Kevin de León, California’s State Senate president pro tempore, is fighting mad. For years, he and his colleagues have worked to expand California’s social safety net, even as much of the rest of the country turned away from any semblance of anti-poverty, progressive politics. Now he feels that the GOP-controlled Congress, in overhauling the tax code, has gone after his state’s residents in the most personal of ways—by raiding their wallets to fund tax cuts for wealthy individuals, big businesses, and the political donor class. “The Republican tax increase bill disproportionately hurts California taxpayers by capping SALT (state and local taxes) deductions. Today, the average California taxpayer takes a $22,000 deduction,” de León pointed out. The GOP measure he said, would “cap it at $10,000, meaning Californians will be double-taxed.”
De León is one of many who believe the tax “reform” legislation was a deliberate attack on those “states that overwhelmingly voted against Donald Trump.” As a result, he argues, California is now in uncharted territory, faced with a hostile federal government and a vindictive president “who personally seeks to negatively impact the sixth-largest economy in the world.”
De León and his colleagues in California’s political leadership have thus concluded that they are in “a race against the clock right now. We’re working feverishly with national tax-law experts to mitigate the damage to California taxpayers.”
As the holidays kicked in, the Senate, the House, the governor, the state’s finance commission, and an array of tax experts began formulating California’s responses. In the first weeks of the new year, these conversations will go public. If, in 2017, California fashioned itself as the epicenter of resistance to Trump’s environmental and immigration policies, in 2018 it will likely aim to position itself at the fore of resistance to Trump’s plutocratic tax policies.
There are three ways the bill hits residents of California, New York, New Jersey, and a handful of other states—all of which are already “donor states,” meaning that their taxpayers send more money to Washington than they get back in federal spending—peculiarly hard: First, in capping the amount of state, local, and property taxes that taxpayers can deduct from their federal income calculations, the bill ensures that middle-income earners in these states will be double-taxed when they pay federal taxes. Approximately 3 million Californians, experts calculate, already pay more than $10,000 a year in state taxes.
Second, in limiting the homeowner mortgage-interest deduction, the bill deliberately targets the middle classes of states like California, where property costs far more than any other state except Hawaii. While progressives have long urged reform of this part of the tax code, their hope was that in eliminating a boon to homeowners, money would be liberated for social spending on affordable housing, health-care expansion, debt-free higher education, and other social goods that would benefit the whole community, including the taxpayers being asked to foot higher bills. Instead, homeowners in Los Angeles, San Francisco, New York, Boston, and other high-cost cities will now be subsidizing billionaires’ tax breaks and a rollback of the estate tax for America’s wealthiest families.
Third, the bill entirely eliminates the personal exemption—a little more than $4,000 per family member—that a family can take off of their taxable income. This deduction was intended to acknowledge that larger families have higher out-of-pocket expenses than do smaller families. Nationally, most households in which couples file jointly won’t see the full effect of losing this exemption, as its cost will be largely offset by the doubling of the standard deduction, from roughly $12,000 to $24,000, as well as a slight lowering of tax rates for most income brackets. But this particular change in the tax code, at the hands of the so-called Family Values party, will hit two groups particularly hard: The first is large families who in the past could protect a significant proportion of their income from the IRS. The second is families who itemize deductions and live mainly in affluent and disproportionately Democratic parts of the country with high costs of living. This sector will be hurt because their annual deductible expenses were already well over $12,000; they won’t benefit from the increased standard deduction, or at least won’t benefit very much, but they will suddenly lose their $4,000 per-person per-year deduction. For a family of four, absent other changes canceling this out, that means an additional $16,000 of their income will be subject to federal taxes.
Left unchallenged, the legislation has the potential to catapult New York, California, and the other high cost-of-living, high-real-estate-value, relatively high-income states into political and economic crisis. After all, in recent years the blue states have made significant efforts to use their state and local tax dollars to boost social-safety-net spending. California has done this by expanding health-care access to millions of residents, by making important environmental investments, and by expanding higher-education grants to large numbers of poorer residents and to the undocumented population.
There’s a political poison pill at the heart of the GOP tax legislation: In restructuring vital deductions, Trump and his Congressional enablers are gambling that electorates in blue states will demand that their state and local governments scale back taxation and local expenditures so as to minimize the cost of the federal changes. If the GOP gamble succeeds, it will strangle blue state efforts to protect, and in some cases expand, vital New Deal and Great Society programs. The goal is to impose a Kansas-like low-tax, low-services model countrywide.
The stakes couldn’t be higher. Which is why California’s legislative leaders are now trying to craft an effective end-run around Congress’s power-grab.
At this point, de León and his colleagues have concluded that compromise is largely futile, and that the best way to respond to the new federal legislation is to be, as de León puts it, “very aggressive. It’s the pick-a-fight strategy.”
To this end, they are making some preliminary noises about re-examining the state property taxes levied on corporations. Like California’s residential property taxes, these taxes are limited by the provisions of Proposition 13, which was passed in 1978 at a time when the state’s taxpayers were in revolt against what they saw as dangerously high taxes. For years now, California progressives have regarded modification of Prop 13 as something of a holy grail; now, they hope, the public, which would have to approve such a change via referendum, will be with them if they make a concerted push for reform.
But changing commercial property tax rates is a longer-term goal, and since increasing taxes at the state level requires either a two-thirds vote in both legislatures or a citizens’ initiative, fundamentally restructuring the tax code by lowering rates on middle-class residents and increasing them on high-end earners and corporations is a hugely risky strategy. Moreover, even if it’s ultimately successful, it would come too late to affect this year’s tax bills.
Which is why tax-law experts like Kirk Stark, Barrall Family Professor of Tax Law and Policy at the UCLA School of Law, have been urging the state to go down a road less traveled. Stark and other specialists, such as Darien Shanske of UC Davis School of Law and Daniel Hemel, of the University of Chicago Law School, have been talking with state officials about ways to convert a large part of the state’s tax receipts into “charitable contributions,” which, under the new tax code, are still deductible from federal taxes.
Here’s how it would work: Many states, in particular red states, already have laws that allow for certain donations to government services—for example, voucher programs used to fund child attendance at private and religious schools—to be 100 percent deductible against state taxes. In other words, if you give $100 to a school voucher program, you either get to pay $100 less in state taxes at year’s end or, if you’ve already paid those taxes via paycheck deductions, you get a $100 refund.
In Alabama, up to $50,000 of such donations to tuition scholarship funds are 100 percent deductible. In South Carolina, there is no limit on the size of such donations. Kansas allows up to $500,000 of donations, at a 70 percent deduction rate. Other states have such deductions on the books for conservation and recreational programs. Missouri has a credit available for donations to a domestic-violence shelter.
What Stark and the others have suggested is a massively expanded use of the tax-credit idea. Stark suggests something like a “California Excellence Fund,” into which the state’s residents could choose to donate money. By statute, the fund would have to turn over all of its dollars to California’s General Fund. The state would then regard such donations as 100 percent deductible from its state taxes. Donate $20,000 to the Excellence Fund, for example, and you would either owe $20,000 less to the state at year’s end or would get a $20,000 refund if you had already paid those taxes. When you file your federal taxes, you would be able to deduct $20,000 instead of the $10,000 maximum allowed for state and local taxes.
The state could in theory also set up a system of charitable contributions to particular parts of the state government—environmental regulatory systems, say, or health-care coverage for undocumented children.
You could, if you liked, increase your federal deduction even more, by giving to the Excellence Fund in excess of what you owe the state in taxes—with that excess still counting as a federal deduction.
Because none of this involves raising taxes, the system could be established via simple majority vote in the legislature rather than the two-thirds vote or citizens’ initiative needed to implement tax increases in the Golden State.
It is, of course, likely that such a move, which could protect billions of California dollars from federal taxation, would be challenged in federal courts. But, says Stark, proponents would be able to cite a 2010 memorandum from the Office of Chief Counsel of the IRS that spells out the value of state tax credits and how the federal government would not regard such tax rebates as “services rendered,” and thus taxable.
Stark points out that Congress would have a hard time legislating against such a move because it would need 60 votes in the Senate (after the stunning victory of Democrat Doug Jones in Alabama, the GOP now holds a narrow, single-vote majority). And if they tried such a move, the Republicans would also have to be willing to go after all those pet charitable deductions now enshrined in red states by the religious right. For both of these reasons, Stark believes, California would be on strong ground heading into the 2018 midterms if it revamped its revenue-gathering systems in this way—and probably on stronger ground afterward if the Democrats pick up seats in or even win control the Senate and/or House.
De León isn’t yet ready to embrace all the specifics of this plan. It’s all happening so fast, he says, since legislators need to revamp California’s code in time for those paying 2018 taxes to avoid suffering a massive financial hit. But he does think it likely that Californians will eventually have the option of making more charitable contributions to the state that are deductible.
“Once we’ve got it all figured out,” he says, “then you’ve got to have a public-relations program to get people to buy in. Remember World War II, and the campaign to get people to buy bonds. It’s the same concept, the same idea.”
Such a campaign would involve framing the charitable state contributions not just as a good personal financial move but as something “statriotic,” or whatever the equivalent of patriotism is for states in an era when the federal government is so hostile to Democratic-controlled states like California.
If it works in California, it’s a fair bet that New York and the other blue states now penalized by Washington would follow with their versions of the Excellence Fund. It won’t make the new federal tax legislation any less heinous. But it might save blue-state residents, and their states’ powerhouse economies, from bearing the worst brunt of the “reform.” It would protect both middle-income residents and the social-safety-net spending their dollars go to locally, while also limiting the dollars sent to Washington to pay for the billionaires’ tax cut.