income tax rate subindex weighs the effect of tax rates on the marginal dollar of individual income using these measures: the top tax rate, the graduated rate structure and the standard deductions and exemptions which are treated as a zero percent tax bracket.

United Van Lines’ annual 2017 survey classifies Wisconsin as a “high outbound” state because more people are moving out than moving in. Of all Badger State moves, 55 percent are outbound, while 45 percent are inbound. (At least, we can take some comfort in knowing that our high-tax neighbor directly to the south leads the nation in outbound moves.)

To be sure, most households have been claiming the standard deduction (instead of itemizing), and that number will rise sharply starting in 2018 now that the standard deduction amount has almost doubled. For them, the clamor over a cap on SALT deductions (limited to those who itemize) is much ado about nothing.

Still, the fact remains that higher-income taxpayers, many of whom are job creators, will continue to itemize and feel the brunt of the deduction cap if they live in high-tax states. Their motivation for moving elsewhere will increase dramatically. And if they move, their employees may follow.

To illustrate the severity of this problem for these taxpayers, consider that in 2015 the average SALT deduction for New Yorkers was $22,000. In Manhattan alone, SALT deductions have averaged more than $70,000! For them, anything over $10,000 will no longer be deductible.

Not surprisingly, low-tax states like Tennessee, Florida and Texas are seeking to exploit the situation by telling businesses and individuals to come on down to greener pastures. 

Instead of trying to figure out how to lower his own state’s high taxes, New York Gov. Andrew Cuomo has declared the new federal law to be “economic civil war” and is trying to come up with some gambit that would enable his constituents to circumvent the SALT deduction cap. Among the schemes being considered are ones that would replace state income taxes with fully deductible payroll taxes on employers or charitable contributions to the state.

Cuomo also is putting together an alliance with New Jersey and Connecticut to sue the federal government over the new tax law, claiming that the SALT deduction cap unconstitutionally discriminates against states such as theirs.

In defense of these tactics, Benjamin Barnes, secretary of the Connecticut Office of Policy and Management, made a telling statement: “I suppose the rational response for us is to lower our taxes … but we have a public that has shown again and again that they expect high levels of service.” In other words, anything is preferable to a “rational response.”

At the end of the day, however, it is unlikely that these schemes will pass muster under either Internal Revenue Service guidance or court interpretation. The Treasury Department already has issued a statement casting doubt on some of them.

Ironically, even if the schemes worked, the result would be to reduce the amount of revenue the federal government collects and stifle some of the programs that these same governors support. As University of Chicago law professor Daniel Hemel says, “The Democratic Party’s long-term agenda requires the federal government being able to raise revenue. (Its plan to circumvent the cap) would be short-termism at its worst, potentially setting back the progressive agenda for decades to come.”

Not only do these governors want to avoid lowering taxes, they want the luxury to raise them even higher. New Jersey’s newly installed Democratic governor, Phil Murphy, had promised during his 2017 campaign to impose a new tax on its wealthiest residents. This would be on top of the 8.97 percent tax rate they currently pay. Go figure.

Alas, that has proven to be too much for even the Democratic president of New Jersey’s state Senate, Steve Sweeney, who cautioned that the state needs to “hit the pause button.” Why? Because, in his own words, “We can’t afford to lose thousands of people … You know, 1 percent of the people in the state of New Jersey pay about 42 percent of its tax base. And you know, they can leave.”

Sounds almost like a fiscal conservative.

To be fair, New York, Connecticut and New Jersey, among others, would be hard-pressed to lower state taxes even if they wanted to do so (which they don’t). The reason is they face huge budget shortfalls, including unfunded pension liabilities for state government employees. In the case of New Jersey, it is short $90 billion of what it needs to pay future benefits.

Which brings us back to Wisconsin. We are fortunate that our state, unlike other high-tax states, has a fully funded pension system. The state also is considering alternative revenue sources, like tolling, for fixing our ailing highway system.

If these things occur, along with finding new ways to cut extraneous costs, Wisconsin has an opportunity to take itself out of the high-tax category by reducing state income and real estate taxes.

In that event, the new federal tax law could be a boon not only for the country at large but also for us in Wisconsin. There has never been a more opportune moment. Are you listening, Gov. Walker?

Jay Miller of Whitefish Bay is a tax attorney and an adjunct professor at the University of Wisconsin-Milwaukee’s Lubar School of Business. He previously served as vice president and tax counsel for Northwestern Mutual. Miller is a visiting fellow at the Badger Institute, focused mainly on tax policy.