Unwinding the 4 State Suit Against the SALT Deduction Cap

Governor Phil Murphy recently has thrown New Jersey into a multistate suit against the federal government.  New York and their Governor Andrew Cuomo, Governor Dannel Malloy of Connecticut, & Brian Frosh the Attorney General for Maryland are also involved in this lawsuit.  After months of talk, leaders of the Democratic party in these states are now suing the federal government over what they have declared is an unconstitutional provision, the cap for the SALT (state and local tax) deduction.

Why is the SALT Deduction an Issue?

The 2017 federal tax act created mandated a cap of $10,000 available for deduction from federal income tax. This deduction is derived from state property, sales, and income taxes. The petitioners of this suit claim that this will disproportionately harm their residents. They are worried that curtailing the tax break would undermine their ability to raise money for government services, including police services and schools. With the deduction cap in place, local leaders have said that taxpayers are likely to begin to seek tax relief closer to home when which would potentially make it more difficult to provide basic services.  Additionally, state officials have said that the SALT cap will depress home values while also reducing state tax revenues. This in turn would force New Jersey and other states to choose between higher state tax rates or cutting investments in education, public services and other vital programs.

Does the Lawsuit have a Leg to Stand On?

The lawsuit has a few main arguments on which it stands. First, the complaint states that the SALT deduction cap violates the Tenth Amendment by interfering with the states’ sovereign authority to set their own tax policies, and by starving states of tax revenue through the collection of this deduction by capping the amount they can receive. Second, the lawsuit alleges that by capping the SALT deduction at $10,000 the federal government has singled out states, such as New Jersey and New York, for disproportionate harm and therefore violates the Constitution. Thirdly, the lawsuit asserts that the 16th amendment, which made possible the modern version of the federal income tax, has been violated because it mandates a full deduction for state and local property taxes and is an unlawful restriction.

What, however, is the reality of the situation? First, this federal policy does not directly limit state tax policy in any way.  There is no provision that limits the state’s ability to levy taxes on their own citizens. The deduction only affects federal deductions from federal income tax and does not restrict in any way state power over their own income tax deductions. Secondly, despite claiming that the cap targets New Jersey, New York, Connecticut, and Maryland, the cap is applied equally to every taxpayer in the country. Every person now is limited by this cap, not just the citizens of the four states involved in this lawsuit. Thirdly, the SALT deduction cap in no way violates the 16th amendment.  In truth, the 16th amendment states that, “The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”. Clearly, there is no portion of this amendment that mandates any sort of deduction at all. To state that removing the unlimited usage of the SALT deduction is an unconstitutional restriction is a stretch at best.

In the event that the lawsuit is successful what would happen?

The reality of the situation is that the removal of the tax deduction cap would only affect around 15% of taxpayers according to the Institute for Economic Freedom at the Heritage Foundation. The other 85% of taxpayers in New Jersey and elsewhere will not be affected. From an equity point of view, the deduction, which some consider a subsidy, overwhelmingly supports the wealthiest residents of some of the wealthiest states in the nation. With the cap people who have a lot of wealth in states, such as New Jersey or New York, will now pay a similar percentage in federal taxes as those in low tax states such as Tennessee and Texas. Currently, they are now not able to receive a disproportionately larger tax deduction than taxpayers in other states because of the cap. At this time the tax playing field has been effectively leveled. States in the past with lower tax supplied the revenue needed to provide for higher tax state’s deductions, and in effect were footing the tax bill of these high tax states.

In the end it seems as though this lawsuit really is without much merit or meaning to the common taxpayer.  It stands on shaky ground, and would support only a small minority of people. Is Governor Murphy using your tax dollars wisely in this lawsuit? Only time will tell.