Cap on tax deductions is challenged by state

Death and taxes have long been regarded as life’s certainties. Maybe add lawsuits. And politics.

The new $10,000 cap on the deductions federal income tax payers can take for their state and local taxes — knowns as the “SALT” deduction — was adopted to help offset the fiscal impact of the tax cuts passed by Republican majorities in Congress in December 2017. Now Connecticut has joined a lawsuit challenging the cap on deductions as unfair to a coalition of states where taxes, real estate values and the cost of living are relatively high.

“The 2017 federal tax law, which resulted from a hyper-partisan and rushed process, drastically reduced the deduction by capping it at $10,000. The cap will cause Connecticut taxpayers to lose an estimated $10.3 billion in SALT deductions in 2018, and will increase Connecticut taxpayers’ federal income tax liability by approximately $2.8 billion in 2018,” said an announcement from Gov. Dannel Malloy and Attorney General George Jepsen in late July.

“This new, drastic curtailment of the SALT deduction has both the purpose and effect of harming Connecticut and other similarly situated states and their residents. Among other things, the new cap will depress home prices, spending, and business sales, and result in slower growth for the Connecticut economy and fewer jobs.”

$27 million?

A separate study of the local impact of the federal “Tax Cuts and Jobs Act,” focusing specifically on Ridgefield taxpayers, was done by student interns who worked in First Selectman Rudy Marconi’s office this spring. They projected a “total taxpayer loss” to Ridgefielders of about $27 million as result of local residents being able to deduct no more than $10,000 for what they pay in both town property taxes and their state income taxes.  

The projection drew astounded reactions when the report was presented to the Board of Selectmen.

“What you’re basically talking about is the town as a whole loses $27 million in discretionary income, that people would donate to charity, or buy clothes,” said Selectwoman Barbara Manners.

Marconi wondered whether the federal tax changes were shaping trends evident in the local real estate market, which town officials track in their regular revenue meetings.

“We’re not seeing the upper end of the market moving,” he said.

But the interns’ work, and the scaffolding of assumptions behind it, were also questioned at the selectmen’s meeting.

“$27 million is a huge number,” Selectman Bob Hebert said.

While projecting the effects of lost deductions as a result of the $10,000 cap, the analysis did not appear to factor in the tax benefits of the reduced tax rates that were a principal goal of the federal tax bill — the tax cuts that the deductions were reduced to at least partially offset.

“There are changes that will be beneficial, as well,” said Assessor Al Garzi.

“We also have the tax bracket reduction,” Hebert said.

“They lowered the percentages of the tax brackets,” said Selectwoman Maureen Kozlark, referring to Congress.

“This is just a part of the pie,” said Selectman Steve Zemo.

The method

The interns — who had some assistance from Garzi — had assumed a median home price of $700,000, and applying the town mill rate they calculated a typical Ridgefielder pays $13,612 in town property taxes. With only $10,000 of that deductible, typical taxpayers would lose an average of $3,612 in deductions per household.

To cover the bulk of residents, they assumed the property owners would fall in the 24% federal income tax bracket, which covers singles from $82,501 to $157,500 and couples from $165,001 to $315,000.

At 24%, the taxes on that no-longer deductible $3,612 would be about $867 per household. With 9,200 households in town, the interns figured the increase in federal incomes taxes paid by all Ridgefielders, as a result of the capped deduction, would be over $7,976,000.

And, using a median household income of $135,000, they’d calculated a Ridgefield household would pay $8,100 annually for the 6% state income tax. With the $10,000 deduction used up on previously calculated town property taxes, the interns figured, taxes on the no longer deductible $8,100, at the applicable 24% federal tax rate, would be $1,944. With 9,200 households, that amounts to some $19,209,600, they said — although a math check suggests this figure should be $17,884,800.

The interns then added $19.2 million in lost income tax savings, to the $7.9 million lost town property tax savings, and calculated that 9,200 Ridgefield households would lose some $27 million as a result of the federal tax bill.

“The estimated total taxpayer loss of $27.9 million does not make any sense,” Hebert said later when The Press asked about the doubts he’d expressed.

Hebert reiterated the view that in a fair analysis the cost to local taxpayers of their lost deductions should be balanced by calculating in the benefit of the reduce federal income tax rates that they’ll be paying.

He cited figures from the Tax Foundation on the size of tax cuts people in the Fourth Congressional District (much of Fairfield County, including Ridgefield) could be expected to receive as a result of the GOP tax bill.

“The Tax Foundation estimates the average 2018 tax cut in the Fourth Congressional District to be $1,937, or 1.4% as a percentage of income based on an average income of $140,311,” Hebert said.

“They estimated tax cut for Ridgefield is estimated to be $2,397 or 1.8% as a percentage of income based on an average income of $135,000.”

(Interestingly, the interns’ projection of $27 million lost, when divided by 9,200 households, works out to $2,935 each, so even with the Tax Foundation’s projected tax cuts subtracted out from cost of the lost deductions, the GOP tax bill would still calculate as a theoretical loss to Ridgefield’s 9,200 households — though more like $5 million than $27 million.)

December change

The “Tax Cuts and Jobs Act” was passed late in 2017 by Republican majorities in both the House and Senate and signed with fanfare by President Donald Trump.

The federal tax bill lowered most tax rates between 0% to 5% from 2017 to 2018, depending on the bracket, with most income levels getting a rate reduction of 3%.

The tax bill also doubled the standard deduction from $6,500 to $12,000 for singles and from $12,000 to $24,000 for couples filing jointly, but also simultaneously eliminated the personal exemption of $4,050 per person or $8,100 for a couple. (The elimination of the $4,050 per person exemption would be especially tough on less affluent families with lots of kids.)

The endpoints of the tax brackets change slightly, as well, from 2017 to 2018, but generally — without factoring in adjustments for lost deductions — the reductions to tax rates are:

  • No reduction at bottom level, for married taxpayers with incomes of less than about $19,000, who will still pay at a 10% rate in both 2017 and 2018;

  • 3% for couples making between about $19,000 and $77,000, with their tax rate falling from 15% in 2017 to 12% in 2018;

  • 3% for couples in the $77,000-to-$165,000 bracket, with rates falling from 25% to 22%;

  • 4% for families in the $165,000-to-$315,000 bracket, with rate falling from 28% in 2017 to 24% in 2018;

  • 1% for couples in the $315,000-to-$400,000 bracket, with rates dropping from 33% to 32%;

  • None for families in the $400,000-to-$600,000 bracket, with tax rates remaining 35% in both 2017 and 2018;

  • 2.6% for couples filing jointly with incomes over $600,000, as rates drop from 39.6% in 2017 to 37% in 2018.

It should be noted that changes to the end-points of the brackets can also have a significant effect. The top bracket started at $470,701 in 2017, and starts at $600,000 in 2018. When combined with the rate changes, this would mean a couple making between $470,701 and $600,000 would see their tax rate drop 4.6% — from 39.6% paid by the top bracket in 2017 to 35% paid by their new second-from-top bracket in 2018).

‘Massive handouts’

But it was not the occasional quirks of the Republican tax bill that Gov. Malloy, a Democrat, cited in announcing that Connecticut would join New York, New Jersey and Maryland in the lawsuit challenging the $10,000 limit or cap on deductions for the state and local taxes — “SALT” deductions.

“President Trump's repugnant tax cuts gave massive handouts to the wealthiest one percent and stuck middle class taxpayers with the bill,” Gov. Malloy said. "Despite massive economic promises from Republicans, real wages have actually decreased since the passage of the tax cut. “At the same time the deficit has exploded by $1.5 trillion,” he said, “providing a convenient excuse for GOP lawmakers to pursue their longtime goal of gutting Medicare, Medicaid and Social Security … This law discriminates against Connecticut taxpayers, who stand to lose over 10 billion dollars in state and local tax deductions. Hundreds of thousands of residents could see a tax increase even as their property values decrease.”