As a Republican bill that would eliminate most of the state and local tax (SALT) deduction advances through Congress, it is prompting newfound concern from politicians and the media in high-tax states about the burdens their wealthy residents face. California governor Jerry Brown, who helped engineer a massive tax hike on his state’s richest residents in 2012, called the federal proposal to end the exemption for local taxes a “gross manipulation” of the tax code and an “attack” on his state—where 98 percent of households earning more than $1 million use the deduction (on average, claiming $462,000 in state and local taxes on their federal tax form). New York governor Andrew Cuomo labeled the reform a “scam,” though Democrats and Republicans have supported it over the years.
The New York Times, under a headline that urges readers to “take claims about the state and local deduction with a grain of salt,” rejected the principal Republican argument for eliminating the deduction: that it serves as a subsidy for high-tax states because it lets them keep their taxes high while giving their residents a break on federal taxes. Instead, the Times argued, states like New York send more money to Washington in taxes than they get back in federal spending, so residents deserve the federal deduction. “Saying Indiana subsidizes New York through the deduction ignores net revenue and spending,” the Times contends. Echoing that argument, Cuomo calls New York a “donor state” to the federal government.
Politicians from high-tax states like New York, California, and New Jersey have made this case for decades, dating back to when former New York senator Daniel Patrick Moynihan first began tracking taxes paid by residents of each state to Washington and comparing them with the amount of federal money flowing into each state. Others have continued Moynihan’s exercise, tracking these flows, but often in the most superficial ways, designed to create the illusion that some states are “dependent” on Washington because they get more than they send, while others are “donors” to the rest of the country.
Much of the money that these analysts count as flowing to the states doesn’t come in the form of discretionary federal aid, however, but as payments that individuals have earned, or for contracts that Washington competitively awards. That’s not exactly “dependency.” As for the revenue side of the ledger, richer states do pay more in net taxes to Washington than less wealthy states, thanks to our progressive tax code—which politicians from “donor” states overwhelmingly support.
An important category of so-called federal spending in the states is retirement benefits, three-quarters of which consists of Social Security payments. Also included are payments to veterans, retirement benefits to federal workers, and disability payments. These are the largest classifications of funds flowing to the states—and they’re a big reason why Blue states fare poorly in the total accounting of federal dollars. On a per-capita basis, California receives the second-lowest annual payments of federal retirement benefits. Illinois ranks fifth-lowest, New York is ninth, and Massachusetts is eleventh. All are so-called donor states. No single cause explains why these states rank so low, but it’s certainly not because the federal government is favoring other states—Washington doesn’t distribute Social Security as discretionary aid. One possible explanation: some of these states often appear on lists of worst places to retire, and census data show a net outflow of older Americans from places like New York, Illinois, and New Jersey. Not surprisingly, warmer Southern states like Alabama, South Carolina, and Florida rank high in their reception of federal retirement dollars.
Another large category of federal spending is contracts, especially defense spending. States like New York and California were once mainstays of defense contracting, but they’ve lost much of their industry over the years and now rank low in per capita defense spending, while Virginia, Maryland, and New Mexico have become ascendant. Though the federal government supposedly awards this spending on merit, over the years it has tried to spread the money around. Its efforts haven’t always been appreciated: in the early 1980s, Defense Secretary Caspar Weinberger, noting the dearth of defense dollars going to New York City, proposed opening a naval base on Staten Island. Much of the city’s congressional delegation blocked the move, and the New York City Council passed a resolution opposing it.
Donor-state politicians regularly lobby for more discretionary federal social spending—that’s often their goal in seeking more money to redress the outflow of dollars from their states. The problem, though, is that these states already get generous amounts of federal social aid. This category, known as grants, includes Medicaid (which accounts for half of the spending) and federal subsidies for housing and local education. New York receives the third-highest per capita funding of any state in this category; other Blue state donors including Massachusetts, Connecticut, California, and New Jersey all rank well above the national average in this spending.
It’s hard to feel sorry for high-tax states when their representatives in Washington willingly raise taxes on their own richest residents. When, for instance, President Clinton proposed cutting the capital-gains tax rate in 1997, members of the New York delegation denounced the move as a gift to the rich, though it disproportionately benefitted New York residents. When President Obama let the tax rate on wealthy individuals rise from 35 percent to 39.6 percent, Democratic senators in California and New York, the two states most heavily affected by the increase, all voted in favor of it, sending more money from those states’ economies to Washington. In New York, the effect of the federal tax hike—on top of state taxes—drove the top rate for wealthy individuals to nearly 50 percent.
All of this helps make the state and local tax deduction such a tempting target. It’s appealing for Republicans to argue that Congress can help fund tax cuts for most Americans by requiring rich New Yorkers and Californians to pay taxes on the $500,000 or so of income that, up until now, they have been able to claim through the SALT exemption. By closing this loophole, Republicans are essentially finding a new way to tax the rich. It’s no secret who they learned that from.
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