Blue States Soak The Rich; Red States Sue To Cut Taxes

The Trump tax reform conspicuously targeted high-tax Democratic states. Now that they’re in control, some Democrats have made undoing the damage a priority.

New York Governor Andrew Cuomo has always been more reluctant than other Empire State Democrats to soak the rich—just last summer he warned that raising taxes on the state’s billionaires would mean they’d “just move next door.” But last week he agreed to a budget deal that boosts state income tax rates on millionaires and would leave New York City’s richest paying the highest combined state and local income tax rate in the nation—14.8% on income above $25 million. New York hadn’t held that dubious title since 2012, when California voters hit millionaires with a 13.3% rate. 

Cynics might suggest that Cuomo caved now because he’s been politically weakened by allegations he sexually harassed subordinates and misled the public about the number of Covid-19 deaths among nursing home residents. But the Governor himself offered another explanation for his change of heart: taxes for the richest New Yorkers will actually go down. Huh? 

It turns out Cuomo is counting on a Democratic controlled Congress to repeal the provision in President Trump’s 2017 tax overhaul which capped the federal tax deduction for state and local taxes (SALT) at $10,000 per household. At the time, the SALT cap did political double duty for Republicans: it made high taxes in states run by Democrats even more onerous and it reduced (a bit) the extent to which the Trump tax cuts tilted towards the rich.  “When SALT is repealed, taxes net in New York State will be lower,” Cuomo insisted Wednesday. “Taxes go up? No. SALT will reduce the tax impact by 37 percent.” (That 37% is, of course, the current top federal tax rate; if President Biden has his way, it could go higher.)

While attention has focused on Biden’s plan to raise federal taxes on corporations and individuals earning more than $400,000, another tax war has been raging around the country—and is itself affecting Washington maneuvering. According to data collected by the Urban Institute, between April and December of 2020, a majority of states collected less tax revenue than in the year before, even as the pandemic put increased demands on their budgets. The five hardest hit states—Alaska, Hawaii, North Dakota, Nevada and Florida—are heavily dependent on tax revenue from either oil or tourism.

While the damage didn’t hew to partisan lines, the responses have. Some Republican led states are considering cutting taxes to revive their economies—or at least want the freedom to do so. So far, a total of 18 red states are plaintiffs in five separate lawsuits challenging a provision in the $1.9 trillion American Rescue Plan Biden signed into law last month which says that state governments cannot use any of the $350 billion in federal pandemic relief funds coming their way to “either directly or indirectly offset a reduction” in their net tax revenue resulting from state tax cuts. In a letter to Treasury Secretary Janet Yellen, 21 Republican state attorneys general described it as “the greatest attempted invasion of state sovereignty by Congress in the history of our Republic.” 

Meanwhile, politicians in red states are pushing assorted tax cuts. Newly elected Republican Montana Governor Greg Gianforte is pushing a small cut in the state’s income tax rate and a new capital gains tax exemption for job creators as part of his ”Montana Comeback” plan. 

Republican Governor Jim Justice of West Virginia—who recently fell from the billionaire ranks—wants to go even further. He’s pushing a “Justice 4 All” plan to eliminate the personal income tax in his state, which he claims will spur job creation, attract new residents and help reverse the state’s steady population decline. Legislation incorporating elements of the plan, which would slowly phase out the income tax and replace some of the revenue with a higher sales tax, passed in the West Virginia Senate but was soundly rejected by the House of Delegates on Friday. Justice has vowed to continue fighting for the plan.

Missouri State Senator Lincoln Hough, a Republican, introduced legislation last month that would reduce the state’s income tax by half a percentage point and argues that any money distributed to Missouri under Biden’s plan should be returned to taxpayers. “It’s their money and they should get to decide what’s best for themselves and their families.” 

By contrast, Democratic state politicians have been targeting the wallets of their wealthiest residents—a longstanding instinct reinforced by the fact that the rich have done extraordinarily well during the pandemic. (By Forbes’ latest tally, billionaires’ wealth worldwide surged to $13.1 trillion as of March 5th, up from $8 trillion the year before.)

It’s not just New York that is seeking to extract more from the rich. Hawaii’s state legislature has been considering a slew of tax changes, including creating a new top marginal tax rate of 16% (up from 11% now) and hiking capital gains taxes as well as the corporate tax rate. Minnesota’s governor is pushing for higher taxes on the rich. And while embattled California Gov. Gavin Newsom has promised to veto any income tax rate hikes, that hasn’t stopped some Democrats in the legislature from pushing for an even higher millionaires tax. 

Massachusetts, which now has a flat tax of 5% on most income, is considering putting a constitutional amendment on the state ballot allowing an additional 4% tax for millionaires.  There’s no guarantee, of course, that this would pass in liberal Massachusetts, which back in the 1980s was known as Taxachusetts. In November, Illinois voters rejected an initiative, backed by billionaire Democratic Gov. Jay Pritzker, that would have allowed the state to raise its flat 4.95% state income tax for the highest earners. But at the same time, Arizona voters approved a 3.5% tax surcharge, on top of the state’s current top rate of 4.5%, bringing its top rate to 8%. 

Overhanging the tax-the-rich momentum is the fear that states’ richest residents, having learned how to work from anywhere during the Covid-19 pandemic, will flee.

Of the nine U.S. states without a broad personal income tax, the bluest is arguably Washington state—home to the world’s richest man, Amazon founder Jeff Bezos. Back in 2010, that state’s voters soundly defeated an attempt (spearheaded by the late Bill Gates Sr. and opposed by Bezos) to impose an income tax on upper income residents. Now Gov. Jay Inslee is pushing a 9% tax on net long-term capital gains above $50,000 per couple. And on March 31, the state’s  House Committee on Finance advanced a bill that would impose a 1% annual wealth tax on intangible personal property (stocks and bonds, for example) worth in excess of $1 billion, explicitly noting in its report how well billionaires have fared during the pandemic. 

Overhanging the tax-the-rich momentum, however, is the fear Cuomo expressed last year: that the richest residents, having learned how to work from anywhere during the pandemic, will flee. Certainly some high profile recent moves suggest that’s possible, with Elon Musk, miffed at Covid-19 restrictions in California, leaving for no-state-income-tax Texas and legendary trader Carl Icahn (whose hand has been less than hot in recent years) moving his office from Manhattan to state income-tax-free Florida. 

Indeed, there were similar fears (or hopes depending on which state house you occupy) three years ago when Trump’s SALT cap took effect. Despite anecdotal reports of an exodus, “there is no clear indication of [that trend],” says Lucy Dadayan, a senior research associate at the Urban-Brookings Tax Policy Center. Data shows that New York had been losing taxpayers, she says, but California gained them.   

In Forbes’ most recent count, California and New York still rank first and second as home base for the 732 billionaires living in the U.S., with 189 and 126 respectively. Florida ranks third, with 70 billionaires, including ex-New Yorker and ex-President Donald Trump, now living at his Mar-a-Lago Club in Palm Beach. Texas has only 64, even counting Musk, who rose to #2 on Forbes’ 2021 billionaire list. 

Often, there are personal considerations (besides a visceral dislike of taxes) behind high-profile moves. Hedge fund billionaire David Tepper famously blew a hole in New Jersey’s budget when he moved (along with his firm, Appaloosa Management) to Miami Beach in 2016. But he had also split from his wife and his mother lived in Florida. Last year he returned to New Jersey, where his new wife has long resided.  

Truth is, people move for all kinds of personal reasons beyond taxes. “There’s a lot more than a simple, ‘the rate goes up and people move,’” says Walter Calvert, a partner at law firm Venable who specializes in state and local taxation. Notably, last year, after Oracle moved its headquarters from California to Austin, Texas, billionaire co-founder Larry Ellison moved his own residence to high-tax Hawaii, noting in a memo to employees that “I’ll be using the power of Zoom to work from the island of Lanai.” (Oracle declined to comment on whether Ellison’s reported purchase of an $80 million Palm Beach mansion means he’ll now seek to become a resident there.)

Regardless of Ellison’s plans, given the work-from-anywhere culture enabled by Zoom and the cloud, there’s enough fear of rich flight that some Democrats are pushing hard for the return of a full deduction for state and local taxes.

“Folks have been moving away in droves since our state and local tax deduction was gutted.”

Seven Democratic governors, including Cuomo, Newsom and Pritzker sent a letter to Biden this month urging him to support repeal of the SALT cap, which they said unfairly subjects Americans to double taxation since money they’ve handed over to their state and local governments is being taxed again by Uncle Sam. “Like so many of President Trump’s efforts, capping SALT deductions was based on politics, not logic or good government. This assault disproportionately targeted Democratic-run states, increasing taxes on hardworking families,”’ they wrote. “This was unacceptable then, and is simply untenable given the dire economic conditions caused by the pandemic.’’ 

Both House Speaker Nancy Pelosi, from California, and Senate Majority Leader Chuck Schumer, from New York, support restoring the deduction. Eight House Democrats are even threatening to oppose President Biden’s $2 trillion plus infrastructure bill unless it repeals the SALT cap. Rep. Josh Gottheimer (D-N.J.) is among those lawmakers. “Folks have been moving away in droves since our state and local tax deduction was gutted,” he said at a January press conference held in front of a U-Haul truck to drive his point home. 

But repealing the cap is distasteful to some other Democrats because it disproportionately benefits the better off—and leaves the party open to charges of hypocrisy when it comes to taxing the rich. None other than JPMorgan Chase Chairman and CEO Jamie Dimon, in his letter to shareholders released this past week, indulged in some finger wagging, saying that it’s not only businesses that put their own interests ahead of what’s best for the country. Wrote Dimon: “State and local governments are equally to blame. Take for instance, fives states (California, Connecticut, Illinois, New Jersey and New York) that continue to fight for unlimited state and local tax deductions (because those five states reap 40% of the benefit) even though they are aware that over 80% of those deductions will accrue to people earning more than $339,000 a year.”