SALT Blawg – State and Local Tax Blog
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Since 2017 when the Tax Cuts & Jobs Act was enacted and placed a hard cap on state and local tax deductions, critics of the cap have campaigned to reverse it. These critics (as well as the cap’s proponents) hail from every walk of life and political stripe. But the mantel against the cap has been taken on most prominently by the Democratic Party and a handful of high-tax States that in recent election cycles have tended to vote Democrats into office, often labeled “Blue States.” The efforts to overturn the cap have been three-fold: (1) state workaround statutes that seek to end-run the cap, (2) judicial challenges to declare the cap unconstitutional, and (3) legislative efforts to repeal the cap. This blog installment focuses on the second of these battlegrounds – judicial challenges.
The principal judicial challenge is the case New York v. Yellen in which four states—New York, Connecticut, New Jersey, and Maryland—filed suit in the US District Court for the Southern District of New York to strike down the cap as unconstitutional. The suit was filed in July 2018. District Court Judge Paul Oetken, an Obama-appointee, after hearing dispositive motions by the parties, rejected the States’ challenge. The Plaintiff-States appealed to the US Court of Appeals for the Second Circuit, headquartered in New York City. On October 5, 2021, a three-judge panel composed of two Obama-appointees and one Clinton-appointee, affirmed the District Court and upheld the validity of the TCJA’s SALT deduction cap. On the merits, the Court heard essentially two types of Constitutional challenges.
First, the Plaintiff-States made a facial challenge. They argued, essentially, that there is a constitutional right to the SALT cap – specifically, that the SALT deduction is required by the text of Article I and the Sixteenth Amendment of the Constitution. The Court explained that “[o]f course” the Constitution’s text “do[es] not expressly require the SALT deduction or limit Congress's tax power to do away with it.” The Court, however, also recognized that Constitutional rights do not always explicitly appear in the text. In this regard, the Court explained that “[i]n order to be faithful to the underlying federal premises of the Constitution, courts must look for the postulates which limit and control,” which includes a review of “historical understanding and practice,” i.e., “[h]ow the SALT deduction has historically been perceived might shed light on the structural limitations on Congress's power that ultimately arise from the Constitution itself.” The Plaintiff-States argued that “the SALT deduction's long and unbroken lineage confirms that it is a constitutional mandate and not merely a policy choice.” Reviewing the SALT deduction’s lineage, the Court referenced changes to the SALT deduction over the preceding decades that demonstrate its lineage is not as unbroken as the Plaintiff-States suggest and that historically it has been accepted that Congress may expand and contract the SALT deduction’s scope based on its policy choices. Pre-TCJA legislative sessions – through both Republican and Democrat-controlled Congresses, had, for example, stricken sales taxes from the deduction’s scope, reduced the deduction’s application by phase-outs, and subjected the SALT deduction to alternative minimum tax limitations.
Second, the Plaintiff-States launched an as-applied challenge. They argued that the SALT deduction cap violates the independent constitutional principle of equal sovereignty among the States. In other words, they argued, Congress knew that the cap's injuries would be unevenly distributed and disproportionately impact states, like the Plaintiff-States, with high tax burdens. The Plaintiff-States relied on the Supreme Court case, Shelby County v. Holder, to claim that facially neutral laws like the SALT deduction cap can violate the principle of equal state sovereignty if they affect States differently. The three-judge panel appeared to lend credence to the Plaintiff-States’ underlying factual premise. It cited a statement by Republicans leading up to the TCJA’s enactment that justified the cap on grounds that the SALT deduction was causing residents of fiscally responsible States to subsidize wealthy residents in States with bloated governments and higher taxes. For example, then-Speaker of the House Paul Ryan, stated: “[p]eople in states that have balanced budgets, whose state governments have done their job and kept their books balanced and don't have massive pension liabilities, they're effectively paying for states that don't.” Similarly, then-President Donald Trump stated that the new law “creat[es] an incentive” for state politicians to “do a good job of running their] state.” The Second Circuit held, however, that the facts alleged by the Plaintiff-States, even if true, simply did not rise to the level of a Constitutional violation. The Court stated: “the SALT deduction cap has no effect on state sovereignty. The outsized effect of the SALT deduction cap on the Plaintiff States arises only because the Plaintiff States previously benefitted most from the SALT deduction, not because the cap applies to some States but not others.”
The October 5 decision is a defeat to those seeking to reverse the SALT deduction cap, and as a practical matter may mark the end of the effort to overturn the cap via judicial challenge. While time remains for the Plaintiff-States to petition the Supreme Court to review the Second Circuit’s decision, the Plaintiff-States face long odds at this point. They have so far lost notwithstanding their home-field advantage and Democrat-appointed judges. Moreover, the perceived necessity of judicial intervention may be waning given the Democrats’ control of both the Executive and Legislative branches. Even the most activist judges that may disagree with Congress’ policy choice to cap the SALT deduction may be inclined to leave the deduction’s fate in the hands of Congressional Democrats who have the power to repeal.
Peter A. Lowy, a shareholder in Chamberlain Hrdlicka’s Houston office, is best known for his tax controversy work and deep experience in the energy sector. He also advises corporations and other taxpayers in a broad spectrum of ...