Democrats in high-cost, high-tax states are plotting ways to do what their states’ representatives in Congress could not: blunt the impact of the newly passed Republican tax overhaul.
Governors and legislative leaders in New York, California and other states are considering legal challenges to elements of the law that they say unfairly single out parts of the country. They are looking at ways of raising revenue that aren’t penalized by the new law. And they are considering changing their state tax codes to allow residents to take advantage of other federal tax breaks — in effect, restoring deductions that the tax law scaled back.
One proposal would replace state income taxes, which are no longer fully deductible under the new law, with payroll taxes on employers, which are deductible. Another idea would be to allow residents to replace their state income tax payments with tax-deductible charitable contributions to their state governments.
Such ideas may sound far-fetched. And until recently, they were mostly the province of tax professors and bloggers. But they are now getting serious consideration in state capitols where some lawmakers see the Republican law as a thinly veiled assault on parts of the country that typically vote for Democrats.
Companies, of course, have long sought to exploit loopholes in the tax code. Governments, as a rule, have not. State leaders, however, said Congress, in singling out certain states, had broken an implicit compact with the states.
“The game has changed,” said Stephen M. Sweeney, the Democratic president of New Jersey’s Senate. “They’ve completely turned the tables against us.”
Another idea would be for states to partly or completely replace their income taxes with payroll taxes paid by employers, similar to existing taxes for Social Security and unemployment insurance.
In theory, such a move wouldn’t change after-tax income for either companies or individuals. It would just change where the tax checks were coming from. Companies would reduce workers’ pay by the amount of the payroll tax, and would be able to deduct the payments on their federal taxes. Because they would never receive the money, workers wouldn’t be taxed on it.
“In effect, it preserves the state income tax deduction,” said Dean Baker, a liberal economist who has been pushing for the plan.
Republicans argue there is a much simpler solution for high-tax states: lower their taxes.
Joseph Pennacchio, a Republican state senator in New Jersey, said that he opposed limiting the state and local tax deduction but that New Jersey should focus less on gaming the system and more on lowering its tax burden. There are signs that may be happening. Mr. Sweeney, the Senate president, said that because of the new tax law, he had “pressed the pause button” on a plan to impose a new tax on millionaires.
“Maybe people are starting to realize,” Mr. Pennacchio said, “you’ve got to tiptoe when it comes to raising taxes, because it can do more harm than good.”
Still, lawmakers from both parties said it would be hard to cut taxes enough to offset the impact of the new tax law. For one thing, states like New Jersey and New York have high costs of living and high housing costs, not just high tax rates. Even if their tax rates were the same, far more homeowners in New Jersey than in Alabama would hit the $10,000 cap.
But perhaps more significant, cutting taxes would also mean cutting funding for schools, subway systems, anti-poverty programs and other services that residents in those states have come to expect.