The Volokh Conspiracy

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The (Likely) End of the SALT Tax Deduction Litigation

Four blue states' misguided legal challenge to the cap on the SALT tax deduction suffered a well-deserved defeat in the Second Circuit. The case is likely over.


As co-blogger Jonathan Adler notes, the US Court of Appeals for the Second Circuit recently issued a ruling rejecting a lawsuit filed by four blue states challenging the cap on the federal tax deduction for state and local taxes. The decision is likely to bring an end to this misbegotten litigation.

In December 2017, the then-GOP controlled Congress capped this longstanding deduction at $10,000 for individual taxpayers and married couples filing jointly, and $5000 for married people filing separately.

The SALT deduction overwhelmingly benefits wealthy taxpayers living in high-tax states. Some 96% of the benefit accrues to the top 20% of households, by income, with over half of that going to the top 1%. The deduction is effectively a federal subsidy for very wealthy taxpayers and profligate high-tax state governments.

Normally, progressives are not supposed to be fans of targeted tax deductions for the rich. But this particular tax break benefits some key Democratic constituencies (as well as a number of blue state governments). Thus, many Democrats have pushed to repeal the cap, and, in 2018, a coalition of blue states filed a lawsuit seeking to overturn it.

The plaintiff states developed a variety of creative, but extremely weak, legal arguments, contending that the cap violated the Tenth and Sixteenth Amendments, and also that it unconstitutionally "coerced" the states. When the four states first filed their lawsuit in 2018, I was highly skeptical of its prospects.

Some other commentators were even more negative. Prominent left-wing legal analyst  Ian Millhiser  called it "one of the stupidest lawsuits of the Trump era." University of Iowa tax law scholar Andy Grewal wrote that "[i]f this lawsuit succeeds, I will post a video of myself eating every single page of the Internal Revenue Code, one-by-one."

In 2019, federal district Judge J. Paul Oetken (an Obama appointee) ruled against the plaintiff states. His opinion highlighted several key weaknesses of their case. Now, a Second Circuit panel composed of three Democratic appointees has reached the same conclusion, for much the same reasons. Jonathan Adler excerpts several parts of the opinion written by Judge Raymond Lohier (also an Obama appointee).

I want to call attention to his assessment of the plaintiffs' "coercion" argument:

The Supreme Court has only once deemed a condition unconstitutionally coercive in violation of the Tenth Amendment. In NFIB [v. Sebelius], Congress "threaten[ed] to withhold all of a State's Medicaid grants, unless the State accept[ed] . . . new[,]  expanded funding and complie[d] with the conditions that come with it." Id. at 575….

The Plaintiff States claim that their citizens face a comparably substantial harm: their federal tax burdens will rise, the value of their homes will fall, and  their jobs will disappear. Specifically, the Plaintiff States allege that their  taxpayers "will pay hundreds of millions of dollars in additional federal taxes, relative to what they would have paid had Congress enacted the 2017 Tax Act without the cap…." We accept these allegations as true, and we assume without deciding that a claim of coercion under the Tenth Amendment can arise from injuries to a State's citizens rather than to the State itself. Yet even then, we conclude that the Plaintiff States have failed to plausibly allege that  their injuries are significant enough to be coercive. As the district court correctly  noted, the Plaintiff States relied on an improper comparison between their taxpayers' federal tax burden under the 2017 Tax Act as enacted, and their taxpayers' federal tax burden under a hypothetical version of the 2017 Tax Act without the SALT deduction cap. Such a hypothetical tells us nothing about the actual financial effects of the SALT deduction cap on the Plaintiff States' taxpayers. And even if such a comparison were instructive, the cost to  individual taxpayers pales in comparison to the threatened deprivation of 10 percent of the States' budgets at issue in NFIB.

This is right, as far as it goes. But I think the coercion argument could have been rejected for more fundamental reasons. First, the entire "coercion" doctrine, as developed by the Supreme Court, applies only to conditions attached to federal grants to state and local governments. It does not apply to grants and tax deductions given to private parties, such as the taxpayers in this case. It is true, of course, that subsidies and tax deductions given to private parties can affect state government finances. But, by that standard, almost any major shift in federal tax or spending policy might be said to "coerce" the states. For example, if congressional Democrats succeed in their efforts to substantially increase corporate and individual income tax rates, less revenue will be available to state governments, especially those heavily dependent on taxes from corporations and high-income individuals.

Second, the coercion rule only applies to situations where states have to meet federal requirements of some sort in order to qualify for grant money. For example, in NFIB, they would have been required to greatly expand the range of people eligible for Medicaid grants, in order to remain eligible for federal Medicaid funding. In South Dakota v. Dole (1987), they were required to raise their drinking age to 21 in order to avoid suffering a reduction in federal highway grants.

In the SALT tax case, by contrast, there are no conditions intended to force changes in state policy. The cap on the tax deduction applies regardless of what state governments do. To the extent the situation is analogous to NFIB at all, it is as if Congress simply decided to cut the amount of Medicaid funding going to the states, but without imposing any new conditions on recipients. Simply cutting a grant or (in this case) a tax deduction cannot possibly qualify as coercion, if the cut doesn't impose any new requirements on states. If it could, Congress would be barred from making any major cuts to federal grants to the states, and perhaps even from axing tax deductions that have an effect on state government finances.

More can be said about the flaws in the plaintiff states' case. But there is no need to beat this almost certainly dead horse further. As Jonathan Adler mentions, the states' could potentially seek an en banc rehearing in the Second Circuit, or petition for certiorari to the Supreme Court. But it is highly unlikely either effort will succeed.

If there is any consolation for the plaintiff blue states here, it is that their red counterparts have since managed to file even dumber cases, most notably the "Texas Turkey" seeking to overturn the result of the 2020 election. But the bad behavior of red states doesn't justify that of the blue ones—or vice versa.

While the SALT tax  lawsuit is probably dead, the effort to repeal the 2017 cap may not be. Several Democratic members of Congress have tried to make abolition of the cap a condition of passing the Biden Administration's massive reconciliation spending bill. Whether these efforts succeed remains to be seen.

In the meantime, my one regret about the outcome of this case is that we will not get to see the video of Prof. Grewal "eating every single page of the Internal Revenue Code, one-by-one." I hear tax code goes well with Tabasco sauce!