Attempt to ban SALT weakened by strong data

Northeastern states argue cap will cause devastation, but recent tax filings show revenue increases in New York and New Jersey

May 23, 2019 @ 2:30 pm

By Bloomberg News

It was always a long shot, but a quixotic lawsuit by four northeastern states to squelch the Trump tax law's cap on state and local tax deductions is being undermined by a repetitive drip of strong economic data.

New York, Connecticut, Maryland and New Jersey will get their first hearing in June on a last-gasp attempt to kill one of the most controversial provisions of the 2017 tax law. To do so, their attorneys general are relying on early-1900s news clippings and Civil War-era congressional debate over whether to even have an income tax.

(More: SALT apocalypse predictions have not come true)

The case, being heard in U.S. District Court in New York, is a mostly forgotten bid started last July to nullify the $10,000 cap on the amount of state and local income and property taxes that Americans can deduct from their federal taxes.

The four states, which all have high such taxes, claim the overhaul, a key accomplishment of President Donald J. Trump, trampled on their right to govern their own finances and violated constitutional protections against unequal treatment under the law, among other arguments.

To make their case, they've drawn on writings of the Founding Fathers, transcripts from congressional debates in the 1860s on the original SALT deduction, and 100-year-old newspaper articles describing lawmakers' thoughts during the ratification of the 16th Amendment, which codified the income tax into the Constitution.

Yet evidence for the the primary complaint — that the SALT cap would devastate state finances by lowering property values and causing people to move elsewhere — is weakening by the day.

In the tax filing season that just ended, New York State saw revenue rise $3.7 billion in April from a year earlier. New Jersey also reported an increase. It's unclear if the revenues would have increased even more were it not for the SALT cap. And the feared exodus from high-tax states has not materialized, with reports that migration was lower than a decade ago.

The states' arguments are a long-shot, say attorneys not associated with the case.

"I don't think they're going to win. I'd love for them to win. It would help me as a blue-state taxpayer. But they're not going to win," said Timothy Noonan, a tax attorney for Hodgson Russ who works in New York City and Buffalo.

Republicans in Congress approved the SALT cap to raise federal revenue that could be used for tax cuts elsewhere. The cap hit higher-tax states especially hard, and it wasn't lost on Democrats that those were their states.

(More: Limited deduction rubs SALT into taxpayer wounds)

"We are confident in the merits of our case.," Connecticut Attorney General William Tong said in a statement to Bloomberg. "Connecticut won't stand idly by while the Trump administration hands big breaks to the wealthiest while sticking it to middle-class taxpayers here in Connecticut."

Declaring War

After the law passed at the end of 2017, state lawmakers declared war on the cap. New York Governor Andrew Cuomo said he would sue to stop it. Lawmakers in New York and other states attempted to come up with workarounds, like changes to payroll taxes or the treatment of certain charitable contributions, to lessen the impact of the cap. Cuomo and the three other governors didn't actually sue Treasury Secretary Steven Mnuchin and his department until July 2018.

"This is their political attempt to hurt Democratic states. It is totally repugnant and hypocritical of the fundamental conservative ideology which they preach," Mr. Cuomo said on a call with reporters in conjunction with the lawsuit.

Since then, the Internal Revenue Service has used regulations to shut down nearly all of the workarounds. That leaves the court case, for which oral arguments have been scheduled for June 18th on preliminary motions by the states to strike the law down and by the federal government to swat the case away.

Putting aside the recent boost in tax revenues, lawyers said states face a problem proving that limiting the SALT deduction abrogates their rights any more than other changes to SALT, which have happened many times over the years, according to Joseph Bishop-Henchman, executive vice president of the right-leaning Tax Foundation.

In the 1960s, for example, Congress changed the deduction from applying to all state taxes to applying to only certain ones, Mr. Bishop-Henchman said.

Much of the states' lawsuit relies on transcripts of congressional hearings or quotes from lawmakers from the 19th and early 20th centuries, when Congress debated allowing a federal income tax. At the time, some lawmakers were concerned that the proposed constitutional amendment to allow the income tax would hurt states' own taxation abilities.

For example, after Virginia rejected the income-tax amendment in the early 1900s, one local newspaper opined, "It will be a long time before Virginia will set her sister States the example of surrendering unnecessarily to the central government any important right now reserved to the States."

The states also quoted an economist writing in an article for a law journal in 1914 that Congress "desired that the question of interference with state taxes should very carefully be safeguarded."

The Department of Justice earlier this year in a filing argued that most of the historical quotations were irrelevant to the case and "inadmissible hearsay."

(More: New York, Connecticut taxpayers look to Plan B options to avoid SALT)

A spokeswoman for New York Attorney General, Letitia James declined to comment. Spokesmen for attorneys in New Jersey and Maryland did not respond to a request for comment.

Georgetown University law professor Brian Galle, who has followed the case, said it's unlikely the states' lawsuit survives long past the June hearing, though he's been surprised before.

"Is it a PR ploy? It's partly that," said Mr. Galle, adding that while he thinks the states' arguments are fragile, "they're not crazy."

"At times people win to the great surprise of law professors everywhere," Mr. Galle said.

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