“Presumably, the capping of the SALT deduction program represents the lion’s share” of that revenue boost, according to several law professors and other experts who wrote about the changes in a Dec. 13 paper, “The Games They Will Play.” The paper anticipated the kinds of economic war games that New York and other states are contemplating.
If states’ shifting to payroll taxes becomes a “large enough trend, [it] could wipe out all the savings from the repeal of the SALT deduction -- and then some,” wrote the authors.
That’s because most federal taxpayers don’t itemize their deductions -- meaning they don’t benefit from the SALT write-off for state income taxes. But all employers could deduct payroll taxes as expenses, the paper notes, making “a sizable portion of all current state income taxes deductible.”
The paper notes that “states already impose a payroll tax for unemployment insurance purposes, and many localities impose an additional payroll tax as well -- and employers currently can claim a deduction for their portion of those taxes.”
But that doesn’t mean that making the switch to payroll taxes would be easy for states. Complications include how to adapt state income tax systems with progressive rates -- like the federal tax brackets; how to handle workers in the gig economy with multiple employers; how to address employees who live in one state but work in another; and how to tax non-wage income, such as from investments.
Also, the Internal Revenue Service might not approve of the approach, according to a Jan. 5 report by Jared Walczak, a senior policy fellow at the conservative-leaning Tax Foundation, a Washington policy group. An employer-side payroll tax, paired with a full tax credit, could be seen by the IRS “to constitute payment of an employee’s income taxes by the employer, which would not only negate the benefit of the plan but could actually increase taxpayer liability,” Walczak wrote.
Sinatra’s Line
Hemel said he thinks New York can work through the challenges presented by its progressive state income tax and its many commuters from other states, showing the way for other states with flatter tax systems and fewer cross-border commuters. “Frank Sinatra’s line applies well here: If this can make it there, it can make it anywhere,” he said.
The payroll tax option has “a lot of sticking points, but conceptually it’s a workable scheme,” said Frank Sammartino, a senior fellow at the Tax Policy Center, another Washington policy group.
New Jersey is also looking into the feasibility of a payroll tax, said Representative Josh Gottheimer, a New Jersey Democrat. But he said the potential complications have him more bullish on another idea: letting taxpayers make charitable donations to a state fund that supports public services like education or health care rather than pay that amount in state income tax. Residents would get a state tax credit for the contributions, which they could deduct on their federal returns as charitable donations -- if they itemize deductions.
California’s Considerations
California is pursuing the same approach -- in part because procedural issues there make a payroll tax approach more burdensome, said Kirk Stark, a UCLA Law School professor of tax law and policy. Any tax increase -- including to payroll taxes -- would require a two-thirds approval in both the state Senate and Assembly, and reducing income tax rates in California would require a constitutional amendment, he said. Still, Stark said, it wouldn’t be impossible.