Since 1861, every version of the federal income tax has included a deduction for state and local taxes (often referred to, using a popular tax acronym, as the “SALT deduction”). Since the SALT deduction minimizes the effect of state and local taxes on taxpayers, it offers greater benefits to those living in states that impose the highest tax burden: the high-tax “blue” states. In 2017, the Tax Cuts and Jobs Act marked a major shift in this long-established federal policy toward state taxes. Among its many provisions, the Act capped the SALT deduction at $10,000 per married couple, providing no federal tax offset for amounts paid in excess of that amount.
Leaders of blue states balked at the change. They accused federal officials of targeting their states for political reasons. They sued the federal government to try to reverse the legislation. They decried that the 2017 law violated key principles of federalism and that it would prompt an economic civil war between the Democratic blue states and the Republican red states.
This Article attempts to address two questions raised by this turn of events. First, how will states respond to this change in federal law? Second, does the capping of the SALT deduction represent a major shift in federal-state relations, an unprecedented attack on blue states, or is it simply politics as usual?
This Article's novel approach to the subject is to consider these questions by exploring the similarities and contrasts between the federal income tax SALT deduction and the federal estate tax state death tax credit, which was established in 1924 and repealed in 2001.
Viewing the 2017 legislation within this broader historical context reveals trends and patterns, providing greater insight than would a study of the SALT deduction in isolation.
This approach yields two results. First, analyzing state legislative responses to the 2001 estate tax changes helps to predict how state governments may respond to the 2017 income tax changes and thus offers insight into the future evolution of state income tax regimes. Second, placing the 2017 Tax Act in a broader historical context reveals a pattern of federal interference with state tax regimes, yielding lessons about the interdependence of federal and state tax law as well as how a changing political climate can shape tax policy.
On issues of tax policy, the nation has increasingly become divided into blue states and red states. In broad strokes, the blue states typically impose a greater overall tax burden on their citizens and are more likely to impose higher state income taxes than their ruby-colored siblings. Since its inception, the federal income tax regime has blunted the effect of these differing tax policies by offering taxpayers a federal income tax deduction for their payment of state and local taxes, popularly referred to as the “SALT deduction.” The SALT deduction facilitates the collection of state and local taxes by reducing the net “cost” of those taxes borne by taxpayers.
In 2017, the Tax Cuts and Jobs Act (2017 Tax Act) marked a major shift in this long-established federal policy toward state taxes. Among its many provisions, the 2017 Tax Act capped the SALT deduction at $10,000 per married couple or $5,000 for a single taxpayer, and it provides no federal tax offset for SALT payments in excess of those amounts. The changes are effective for tax years 2018 through 2025.
The response from state leaders in high-tax, blue, states was predictable. New York Governor Andrew M. Cuomo may have been among the most vocal of these critics. Cuomo asserted,
Washington has launched an all-out direct attack on New York State’s economic future by eliminating full deductibility of state and local taxes. . . . You’re now robbing the blue states to pay for the red states. It is crass, it is ugly, it is divisive, it is partisan legislating, it is an economic civil war. And make no mistake, they are aiming to hurt us. This could cause people to leave the state of New York.
He promised to protect the blue states from this “politically motivated” and “unprecedented” Congressional assault.
Cuomo’s strong words were not his only response to the 2017 law. He and three other blue-state governors also brought a federal lawsuit, seeking to set aside this “unconstitutional assault on the States’ sovereign choices.” That action, filed July 17, 2018, and captioned New York v. Mnuchin, is working its way through the federal courts.
Cuomo’s characterization of the 2017 Tax Act as an assault on New York’s tax system and his fear that it may cause an out-migration of New Yorkers reveals the extent to which federal and state tax law and policy are intertwined. A shift in national tax policy can immediately impact state tax regimes; taxpayers rethink where they live and work and states reevaluate their tax regimes.
In the case of the cap on the SALT deduction, politicians and policy analysts may wonder what the federal change will mean for the income tax regimes in blue states like Cuomo’s New York. How will those lawmakers respond to the prospect of their residents migrating to more politically hospitable, redder states? Does the capping of the SALT deduction represent a major shift in federal-state relations, an unprecedented attack on blue states, or is it simply politics as usual?
This Article makes a novel attempt to explore such questions by comparing and contrasting the SALT income tax deduction and the estate tax state death tax credit, a long-standing provision of federal estate tax law that had offered a federal credit to offset state death taxes. In 2001, as part of the Economic Growth and Tax Relief Reconciliation Act (2001 Tax Act or EGTRRA), Congress repealed the state death tax credit and replaced it with a deduction. This 2001 change in federal tax law prompted a major shift in state tax policy, as more than half of all state legislatures altered, or completely eliminated, their state estate tax regimes in response. Congress then prompted further changes as it repeatedly raised the federal estate tax exemption, subjecting fewer and fewer estates to federal estate taxation and thus reducing the number of estates that could utilize the new deduction.
By comparing and contrasting the history of these two somewhat analogous provisions, the state death tax credit and the SALT deduction, this Article aims to achieve two results. First, analyzing state legislative responses to the 2001 estate tax changes may help predict how state governments will respond to the 2017 income tax change, and thus offer insight into the future evolution of state income tax regimes. Second, placing the 2017 Tax Act in this broader historical context reveals a pattern of federal interference with state tax regimes, yielding lessons about the interdependence of federal and state tax law and how a changing political climate can shape tax policy.
This Article is organized as follows. Part II provides a brief overview of both the state death tax credit and the SALT deduction. Part III illustrates several ways in which states responded to the repeal of the state death tax credit and the subsequent changes in federal estate tax laws, creating a taxonomy of major responses. Part IV then applies that taxonomy to the question of the SALT deduction, drawing relevant lessons about the past interplay between federal and state tax policy in an effort to help predict future state legislative responses. Part V explores more general lessons about the interaction between federal and state tax policy and the ongoing battle between red and blue states, before offering a brief conclusion.
This Part provides a brief overview of the state death tax credit and the SALT deduction, setting out their historical origins and indicating how both were altered by 21st century Congressional action.
The history of state death taxes can be traced back to Colonial America, where colonies imposed probate fees at death. In 1826, Pennsylvania became the first state to enact a formal death tax. By the beginning of the 20th century, various forms of death taxation had grown to be significant sources of state revenue. When Congress instituted the federal estate tax in 1916, its incursion into a sphere of taxation previously reserved to the states raised crucial policy questions. Was it proper for the federal government to step into this new field of taxation? If so, did it have any obligation to ensure the continued viability of the state estate tax regimes?
This policy debate ended with the institution of a mechanism known as the state death tax credit. Ultimately codified in section 2014 of the Code, the state death tax credit provided a decedent’s estate with a dollar-for-dollar credit against federal estate taxes for state death taxes paid up to specified limits. To the extent that state death tax was imposed at or below this limit, the state tax was fully offset by the federal credit, thus effectively providing a “free” source of revenue for states.
Eventually, every state modified its estate tax regime to take advantage of the state death tax credit, with the vast majority of states imposing estate taxes exactly equal to the available federal tax credit. As a result, these states were able to collect this form of revenue without suffering any competitive disadvantage relative to other states. The result was a dramatic increase in the utility of estate taxes as a form of state revenue and a dramatic lessening of interstate competition.
For eight decades, the credit remained in place. Then, by enacting EGTRRA in 2001, Congress repealed the credit and replaced it with a deduction. The repeal was phased in over four years and became fully effective in 2005. By its terms, the repeal was slated to sunset after 2010, at which time the deduction would revert back to a credit. Ultimately, however, the repeal was extended and then made permanent, thus also making permanent the deduction for state death taxes.
After repealing the state death tax credit, Congress was not done tinkering with estate taxation. Rather, Congress has repeatedly raised the amount of the “unified credit,” the exemption level below which estates are exempt from federal estate taxation. To the extent that these changes reduce the number of estates subject to federal estate taxation, they also reduce the number of estates that can utilize the deduction for state death taxes. Thus in addition to replacing a credit with a deduction, Congress has actively reduced the number of estates that can make use of that deduction.
The results have been grim for state estate tax revenues. In the year 2000, the state death tax credit enabled every jurisdiction to collect a state estate tax, with a total collection of approximately $8 billion. By 2018, just 18 jurisdictions imposed a state estate tax and total collections had declined to $4.6 billion.
The SALT deduction traces its origins back to the very beginning of federal income taxation. The 1861 income tax, the nation’s first, included a deduction for state and local taxes. Over time, that deduction was refined, but never eliminated. Eventually, the deduction was codified as section 164 of the Code, and it became a seemingly-permanent fixture of federal law.
As had been the case with the state death tax credit, the SALT deduction’s perceived permanence proved illusory. The 2017 Tax Act imposed new limits upon the SALT deduction, capping that deduction at $10,000 for married taxpayers filing jointly or $5,000 in the case of a married individual filing a separate return. Taxpayers receive no marginal federal tax benefit for payment of SALT that exceeds the cap.
The repeal of the state death tax credit and the capping of the SALT deduction are analogous legislative events. Both represent a major change in a long-standing provision of federal taxation. Both increase the prospect of double taxation and increase the net out-of-pocket costs for taxpayers exposed to both federal and state taxation. Both provide powerful incentives for states to alter their tax policies and for taxpayers to migrate from high-tax jurisdictions to lower-tax ones. In broadest strokes, both favor red states over blue ones.
The analogy between the estate tax and the income tax is in no way a perfect one, and the state death tax credit and the SALT deduction differ in material ways. Nevertheless, enough similarity remains so that the history of state estate taxes after the repeal of the state death tax credit may yield crucial insight into how state legislatures might respond to the capping of the SALT deduction. Specifically, the history of state estate taxes in the last two decades offers an opportunity to see how states organized their tax regimes around the existence of a federal credit, and how they responded when Congress first replaced that credit with a mere deduction and then reduced the number of estates that could utilize that deduction. As discussed more fully in subsequent Parts, those lessons from the history of estate taxes can both help predict how states might respond to the capping of the SALT deduction as well as yield broader lessons about the interplay of federal and state tax policy.
This Part reviews how states modified their state estate tax regimes to respond to the repeal of the state death tax credit and its replacement with a deduction, aggregating those responses into several major categories.
Twenty-nine states completely abandoned estate taxes as a form of revenue production in response to the repeal of the state death tax credit. These states reached this result in one of two ways.
For 24 of these states, the passage of EGTRRA automatically brought an end to the state’s estate tax. In each of these states, the state estate tax was structured as a “pick-up” or “sponge” estate tax, defined by reference to any available federal credit. Accordingly, when that credit disappeared, so too did the state estate tax. In the states that had structured their state estate taxes in this manner, legislative action would have been required to reinstitute an estate tax. As discussed below, other similarly-situated jurisdictions enacted new forms of state estate taxes. But none of these 24 jurisdictions did so.
Five other jurisdictions—Arkansas, Idaho, Iowa, South Carolina and South Dakota—affirmatively repealed their state estate taxes soon after the passage of EGTRRA by updating statutory cross-references to the Code. Prior to EGTRRA, each of these states had imposed an estate tax based on the state death tax credit as it existed prior to EGTRRA; thus such taxes should have remained in place even after the state death tax credit phased out. However, these states took legislative actions that affirmatively eliminated their state estate taxes as the state death tax credit phased out, ensuring that they would no longer impose a state estate tax that was not fully offset by an available federal credit. While such activities could be characterized as mere legislative “housekeeping” designed to update the states’ cross-references to the federal estate tax statute, they nevertheless represented conscious legislative choices to allow EGTRRA to have the effect of repealing the estate tax in those states.
Some of the states discussed above, including Arizona and Arkansas, are worthy of special note insofar as their estate taxes were repealed twice. The first repeal in Arizona was an automatic one, as the state had a pick-up estate tax that was rendered ineffective by the passage of EGTRRA. Nevertheless, the state legislature subsequently took the additional step of affirmatively repealing the defunct tax. Arkansas’ estate tax had been computed by reference to the state death tax credit in effect on January 1, 1999, and thus remained in place after EGTRRA. In 2003, however, the state updated that cross-reference to read January 1, 2002, thus codifying the effects of EGTRRA and nullifying the state estate tax. The legislation took the further step of providing that the state’s entire estate tax “shall cease to be operative when the federal Credit for State Death Taxes set forth in 26 U.S.C. § 2011 is repealed completely for the estates of decedents dying on or after January 1, 2005.”
As discussed further below, these double repeal states offer crucial evidence about the intensity of interstate competition on tax policy and the desire of some states to identify themselves as being low-tax jurisdictions for purposes of attracting and retaining wealthy citizens.
A second major category of state responses includes those states that initially attempted to maintain a state estate tax after EGTRRA but later abandoned that effort. The nine states in this category are: Delaware, Kansas, Nebraska, New Jersey, Ohio, Oklahoma, Pennsylvania, Virginia, and Wisconsin.
Four of these states—Kansas, Ohio, Oklahoma, and Virginia—had stand-alone estate taxes that were unaffected by EGTRRA but which the state legislature subsequently repealed. The other five states saw their state estate taxes disappear in three steps: (1) the pick-up estate taxes were nullified by EGTRRA; (2) the states then enacted stand-alone estate taxes designed to replace the pick-up taxes; and (3) the states reversed course by repealing the stand-alone estate taxes entirely. For these states in particular, the road to repeal was full of twists, turns, and political battles.
Consider, for example, the case of Delaware. Prior to 2001, the state had a pick-up estate tax that was effectively repealed in 2005 due to EGTRRA. Effective 2009, Delaware attempted to recover the lost revenue by enacting a stand-alone estate tax which included the rate table from the state death tax credit as it existed prior to EGTRRA. That effort proved politically controversial and ultimately short-lived, as Delaware repealed that tax effective in 2018.
Delaware and the other states in this category—Nebraska, New Jersey, Pennsylvania, and Wisconsin—all ultimately agreed that a stand-alone estate tax was not worth either the political conflict it generated or the risk that it would incentivize wealthy taxpayers to leave the state.
In 13 jurisdictions—Connecticut, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington—state estate taxes still exist. In several of these states, they exist because the drafting of the state estate tax was such that the tax was not calculated by reference to the state death tax credit and thus did not disappear when that credit was repealed. In others, state legislators imposed new stand-alone estate taxes after repeal of the state death tax credit, and those taxes remain in place today. Many of these states designed their estate taxes to replicate a pick-up tax, utilizing the exemption level and rate structure in place prior to EGTRRA.
As discussed more fully below, most of the states in this category have increased their state estate tax exemption in response to increases in the federal exemption. While this structural pattern serves many purposes, including administrative efficiency, it also has the practical effect of ensuring that the state estate taxes are payable only by estates that are large enough to generate an offsetting federal estate tax deduction for the payment of those state taxes.
Even in the states that still impose estate taxes, the future of those taxes remains somewhat uncertain. The federal estate tax exemption has continued to increase, making the federal estate tax irrelevant for, and thus a deduction for state death taxes useless to, the vast majority of Americans. The states in this category may have retained their state estate taxes, but not at the same rate and perhaps not for long.
This Part identifies three key lessons revealed through a study of EGTRRA and its effect on state estate taxes: (1) a federal credit has a far greater ability to shape state tax policy than does a mere deduction; (2) states will actively restructure their own state tax regimes in an effort to maximize federal tax deductions for their taxpayers; and (3) state leaders will actively exploit different tax treatment among jurisdictions as part of ongoing interstate competition to attract wealthy taxpayers and business capital. An understanding of these state responses to EGTRRA and its aftermath may help predict state responses to the 2017 Tax Act.
The first lesson to be learned from the history of the state death tax credit provides a bit of good news to beleaguered blue states: a credit like the state death tax credit was superior to the current deduction as a tool for a limiting interstate competition and facilitating the imposition of a state tax. Accordingly, the capping of the SALT deduction should not generate the same level of disruption and crisis as did repeal of the state death tax credit.
There are two major reasons for this phenomenon. First, the state death tax credit and the SALT deduction were structured in very different ways. The state death tax credit was based on a specific rate table codified in section 2011 of the Code, and it only applied to death taxes imposed at the state level. As noted above, this structure made it a relatively simple matter for states to draft statues imposing a “pick-up” state estate taxes, the amount of which were defined by reference to the maximum federal credit. When Congress repealed that credit, it also effectively repealed all of the state death taxes defined by reference to that credit, confronting states with an immediate revenue loss.
In contrast, the SALT deduction was unlimited in amount and applied to the cumulative total of various taxes imposed by different government entities. Accordingly, there was neither a way for a state to construct a “pick-up” state income tax nor any reason for states to do so. As a result, the capping of the SALT deduction has neither direct nor immediate effect on the state income tax regimes and the revenues they produce.
Second, a deduction in general has less marginal impact on an individual’s tax liability than does a credit. As a result, the capping of the SALT deduction has a far less dramatic effect on taxpayers’ marginal rates than did repeal of the state death tax credit. To appreciate this distinction, one must understand the significant operational differences between a credit and a deduction. A credit provides a dollar-for-dollar reduction in tax liability. In the case of the state death tax credit, this meant that state estate taxes up to the amount of the credit would be fully offset by a dollar-for-dollar reduction in federal estate taxes due, the result being that a state tax resulted in no net increase in total taxes paid by a given estate. In contrast, a deduction reduces the amount subject to tax rather than the amount of the tax itself. Put another way, it provides only a partial offset equal to the amount of the deduction multiplied by the applicable marginal tax rate. Thus, assuming a marginal tax rate of less than 100%, a deduction will always have less value to a taxpayer than would a credit.
A comparative example should help illustrate this distinction. Assume that an estate paying federal estate tax at a marginal 55% rate was located in a “pick-up tax” jurisdiction, such as New York, that assessed a state estate tax at a maximum marginal rate of 16%. An incremental dollar of taxable estate thus would generate 55 cents of gross federal estate tax, 16 cents of state estate tax, and 16 cents of federal credit. The result would be a payment of 16 cents to the state and 39 to the federal government, for a total tax of 55 cents. After the state death tax credit was replaced with a deduction, that same payment of 16 cents of state estate tax would merely reduce the amount subject to federal estate tax from one dollar to 84 cents. When the 55% rate was applied to that 84 cents, the result would be 46.2 cents of federal estate tax due. Instead of generating combined state and federal estate tax at a combined 55% marginal rate, that estate would pay 16% to the state and 46.2% to the federal government, for a combined marginal rate of 62.2%. The difference represents the 7.2% higher marginal rate resulting from the credit’s repeal.
A similar example in the income tax realm yields a far less dramatic result. Assume now that same taxpayer discussed above is alive and subject to income tax at the current maximum 37% federal rate and 8.82% New York rate. An additional dollar of taxable income thus would generate 8.82 cents of state income tax. Assuming that the taxpayer is entitled to a SALT deduction for this amount, the amount subject to federal income tax would be reduced from one dollar to just under 91.2 cents, and lower the federal tax bill from 37 cents ($1.00*37%) to 33.7 cents ($0.912*37%), a reduction in the effective marginal rate of only 3.3%. For this taxpayer, the capping of the SALT deduction only increases the effective income tax rate by a mere 3.3%, a far less dramatic swing than the 7.2% increase in estate tax marginal rates caused by the repeal of the state death tax credit.
In sum, the structural differences between the SALT deduction and the state death tax credit make the capping of the SALT deduction a far less significant event than the repeal of the state death tax credit. Because states did not draft their state laws by reference to the SALT deduction, as they had in the case of estate taxes, the capping of that deduction has no direct impact on state income tax regimes and no immediate effect on state revenues. In addition, due to the fact that a SALT deduction offers taxpayers smaller benefits than the state death tax credit, the capping of the SALT deduction has a less dramatic impact on taxpayers than the repeal of the state death tax credit.
As a result of these differences between the state death tax credit and the SALT deduction, we may rightly expect the capping of the SALT deduction to generate a more muted state legislative response than the repeal of the state death tax credit. This may be a silver lining in the political cloud now hanging over blue states.
The next lesson to be learned from the history of the state death tax credit is that state legislatures will seek to maximize available federal deductions for their taxpayers and avoid imposing state taxes on those who cannot utilize the resulting federal deductions.
As illustrated above, with a federal credit in place, states could impose tax up to the amount of the credit without imposing any net tax on their citizens. With a mere deduction, the offset is incomplete, as the deduction serves to reduce but not eliminate taxes. Going one step further, according any value to a deduction presupposes that a taxpayer will owe the tax that is reduced by the deduction. After all, a deduction has no value if the taxpayer does not have any federal tax liability that will be reduced by the deduction; that taxpayer cannot use the deduction. As a result, a state seeking to maximize the value of a federal deduction for its taxpayers, in the aggregate, should theoretically seek to ensure that the state tax is only paid by those taxpayers who have a federal tax liability to offset.
State legislative activity in the past two decades demonstrates that state governments followed this pattern when responding to EGTRRA. Specifically, in this regard, consider state legislative responses to post-2001 increases in the federal estate tax exemption. As that exemption increased, fewer taxpayers paid federal estate tax, and thus fewer taxpayers could benefit from a deduction for state estate taxes. The states that continued to tax an estate below the applicable federal exemption imposed a tax on taxpayers who could derive no federal tax benefit with respect to the state estate taxes paid.
As a consequence, many states that continue to impose state estate taxes have sought to avoid this result by increasing their state estate tax exemptions to match the federal exemption. While such an approach achieves administrative efficiencies by requiring state tax returns only when federal returns are also due, it has the significant effect of imposing state estate taxes only on those who also owe a federal estate tax against which to deduct those state taxes. Thus, while states can no longer freely impose taxes on taxpayers without any net effect, they are seeking to avoid the situation in which state estate taxes are imposed on those taxpayers who will not receive any offsetting federal deduction. While not nearly as significant an incentive in the structure of state estate taxes as the state death tax credit had once been, the federal deduction for state death taxes continues to have an effect on the structure of state estate tax regimes.
Applying this lesson to the 2017 Tax Act suggests that states similarly will attempt to structure state taxes to maximize the deductions available to their taxpayers. Indeed, this thesis has been borne out by states’ early effort to restructure state income taxes, which are subject to the $10,000 cap, into a different form that might still qualify for a deduction.
The initial effort in this regard attempted to convert some state taxes into deductible “charitable contributions.” Several states pursued this strategy, establishing charitable funds used to benefit the state government that allowed contributions to such funds to offset taxpayers’ state tax liabilities and potentially qualify as a charitable contribution deduction for federal income tax purposes. This effort was thwarted by subsequent federal regulations denying a federal deduction for these “charitable contributions.” Although unsuccessful, at least for now, the effort reflects the same general theme on display in the estate tax regime after EGTRRA, namely states attempting to structure their state taxes in a manner that will maximize their taxpayers’ offsetting federal deduction for that tax, even if the change provides no additional state revenues.
Indeed, the attempt to convert taxes into charitable gifts was not the only effort by states to restructure state tax regimes to maximize their taxpayers’ federal deductions. Connecticut, for example, altered its state income tax regime by enacting a pass-through entity tax. This new tax, designed in direct response to the 2017 Tax Act, allows a pass-through entity, such as a partnership or LLC, to deduct state income taxes at the entity level rather than passing those deductions through to the individual partners to report on their personal returns. When taxes are deducted at the entity level they are not subject to the $10,000 cap on the SALT deduction, whereas they are subject to this cap if passed through to the individual partners. Other states have followed the same route by enacting their own entity-level tax or are considering doing so.
States are also considering even more dramatic ways to restructure state income taxes to maximize available deductions for taxpayers. For example, as part of its 2019 Budget Act, New York created the Alternative Employer Compensation Expense Program. Touted as “part of Governor Cuomo’s multi-pronged effort to fight the federal tax assault” represented by the capping of the SALT deduction, this optional program enables employers to collect a 5% payroll tax on employees that would offset the employees’ state income tax liability. The result effectively converts SALT that are subject to the $10,000 cap into payroll taxes that are fully deductible by the employer. Similar taxes are under consideration elsewhere.
All of this legislative activity demonstrates the extent to which states are attempting to redesign their state income tax regimes in response to changes at the federal level, with the ultimate goal of maximizing federal deductions available to their taxpayers. Just as many of these same states raised their estate tax exemptions to allow taxpayers to avoid paying an estate tax at the state level that would not generate a deduction at the federal level, so too are these states redesigning their income and payroll tax laws to achieve a similar result.
In sum, the second lesson of the history of the state death tax credit is that states will structure their tax regimes in an effort to maximize their taxpayers’ available federal deductions. We thus may expect ongoing state legislative efforts to restructure state income taxes in response to the capping of the SALT deduction.
The third lesson learned from state responses to EGTRRA is that interstate competition among states is alive, well, and fierce. The willingness of state governments to actively solicit wealthy citizens and exploit differences in tax rates is a dynamic and powerful force. Nearly a century ago, it was the prime reason that Congress instituted the state death tax credit. In an age of social media, 24-hour news, and polarized national politics, the effect is arguably more powerful today than it was in decades past.
The Congresses of the 1920s dramatically underestimated the lingering force of interstate competition. They predicted that the state death tax credit could be safely repealed after being in effect only a few years, expecting that once uniformity was achieved, state governments would allow it to stay in place. In essence, the credit’s architects predicted that the states would form what amounted to a noncompetitive cartel on the issue of state death taxes, and would learn to cooperate, rather than compete, in efforts to collect such taxes.
The events occurring after EGTRRA have proven that prediction incorrect. Consider in this regard Arizona. As of 2001, Arizona had a pick-up estate tax that was rendered ineffective by the passage of EGTRRA’s repeal of the state death tax credit. However, as noted above, EGTRRA was scheduled to sunset in 2010. Accordingly, Arizona’s estate tax could be expected to spring back to life in 2011, placing the state back on equal footing with all the other states who would see their pick-up estate taxes similarly restored. But, as noted above, rather than allowing this possibility to play out, Arizona affirmatively repealed its dormant tax in 2006. The only real consequence of this legislation was that if EGTRRA were to sunset as scheduled in 2010, Arizona’s estate tax would not return.
In that event, Arizona estates would receive no actual benefit—their federal estate taxes would increase by an amount equal to the unutilized credit. Accordingly, one may rightly ask why Arizona chose to make this legislative move at a time that its estate tax was idle and not affecting any Arizona estates. While the record is not clear, the obvious answer is that the repeal was pure political theater—a chance for Arizona to show just how opposed it was to estate taxation and to publicly reaffirm its position as a red-state retirement haven. Arkansas similarly repealed its tax before waiting for EGTRRA to sunset. The pick-up tax cartel had fallen apart.
To the extent that Congressional leaders of the 1920s hoped the state death tax credit would foster interstate cooperation rather than competition, they were wrong. The state death tax credit fostered an 80-year truce but not a lasting peace. State legislatures renewed their long-dormant competition at their first opportunity.
Some states were not content to rely on mere legislative changes to reignite interstate competition after EGTRRA. Florida decided to take its case on the road. During his tenure as the governor of Florida, Rick Scott traveled to blue states some 20 times for the purpose of touting Florida’s favorable tax climate and attempting to convince taxpayers to relocate to the state. A former resident of Greenwich, Connecticut, he ignited a political firestorm on a 2017 trip to his former home state by urging those upset with Connecticut’s tax policies to “give up, capitulate and come move to Florida.”
After passage of the 2017 Tax Act, the then (and current) U.S. Senator from Florida once again journeyed north. In March 2019, Scott took to both Twitter and the mainstream media to rub some salt in New York’s wounds, specifically criticizing New York for its tax policy and touting Florida’s more favorable tax climate. In a Wall Street Journal op-ed, he criticized the “tax-happy leaders” of states like California, Connecticut, Illinois, New York, and Pennsylvania and contended that the $10,000 cap on the SALT deduction “stops high-tax states from burdening the rest of us with their irresponsible decisions.” Scott also made the theme of interstate competition explicit, contending that “America is a marketplace where states are competing with each other, and New York is losing. Their loss is Florida’s gain.”
A third lesson thus learned from the state death tax credit and the SALT deduction is that interstate competition is alive and well. Soon after Congress repealed the state death tax credit, state legislatures and other state leaders began to exhibit the same competitive behavior that had motivated creation of the credit nearly a century earlier, actively seeking to lure wealthy citizens from high-tax states to lower-tax ones. Early indications are that state leaders will respond to the capping of the SALT deduction in the same way.
The prior Part discussed how the capping of the SALT deduction likely will prompt increased interstate competition to attract wealth and capital, forcing states to restructure their tax systems in response. As also discussed above, New York’s Governor Andrew Cuomo and three other state governors have foreseen these consequences and are attempting to prevent them through litigation seeking to invalidate the SALT deduction. Cuomo and the other plaintiffs in this action do not merely allege that the capping of the SALT deduction will hurt their states; they contend that it was intentionally designed to do so. In essence, they claim that the federal government is at war with their blue states, directly interfering with their tax regimes and violating long-established principles of federalism. By exploring the relevant history of the state death tax credit alongside that of the SALT deduction, this Part offers some historical perspective on that claim.
Before addressing the question of whether the capping of the SALT deduction was, as Governor Cuomo alleges, a major shift in federal policy that undermined key notions of federalism, we must first determine the original intent of the state death tax credit and the SALT deduction. In this section, I seek to establish that the state death tax credit and the SALT deduction were in fact designed to protect state sources of revenue from federal encroachment.
As I have demonstrated elsewhere, the relevant legislative history with respect to the state death tax credit clearly establishes this Congressional intent. Indeed, the credit was designed specifically for this purpose.
In the case of the SALT deduction, the original Congressional intent is considerably less clear. The SALT deduction traces its origins to the 1861 and 1862 Tax Acts. These acts, designed to augment federal revenues during the Civil War, established the nation’s first income tax and contained the first formulation of the SALT deduction. The argument that this first SALT deduction was motivated by principles of federalism is grounded in a statement made by Representative Justin Smith Morrill during his reporting of the 1862 Act:
It is a question of vital importance to [the states] that the General Government should not absorb all their taxable resources—that the accustomed objects of State taxation should, in some degree at least, go untouched. The orbit of the United States and the States must be different and not conflicting. Otherwise, we might perplex and jostle, if we did not actually crush, some of the most loyal States of the Union.
In a 1985 article, Professors Sarah Liebschutz and Irene Lurie quoted Morrill’s above statement, contending that:
[w]ith the Union’s power to tax viewed by some as an encroachment on the states, it is understandable that an expression of this power in the Civil War income tax would contain a safeguard. The deduction of state and local taxes was seen as such a protection by the chairman [sic] of the House Ways and Means Committee, Justin Smith Morrill, at the time . . . .
In the immediately-following article in the same publication, Senator Daniel Patrick Moynihan quotes extensively from the same paragraph of legislative history, similarly contending that “Chairman [sic] Morrill . . . explained that, as a matter of simple logic, the deduction would be necessary both to avoid double taxation and to preserve a principle of federalism.” With these two coordinated references to Morrill, a federalism myth was born.
The Morrill quote, and its interpretation in these 1985 articles, has found its way into a variety of publications, ranging from a law review article, to Congressional testimony, to newspaper coverage, to the complaint in New York v. Mnuchin.
However, to contend that Morrill clearly linked the SALT deduction to federalism principles may be to misquote the gentleman from Vermont. A review of Morrill’s full remarks casts strong doubt on the thesis that he was referring to the SALT deduction as a means by which Congress would avoid “perplexing, jostling, or otherwise crushing” state tax regimes. Indeed, he specified that the 1862 Act was designed to minimize conflict between the federal government and the states in two specific ways:
the first, by the avoidance of any tax or duty on live stock, and by declining to increase the direct tax on real estate . . . and the second, by a selection of new objects of taxation, and such others as for many reasons can sustain even the double taxation to which they may be for the time subjected.
Morrill did not mention the SALT deduction as a solution to this federalism problem.
Indeed, the broader legislative history actually suggests that Morrill thought that Congress’ choice to tax incomes rather than property was itself a key means of avoiding intergovernmental competition and safeguarding the collection of state revenue. Specifically, as quoted above, he was concerned that “the accustomed objects of State taxation should, in some degree at least, go untouched,” and stated that goal would be met in part “by a selection of new objects of taxation.” The 1861 and 1862 income taxes themselves met this test. They were the first federal forays into the sphere of income taxation—a type of tax that state governments had never seriously imposed. What better way to protect “accustomed objects of State taxation” and avoid interfering with state revenues than to impose a form of taxation the states themselves had never seriously imposed. Thus, in contrast to the estate tax, which was a traditional form of state revenue before Congress entered the field, the income tax was imposed on the federal level nearly half a century before the first state imposed its own income tax.
There are other reasons to doubt that either Morrill or others in the Congress of 1862 thought of the SALT deduction in terms of federalism. First, as discussed above, the first SALT deduction applied to not only state and local taxes but also federal excise taxes. If the purpose of the SALT deduction were to prevent Congress from cannibalizing state revenues, there would be no reason to extend the deduction to federal taxes as well.
Second, under the 1862 Act, initial federal income tax rates ranged from three to five percent. The SALT deduction thus offered a taxpayer a mere three-cent to five-cent federal tax benefit for every dollar of state and local tax paid, an almost immaterial offset. If Congress was truly intending to facilitate imposition of tax by states and local governments, it presumably would have chosen a stronger means of doing so.
In sum, neither legislative history nor historical data supports the thesis that notions of federalism motivated the initial creation of the SALT deduction.
However, over time, both the legislative history and the data begin to tell a different tale. Specifically, by the mid-to-late 20th century, the text of the deduction and the tax landscape had both dramatically changed, and there emerges far clearer evidence that Congress had begun to view the SALT deduction as protecting state tax revenue and serving the policy goals of federalism. For example, in 1943, Congress eliminated federal excise taxes from the scope of the deduction, marking the first time it was truly a “SALT” deduction. Two decades later, a 1963 House of Representatives report characterized the deduction as an “important means” of accommodating collection of both federal and state income taxes and urged continuance of the deduction. Just over two decades later, in 1986, during protracted debates about the future of the SALT deduction, 76 U.S. senators voted in favor of a “sense-of-the-Senate” resolution stating that “[t]he deduction for State and local taxes is a cornerstone of Federalism, protecting State revenue sources from the effects of double taxation and allowing State and local governments that flexibility to develop tax structures without Federal interference.” The resolution further stated that “elimination of the deduction for State and local taxes would constitute an unjustified Federal intrusion into the fiscal affairs of States and prejudice the right of State and local governments to select appropriate revenue measures.”
Accordingly, at some point decades after creation of the SALT deduction, lawmakers had come to appreciate the connection between the SALT deduction and federalism. It is thus accurate to say that Congress retained the SALT deduction for decades as a means of protecting state sources of revenue, even if it is probably not accurate to attribute those same motives to Justin Smith Morrill and the deduction’s initial creation.
Having clarified the relevant legislative history, this Part turns to a consideration of the larger policy implications raised by capping the SALT deduction. The first of these policy lessons is that Congress in the 21st century has shown increased willingness to muscle the states out of traditional forms of tax revenue, often though the passage of somewhat opaque tax provisions. The two major federal tax changes discussed in this analysis, the repeal of the state death tax credit and the capping of the SALT deduction, both reflect this troubling trend.
The 2001 passage of EGTRRA revealed that the federal government is willing to actively compete with states for tax revenue and do so in a less than straightforward manner. As its name suggests, EGTRRA was touted as legislation that would bring “economic growth” and federal “tax relief”; in the aggregate, the law certainly reduced federal taxes. However, the repeal of the state death credit was actually a revenue measure hidden therein—a stealth shifting of tax revenues from state governments to the federal government structured in a way that much of the population did not fully comprehend what the federal government had done.
The capping of the SALT deduction seemed to follow a similar pattern. Enacted as part of legislation called the Tax Cuts and Jobs Act of 2017, it is another revenue-generating provision buried within a tax cut—another example of chipping away at federalism principles in the name of federal revenue generation.
My point is not to naively suggest that every provision of a bill referred to as a “tax cut” must itself cut taxes. To the contrary, tax acts certainly can and do routinely pair revenue raisers with revenue losers as part of tax restructuring and reform. My contention is simply that the capping of the SALT deduction, like the repeal of the state death tax credit before it, raises some taxpayers’ federal tax rates in a way that might be difficult to detect or quantify, stealthily shifting revenue into the hands of the federal government and out of the hands of the states.
By considering both the repeal of the state death tax credit and the capping of the SALT deduction as analogous, rather than isolated, events, a larger structural pattern thus emerges. The federal government that a century ago sought to preserve state revenue and mitigate double taxation has now seemingly undergone a fundamental change of posture. It now increasingly adopts measures to impose its estate tax and income tax revenues first. The states are then left to figure out how, if at all, they will impose their own.
As shown above, the repeal of the state death tax credit and the capping of the SALT deduction reflect that Congress has become increasingly aggressive in competing with the states for tax revenue, a posture that most directly affects the blue states. However, blue-state leaders like Governor Cuomo have a far greater concern. They see a Congress intent on both fanning the flames of interstate competition and trying to alter its outcome by actively crafting tax law to favor the red states over the blue. As shown in the remainder of this Part, while this phenomenon may be exacerbated in a partisan nation often communicating via Twitter, it is not unprecedented.
Understanding the partisan impact of the 2017 Tax Act requires a return to where this Article began, with a review of the Electoral College map. Comparing that map from the 2016 Presidential election to the list of states impacted by capping the SALT deduction makes clear the 2017 Tax Act’s unequal effect. Specifically, the nine states that received the greatest percentage benefits from the SALT deduction in 2016 were New York, New Jersey, Connecticut, California, Maryland, Oregon, Massachusetts, Minnesota, and Rhode Island, along with the District of Columbia. These states and the District of Columbia cast all of their electoral votes in the 2016 election, 150 in total, for Hillary Rodham Clinton for president. The states receiving the smallest benefits from the SALT deduction were Mississippi, Texas, Louisiana, Alabama, Florida, Nevada, Tennessee, South Dakota, Wyoming, and North Dakota. Nevada cast its six electoral votes for Clinton while the other nine states cast a total of 108 votes for Donald J. Trump. A recent study by the Federal Reserve Bank of Atlanta confirms what this look at the Electoral College map suggests—the capping of the SALT deduction hurt the blue states that voted for Clinton far more than the red states that voted for Trump.
Many have furthered the thesis that this disparate impact is no accident, that the capping of the SALT deduction was specifically designed to punish the blue states and reward the red ones, targeted to a degree that cannot be dismissed as mere politics as usual. Indeed, New York’s Cuomo and three other blue-state governors have set forth this argument in their complaint in New York v. Mnuchin, which includes a laundry list of potential evidence of such intent found in the statements of federal officials. Other inflammatory statements, as often seems to be the case, can be found in the President’s Twitter feed.
While it goes far beyond the scope of this Article to evaluate the probative value of this proffered evidence, there is no doubt that we are in an era of extremely partisan politics often conducted on a social media platform that did not exist for prior generations of politicians. The political climate today is thus very different from that of just two decades ago.
For example, when the state death tax credit was repealed in 2001, a New York Times front-page story featured rather muted reactions from lawmakers who supposedly were “furious” about the change. The story noted that the repeal of the credit would cause New Hampshire, one of the most directly impacted states, to lose 4.6% of its total state revenue. The state’s Democratic governor, Jeanne Shaheen, who in those days spoke to a news reporter rather than tweeting her opinion, gave an assessment that was not exactly incendiary: “Anytime you lose revenue that accounts for 4 percent of the general fund budget, it’s difficult to make up,” she said, adding “[n]obody ever likes to raise taxes. And particularly when you’re eliminating a whole area of taxes, it makes it hard.” It was not quite the stuff of today’s viral tweets. Senator Bob Graham, a Democrat and former governor, told the same reporter that the change left “states feeling they are very distinctly the redheaded third cousin at the family picnic,” an oblique way of saying the states were not being treated very nicely. Under the auspices of the National Governor’s Association, a bipartisan group of 37 state governors sent a letter to Congress about the rapid repeal of the state death tax credit, the tone of which was almost cordial by today’s standards.
Sixteen years later, the capping of the SALT deduction generated far more partisan sizzle. Governor Cuomo tweeted that “[t]his partisan tax bill pillages blue states to finance cuts for red states. This is partisan politics over any semblance of good government,” and attached a video clip in which he referred to the change as “egregious,” and “obnoxious,” designed to “pillage the blue to give to the red,” and “put a dagger in the heart of New York.” He then sued the federal government to stop the change. New Jersey Governor Phil Murphy launched a Twitter assault and a lawsuit of his own.
The contrast between 2001 and today is thus startling. After passage of both EGTRRA and the 2017 Tax Act, state leaders were rightly upset that the federal government had solved its own fiscal problems by effectively raiding state treasuries and, in the process, affecting some states far more than others. But the tone of the state responses and the means by which they were expressed are very different today than they were two decades ago. Recent reports from Pew Research confirm what every Twitter user can intuitively sense—political discourse on social media is often angry and disrespectful, contributing to a partisan divide that is deeper than ever before.
While both the repeal of the state death tax credit and the capping of the SALT deduction undercut long-standing pillars of state tax policy, the very different responses from state leaders reveals much about today’s partisan political climate.
It may well seem that politics has achieved a new low, more partisan and vengeful than ever before. Indeed, Governor Cuomo has contended that the capping of the SALT deduction represents an “unprecedented” assault on state tax systems. But the history of the state death tax credit provides a different perspective. A targeted Congressional assault designed to punish specific states with specific state tax regimes is not unprecedented in the field of tax legislation. Indeed, if we look back a century, to the 1920s, we see an even more direct federal intervention in state tax policy, an even more precisely targeted assault on some states’ chosen tax regimes. That attack on state sovereignty had a name. They called it the state death tax credit.
Back in the 1920s, some rogue states such as Florida and Alabama tried to position themselves as havens for American wealth, designing their state tax policies to attract and retain wealthy citizens. These southern states had voted for the Democratic Presidential candidates in 1920 and 1924, losing both elections to the Republican North. To lawmakers in these red states, Florida was a threat that had to be dealt with.
The Chairman of the House Ways and Means Committee, William Green of Iowa, took to the floor of the Congress to tell Florida exactly what he thought of their state tax policy:
Let me say to the people of Florida and to its representatives in this House, that you never can make a really great State through colonies of tax dodgers or money grabbers; parasites and coupon cutters, jazz trippers and booze hunters. Your delightful climate and your natural resources are a sufficient attraction if you do not offset them by filling up your community with members of that ancient and dishonorable order of tax dodgers, who, of all citizens, are the most narrow, the most selfish, and the most unpatriotic. I congratulate those States whose patriotic citizens have not yielded to the alluring but improper inducements offered by the State of Florida.
Congress went on to enact the state death tax credit for the primary purpose of negating Florida’s ability to attract wealthy residents through favorable estate tax policy. It was a direct attempt to alter the relationship between the other states and Florida, a direct assault on the sovereignty of that state’s tax policy.
Opponents decried this attempt “to intermeddle with the domestic affairs of States.” They alleged it was “in direct conflict with” key principles of federalism and “repugnant to the Constitution.” Florida Congressman Green provided the most pointed, and eloquent, critique. He warned his colleagues that they were crossing a dangerous line by using federal legislation to undermine state tax policy:
The precedent that you are undertaking to establish to-day is so far-reaching that our Republic will face a chaotic condition, and so long as the powerful States wreak their revenge and vent their spleen upon the weaker States, taking from them their rights and constitutions, our Nation is destined to crumble.
He then accused his fellow members of dishonoring the memory of Florida’s World War I dead:
You have forgotten, apparently, that when the great war cloud overhung our Nation and the patriotic sons from every corner of the 48 States were called to defend the American flag, which shall forever wave free, that Florida also took her part in this, and that Florida mothers went to the station with their sons, pinned a flower on their uniforms, kissed their fiery cheeks—with a smile on their lips and a pain in their hearts—and sent them to be buried in Flanders fields; and suppose that these sturdy sons of Florida could swing back the portals of glory and with their battle-scarred faces peer down upon this assembly and see you about to scrap the constitution of their native State, and in so doing violate the Constitution which they shed their life’s blood to defend.
Florida’s Governor also disliked the new law. So he brought a federal lawsuit. Using an argument echoed nearly a century later by the governors of four northern states, Florida prayed for judicial relief from this “invasion of the sovereign rights of the state and [] direct effort on the part of Congress to . . . penalize it and its property and citizens.”
Like so many other events in the history of taxation, the capping of the SALT deduction thus looks very different depending on the comparisons being made and the breadth of one’s perspective. When the 2017 Tax Act is compared to the 2011 repeal of the state death tax credit, the 2017 Tax Act looks like a far more targeted assault on state sovereignty, borne of a more deeply partisan political climate, and more overtly calculated to punish blue states for their choice of tax policies and their actions at the ballot box. But when compared to the creation of the state death tax credit nearly a century earlier, the 2017 Tax Act looks completely different.
In 1924, Florida was targeted every bit as directly as were the blue states in 2017, and elected officials who sought to undermine Florida’s state tax policy and reduce its competitive advantage mentioned Florida’s name repeatedly. The capping of the SALT deduction thus may well be every bit as “crass, . . . ugly, . . . [and] divisive” as Governor Cuomo suggests it is. It may have been politically motivated. The courts may yet decide it was improper. But there is one thing history proves it is not. It is not unprecedented.
When Congress imposed a $10,000 cap on the SALT deduction, leaders of high-tax, blue states balked. They accused federal officials of targeting their states for political reasons and brought suit against the federal government to try to reverse the legislation. They argued that the 2017 law violated key principles of federalism and would prompt an economic civil war between the Democratic blue states and the Republican red states.
This Article has sought to predict how states may respond to this change in federal law and has considered broader policy questions implicated by the 2017 tax law concerning the interrelationship between federal and state tax law. This Article’s novel approach to the subject has been to consider these questions by exploring the similarities and contrasts between the income tax SALT deduction and the estate tax state death tax credit implemented in the 1920s. Viewing the 2017 Tax Act within the historical context provided by an understanding of the origins of the state death tax credit and the impact of its 2001 repeal reveals larger trends and patterns, yielding predictions about the future direction of state tax law as well as providing lessons about the interdependence of federal and state tax regimes.
This analysis has produced a number of predictions about the future of state taxes. Although the capping of the SALT deduction may generate a more muted state legislative response than did the repeal of the state death tax credit, we can still expect blue states to restructure their state tax regimes in an effort to maximize the value of the deduction for their taxpayers. The change in law will also incentivize, and thereby increase, interstate competition for wealth and capital as the red states seize this new opportunity to tout their relative tax advantages.
Finally, viewing the SALT deduction in this broader historical context reveals two other lessons about federal-state relations. First, in the recent past, Congress’s fundamental attitude toward state revenue appears to have changed, with the federal government chipping away at established principles of federalism by more directly competing with the states for revenue. Second, the capping of the SALT deduction in a manner calculated to benefit some states and injure others is not historically unprecedented. In the 1920s, Congress took an equivalent action, designing the state death tax credit for the specific purpose of negating Florida’s effort to lure wealth and capital through favorable tax policies, undermining that state’s chosen tax policy and weakening its ability to compete with other states.
History thus reveals that long before our current age of polarized politics and inflammatory tweets, Congress used tax legislation to directly target the tax policies of certain states, actively intervening in the battle among the states. A century later that battle rages on, with Congress once again seeking to alter the outcome.
My thanks to Matthew Schaefer and the editorial staff of The Tax Lawyer for their thoughtful revisions to this Article, and to Dean Jennifer Brown and the Carmen Tortora Sr. Professorship Fund for providing financial support.
