The Escalating Partisan Tug Of War Over Rich People's State And Local Taxes

Democrats wanted to give states billions of dollars to prevent pandemic layoffs, but they didn’t want Republican legislatures taking the money and cutting rich people’s taxes instead.

So the American Rescue Plan, the massive stimulus package passed earlier this month, disallows states from using the money to pay for any new tax cuts, and Republicans are furious. A group of GOP attorneys general said it could be “the greatest attempted invasion of state sovereignty by Congress in the history of our Republic.”

It’s not that. But it could be the greatest attack on state sovereignty since 2017 when Republicans took a whack at Democratic states with their Tax Cuts and Jobs Act. 

Using practically the same terms, Democrats criticized the law for limiting the amount of state and local taxes that households could deduct from their federal income tax bills. Losing the deduction meant higher taxes for some households and the possibility of blowback against Democratic state and local governments. 

The so-called SALT deduction “is essential to prevent the federal tax power from interfering with the States’ sovereign authority to make their own choices,” said a coalition of attorneys general from Democratic states in a futile 2018 lawsuit .  

“Washington has launched a calculated and direct assault aimed at the very heart of New York,” Gov. Andrew Cuomo (D) said that year .  

The previously unlimited deduction allowed Democratic legislatures to draw lots of revenue from state income and property taxes without overly burdening their residents, since whatever amount they paid they could then deduct from their federal taxable income. It amounted to an indirect subsidy of state governments or, as then-House Speaker Paul Ryan (R-Wis.) said, it propped up “big government states.” 

The Republican tax law capped the deduction at $10,000, though raw partisanship was not the only reason why doing so also limited the cost of the bill and helped simplify the tax code by getting more people to use a standard deduction instead of itemizing their expenses. 

The change resulted in tax increases on some higher-earners in parts of New York, New Jersey and other Democratic states that use high taxes to pay for public goods like health care and education. Without the full deduction, Democratic states could face pressure to cut taxes and eventually cut spending, though that does not appear to have happened so far.

(The awkward thing about Democrats railing against the SALT cap was that they said the law overly benefited the rich, but the cap was pretty much the law’s only provision that disadvantaged higher earners. Repealing it would further enrich the wealthy, since more than half the benefit of a repeal would go to households with million-dollar incomes.)

Now Republicans say it’s Democrats bludgeoning red states, even as the American Rescue Plan hands out $219 billion for states to replace revenue lost from diminished economic activity. The law specifically says states can also use the money to help households and businesses, to boost pay for state employees doing essential work, or to invest in water, sewer or broadband infrastructure. 

But the law forbids states from using the money “to either directly or indirectly offset a reduction in the net tax revenue ... resulting from a change in law, regulation, or administrative interpretation during the covered period that reduces any tax.” 

Since money is fungible, Republicans say, this provision could prevent states from cutting taxes at all, even if the tax cut was planned in advance and even if it has nothing to do with the aid in the Rescue Plan.

The Treasury Department hasn’t yet provided guidance on what kinds of tax cuts would still be allowed by the law, but Secretary Janet Yellen seemed sympathetic to Republican concerns when she testified on Capitol Hill this week. 

“We will have to define what it means to use money from this act as an offset for tax cuts,” Yellen told the Senate Banking Committee. “And given the fungibility of money, it’s a hard question to answer, but that’s what we’re required to do and we will do our best to offer guidance on it.”

In both the Rescue Plan and the 2017 tax law, the federal policy may have incidental political effects, but it wasn’t written just to dominate and punish the other political party, said Richard Auxier, a senior policy associate at the Urban-Brookings Tax Policy Center. A nuanced policy change doesn’t have to be crammed into a two-sided ideological battle. 

“We’re taking things that are interesting and do have political effects, but we make them as simple and as conflict-driven as possible,” Auxier said. 

Senate Finance Committee Chair Ron Wyden (D-Ore.) said Democrats did not intend to quash all state tax reductions and that the Treasury Department has the expertise to write good guidance for states.

“It was important to make sure that those monies were not going to be used for another boondoggle for the very wealthy,” Wyden told HuffPost. 

Sen. Mike Crapo (R-Idaho), the committee’s top Republican, said he could see the similarity between the partisan responses to the two laws but that the Rescue Plan is potentially the greater affront to states. 

“In the first case [Democrats] are objecting to a chance in the federal tax code and in this case they are trying to assert federal control over state sovereignty,” Crapo said.