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 likley 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!

NEXT: The Mayflower Subcompact

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  1. Repealing the SALT cap would be a big lowering of tax as a %tage of AGI for the upper 5%.
    The imposition of the SALT cap was accompanied by the elimination of the AMT which had not be inflation adjusted for many years. For the upper 5% that combination meant that their tax % of AGI did not change very much

    1. cuncur - I did not have a single client that paid more income tax after the cap of $10k on SALT because the increase in the amt exemption, increase in the standard deduction and the lowered tax rates. It is only a narrow range of taxpayers that paid more income tax due to the cap of SALT at $10k.

    2. The AMT changed, but wasn't eliminated.

  2. I live in the People's Republic of NJ, and after a few years, I am glad we did away with SALT. Why? Time savings. When I itemized, just gathering all the data for the gazillion deductions was a huge PITA. It took days and days (even when I had everything organized just so). And then the data entry into TurboTax. Ugh!

    My taxes now take two hours. The time savings is substantial.

    SALT was just enabling the People's Republic of NJ to spend other people's money irresponsibly. That is over. It is about time. Maybe we will get some fiscal sanity, but I doubt it.

  3. Even more fundamental: "coerce" the states to do what? Presumably, lower their tax rates to offset the increased federal taxes. Which I don't think any have done, so how coercive can it be?

    1. To be sure CA has not lowered its taxes despite accumulating a huge surplus of unspent tax dollars

  4. I’ll point out that after screaming about how unfair the SALT tax limitation is that the Democrats, who could have repealed it in their first reconciliation bill for Covid assistance, but didn’t, and could also repeal it in their 2nd reconciliation bill if it ever passes, but have not proposed it.

    It was good policy when Trump signed it, and it’s still good policy now which the Democrats have implicitly acknowledged.

    1. I mostly agree, but please recall that the screaming was mostly a reaction to Republican glee at finding a way to stick it to the blue states.

  5. I wonder if the lawyers for the states will be threatened with disbarment for filing the wasteful, meritless action, and appealing the district court's order . (A total of four Democratic appointees -- including two "Obama appointees" -- ruled against them, not that there are, you know, Obama judges or Trump judges.) Maybe threatened disbarment doesn't apply to plain old "dumb[]" cases ( as opposed to "even dumber" ones).

  6. The 2017 tax act which capped the state and local tax deduction at $10k also included the large increase in the AMT exemption. further the standard deduction was raised to $24k for Married taxpayers. The tax rates were also lowered.

    As a result, even with the loss of the SALT deduction/ limited to $10k, almost all my clients in NY and CA paid less income tax. Point being, the cap on the SALT did not result in an increase in income tax, at least not for a large segment of the residents of high tax states.

  7. "The deduction is effectively a federal subsidy for very wealthy taxpayers and profligate high-tax state governments."

    Exactly backwards.

    1. You're going to have to explain that one. Are you saying that the deduction is beneficial to poor people? Or that the deduction is somehow to the benefit of low-tax states?

      Are you perhaps confusing 'the deduction' with 'the cap on the deduction'?

  8. It's "interesting" that "libertarians" are almost uniformly in favor of the SALT abolition. But why? An income tax is a tax on, you know, INCOME, and money you have to pay to the government isn't, well, INCOME. Obviously, you can't spend it.

    It was for this reason that the SALT deduction was written into the original federal income tax. Of course, you don't get to deduct your federal tax from your income, so what is the deal with that? Well, you do get a "standard deduction"--which, by the way, many states don't give you--and, if you make a lot more, so that your taxes are larger than the SD, well, you're rich, you can afford it.

    Of course, the Republicans abolished the SALT as a way to punish the blue states. Cool, right? Well, if it's OK to use the federal tax code to punish "bad" blue states, how about using it to punish "bad" red ones? Is it possible to figure out a way to punish states that want to restrict/ban abortion? Do you really think that Hillary and Nancy and AOC and all the rest of those, well, "girls", can't come up with something along those lines? I wouldn't put it past them.

    1. It is a tax on income (money received). Just because income goes out doesn't mean it wasn't income at one time. So super dumb point by you.

    2. Libertarians should favor the abolition of the entire SALT deduction, because people should be aware of what exactly their governments are extorting from them, painfully so. Otherwise there'll be no taxpayer anger to demand governments reduce what they're spending.

      Less taxes is desirable, but no free lunches either. The only way you get to low taxes is make sure people pay all their taxes good and hard.

    3. The federal government doesn't offer this deal to its own taxes-- you still pay federal income tax on money you never see that vanishes into the Social Security and Medicare ether. You earned the income, but the legal fiction is you consented to it being taxed in this way. So why would the feds offer a sweetheart deal to state taxes they don't offer to their own taxes? And this legal fiction is more of a reality for our friends in blue states, if they felt moving they could. So SALT deductions are just a way for rich people to vote for government spending without paying for it, which isn't particularly libertarian.

  9. 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.

    This is about 98% true, but sticking in the word "profligate" is uncalled for. High-tax states that are spending money on things that their citizens want are not inherently profligate. Besides, low-tax states may be wasteful also.

    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.

    There are two parts to this story. First, it is correct, as a matter of arithmetic, that the deduction primarily benefits better-off taxpayers. On that basis, I'm no really against the cap, though it does cost me a fair amount of money.

    But the second part is important too, if only to understand the blue-state reaction, which is as much emotional as logical. The cap was treated by the right not as a progressive way to increase revenue. rather, it was a poke in the eye to the blue states. "Ha, ha. We'll show 'em." Remember, the cap didn't hit all "wealthy taxpayers," just those living in some states. I think that was a more powerful motivation than revenue considerations.

    Don't discount that.

    1. Okay - it was a poke in the eye of the blue states,
      but the reality, because of other changes in the tax law, AMT modification being the biggest, that poke in the eye actually reduced the federal income tax paid by the blue state residents.

  10. Taxachusetts (my former hone state) gave its citizens an option to pay more taxes if they wanted to for all those things that progs claim to care about and want the government to do. Very few (maybe less than 1%) actually did, proving the point that they just want to spend other people’s money.

  11. People who have no ethical issue with systemized robbery because they hope to gain by it deserve to get betrayed by their rulers. They hide behind secret ballots and majority rule but the reality is a few elected and their cronies exploit the majority. Good!
    I resist being robbed (taxed). And I save myself somewhat, but I still suffer from coercive (immoral) govt. The difference between myself and the "cheating" voters is I am no hypocrite. I don't vote. I don't authorize anyone to rule me.

  12. Sadly they missed the socialism argument - the 39 mooching states refuse to support their own citizens and the SALT cap increased the financial liability of the 11 states who actually pays the bills for those moochers.

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