By Kathleen Pender, SAN FRANCISCO CHRONICLE
December 4, 2017
The governors of California and New York and governor-elect of New Jersey joined forces Monday to attack GOP plans to do away with the state and local tax deduction — calling it a possibly illegal or unconstitutional transfer of wealth from predominantly Democratic states, which tend to have higher income taxes, to predominantly Republican states, which generally have lower or no state income tax.
“This bill will divide the blue states from the red, the Democrats from the Republicans. It is evil in the extreme,” Gov. Jerry Brown said in a call with reporters.
In the conference call, New York Gov. Andrew Cuomo said any lawmakers who voted for the bill would be “voting against the interest of their constituents, period.” The call also included New Jersey’s governor-elect, Democrat Phil Murphy, who said the deduction “has been part of the tax code since the income tax became legal in 1913.”
What they didn’t say is that the biggest losers would be state governments themselves. If this provision passes, “there’s no question, it’s going to make it very hard” to raise state and local taxes, says Jamie Court, president of the nonprofit Consumer Watchdog.
State and local governments have been able to “sell” tax increases by pointing out that they are deductible on federal returns. If you are in the 33 percent bracket, the deduction hypothetically knocks a third off the tax.
In reality, many people, even in California, get little to no benefit from the state and local tax deduction for one of three reasons. Either they don’t itemize deductions; they are subject to the alternative minimum tax, which doesn’t allow for state and local tax deductions, including property tax; or they are subject to the Pease phase-out of itemized deductions, which starts whittling away itemized deductions when taxable income hits $330,000 (married) or $266,700 (single).
Both the House and Senate GOP tax plans would do away with the deduction for state and local income and sales taxes entirely, but would allow itemizers to deduct up to $10,000 in property taxes per year.
The House-passed version would also eliminate the AMT. The Senate version passed Friday would preserve the AMT but raise the exemption amount so fewer people would be subject to it. Both versions would eliminate the Pease limitation.
If either of those versions passed, some people who can’t take the property-tax deduction today because they are in AMT could deduct up to $10,000, assuming they have enough other itemized deductions to continue itemizing. Some subject to the Pease deduction might be able to deduct a little more.
In San Francisco, Chief Economist Ted Egan estimates that the average property tax bill is around $7,600 a year for single-family homes and $9,500 for condos, because condos are generally newer and assessed at market value more recently.
For those who are getting the full benefit of the state and local deduction, losing it will certainly hurt. It will also hurt governments that rely on those tax revenues if citizens resist future tax increases — or even call for tax cuts when they see their next federal income tax return.
California has much to lose because it relies heavily on the income tax. It has the nation’s highest state income tax rate, 13.3 percent. And the income tax generates 32.2 percent of all state and local tax collections, the fourth highest of any state.
By comparison, the property tax generates only 25.4 percent of all state and local tax collections in California, mainly because Proposition 13 limits increases. By this measure, it ranks only 38th among the states.
Property tax revenues go mainly to counties, cities and school districts. Allowing a partial property tax deduction would take some of the sting out. But local governments could still have a harder time getting voters to approve local property tax increases. Parcel taxes require a two-thirds majority. Others require a two-thirds majority if the tax is dedicated to a specific use or a simple majority if it goes into the general fund. If the GOP proposal passed, you could see more of the latter type.
“I think local governments’ hands are really tied. Most cities don’t have a lot of local sales tax,” said Chris Hoene, executive director of the California Budget and Policy Center. If the property tax deduction is limited, “I think you will see them look more toward transaction taxes and fees.”
At the state level, Democrats can pass tax increases with a supermajority, which they have barely in the Senate and should have in the Assembly after Tuesday’s vote to fill a vacancy. Even so, “If this holds — the elimination entirely of the income tax deduction and the partial elimination of the property tax deduction — I’m sure there will be pressure on us around the state income tax, which is a key part of our budget,” said state Sen. Scott Wiener, D- San Francisco.
“We are not going to let Donald Trump dictate California’s approach to our budget,” Wiener said. But “we are going to have to do a lot of thinking and analysis about how to respond in a way that supports our residents while also keeping our government intact.”
Even though San Francisco, as a city with high income and property taxes, would be hurt by the elimination of the state and local tax deduction, if you look at the package as a whole, the impact is not so clear-cut.
Egan has been trying to do that, and hasn’t come up with a conclusion just yet. But he points out that “the distributional impacts of the tax plan,” according to the Tax Policy Center and other sources, favor wealthier areas, “which ours is.” He added that some of the proposed changes “could help businesses in the area,” which would also help people “to the extent that it increases salaries and job opportunities.”
Paying their share
Here are the 10 states with the highest percentage of state and local tax revenue from income taxes.*