Congress has broad authority to levy taxes on entities, transactions, and property of all sorts. This includes individuals, businesses, not-for-profits, profits, income, investment returns, imports, and well, you get the idea. Under the 16th Amendment, Congress can and has adopted a graduated income tax, whereby persons and entities with more resources are generally taxed at a higher rate than those with less. Layer onto this a smorgasbord of deductions, exemptions, exclusions, credits, phase outs, phase ins, and what you’ve got is a rather byzantine system of collecting revenue. This system, as one federal judge aptly put it, “will affect some taxpayers more than others and, by extension, will affect some states more than others.”

So which states pay in more than they take out of this system? According to the analysis of one widely cited source, the Rockefeller Institute of Government,[1] New York has the largest negative gap between what it pays to the federal government and what it gets back of any state. With Albany’s latest budget project showing the state government potentially $15 billion in the red, does it make any sense that New Yorkers are sending more money to D.C. than they get back, and is there anything anyone can do about it?

The Numbers

Governor Cuomo, in a public spat with then-Senate Majority Leader Mitch McConnell claimed that New York paid $116 billion more to the federal government then it got back (the differential is often referred to as the “balance of payments”). This was technically true, at least according to the Rockefeller Institute’s analysis, for the four-year period from 2014−18. In fiscal year (FY) 2018, the negative balance of payments for New York was $22 billion (or $1,125 per capita). A report issued by Comptroller Tom DiNapoli’s office determined that the negative balance of payments was up to $26.6 billion for FY 2019.[2] That works out to a return of just $0.90 back for every dollar sent out, compared to an average of $1.21 across all 50 states.[3] DiNapoli’s office has documented negative balance of payments for New York every year since 2013.   

Causes for the Disparity

States with older populations tend to receive more in federal outlays because of social security and Medicare, two programs that together make up 37.36% of all federal outlays.[4] Certain states can also get big influxes of federal funding in the wake of a major disaster such as a hurricane or flood. Similarly, wages paid to residents of states with large federal workforces, such as Virginia, Maryland, and New Mexico tend to skew those state’s share of federal spending upward. On the other side of the ledger, states such as New York that have a larger share of high-income residents will consistently pay more in federal income taxes due to the tax system’s progressive structure.

According to DiNapoli’s analysis, New York is “pretty close to the middle of the pack” in terms of federal spending outlays, and that the large negative balance of payments is caused by its disproportionately large share of tax revenue contributed. New York paid $305 billion in federal taxes during FY 2019; more than any state other than California.[5]

The SALT Saga

Observers expected New York’s negative balance of payments to widen once data from the cap on state and local tax (SALT) deductions in the 2017 Tax Cuts and Jobs Act (TCJA) started being reflected in the analysis. The SALT deduction allows tax filers to deduct state property, sales, and income taxes from their federally taxable income. TCJA capped the SALT deduction federal filers can take at $10,000. While the cap only affected around 11 million taxpayers, primarily those earning over $100,00 per year,[6] these residents are concentrated in high-tax states like New York.

In 2018, Connecticut, Maryland, New Jersey, and New York jointly sued the federal government in response to the TCJA. The complaint alleged that the SALT deduction cap 1) violated the 10th Amendment by interfering with the states’ sovereign authority to set tax policy; 2) starved them of tax revenue; 3) singled out certain states for disproportionate harm; and 4) violated the 16th amendment’s (alleged) mandate for a full deduction of state and local property taxes.

The IRS vigorously defended the suit, arguing that the Constitution contained no requirement to offer any deduction for SALT whatsoever, much less one at any particular level. It claimed that the SALT deduction cap merely changes the “landscape” states face when determining how to structure their revenue systems and that collecting less tax revenue wasn’t the type of direct and specific harm necessary to convey legal standing. IRS lawyers added that the federal Anti-Injunction Act, which generally blocks lawsuits trying to restrain tax assessment or collection, also prohibited the suit.

The U.S. District Court for the Southern District of New York dismissed the suit in September of 2019. It determined that the states hadn’t plausibly alleged that the cap meaningfully constrained their local tax decision-making and that nothing in the Constitution stopped Congress from jettisoning the entire exemption, that it itself had created “as a matter of grace.” In its dismissal, the court emphasized Congress’s broad Constitutional authority to enact a plenary tax code.

Appeal

The indefatigable quartet appealed the Southern District’s decision up to the Second Circuit Court of Appeals. Their appeal argued that the Constitution requires Congress to “provide a deduction for all or nearly all state and local income and property taxes to ensure that the federal government does not crowd states out of traditional sources of revenue and thereby interfere with their sovereign taxing authority.”

The Second Circuit held oral arguments on the appeal way back in December of 2019. The court appeared skeptical of the appellants’ theories, with one judge telling a lawyer for the appellants: “When it comes to taxes, the Supreme Court tells us unless there is something explicitly in the Constitution . . .  we’re going to step out of the way.” Thus, pending a surprising result out of the Second Circuit, the cap remains in effect until January 01, 2026. Of course, the razor thin Democratic majority in the 117th Congress may be taking its own stab at eliminating the cap.

Additional Litigation

A second lawsuit, filed in July of 2019 by the same plaintiffs (sans Maryland), defended some of the workarounds created to permit resident tax-filers to write off SALT over the $10,000 cap from negative IRS guidance published in June. The IRS guidance branded the workarounds a “quid pro quo,” pointing out that their purpose was merely to allow taxpayers to write off payments to local governments, formerly deductible as SALT, as a “charitable contribution.”[7] The tri-states’ suit sought to legitimize the state schemes, which allow municipalities to establish “charitable” funds to pay for local services and offer property tax credits to incentivize property owners to donate.

There are more than 100 existing state charitable tax-credit plans, incenting everything from private school tuition to conservation easements, spread over 33 states that this lawsuit could potentially impact.[8]

Not Getting Any Easier

New York taxpayers may soon be squeezed even more by the rise of the at-home workforce. As of 2018, nonresidents generated $7.4 billion of New York State personal income taxes, 15% of the total. Many of these are New Jersey taxpayers commuting to Manhattan to work in the finance sector. The NYS Department of Taxation has taken the position that those now working from out of state homes are still required to pay NYS income taxes unless their employer has “established a bona fide employer office” in their home state. New Hampshire challenged a similar rule promulgated by the Commonwealth of Massachusetts in a high-profile U.S. Supreme Court case.

Conclusion

If the disparity in balance of payments between states continues to widen, and especially if budget deficits faced by states such as New York are not addressed in forthcoming federal stimulus relief, we can expect disputes between the states and federal government to continue to find their way into court.

If you have questions concerning any of the policies discussed in this post, the attorneys at the Wladis Law Firm may be reached at (315) 445-1700 or by emailing Chris Baiamonte at cbaiamonte@wladislawfirm.com. We will do our best to provide you with updates and will be available to answer questions as circumstances change.

---

[1] The Rockefeller Institute of Government is a public policy research arm of the State University of New York.

[2] https://libn.com/2020/01/14/new-york-again-sends-more-to-federal-government-than-it-gets/.

[3] Other estimates peg this at an even more unfortunate $0.70 on the dollar. https://www.moneygeek.com/living/states-most-reliant-federal-government/. 

[4] https://www.cbo.gov/publication/56324.

^[5] Florida has a population approximately 2.5 million higher than New York and Texas approximately 10 million.

[6] https://www.reuters.com/article/us-usa-taxes-lawsuit/u-s-appeals-court-skeptical-of-ending-cap-on-state-and-local-tax-deductions-idUSKBN28D2SK. 

[7] 26 CFR Part 1 [TD 9864].

[8] J. Bankman, et. al., State Responses to Federal Tax Reform: Charitable Tax Credits, 159 Tax Notes, 641 (April 30, 2018).