Proposition 208 exposes deficiencies in our federal income tax deductions

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Proposition 208 adds raises deserved to those in education.  But it also reveals deficiencies in our tax system.

Teachers in Arizona will receive well-deserved increases through Proposition 208, the initiative that raises taxes on the state’s 50,000 or so highest-income earners and uses the resulting proceeds to fund higher teacher salaries.

But did you know that due to an unequal change in the tax treatment of state and local tax payments – SALT for short – Proposition 208 also benefits Texans? It does. Here’s why:

Prior to Donald Trump’s presidency, government income tax increases to fund higher teacher salaries had little impact on federal income. The higher teacher’s salary would be subject to both federal income and labor taxes, thus increasing federal tax revenues. But those who paid additional state taxes could deduct the payments from their federal tax returns, which would reduce federal tax revenues.

In other words, the net effect of something like Proposition 208 before Trump would have been more or less a federal wash.

Trump’s tax bill changed the balance

But Trump’s 2017 tax law fundamentally changed the state-federal tax balance. The Trump Tax Act has capped federal state and local tax (SALT) withholding tax at $ 10,000. High-income Arizonans already pay more than $ 10,000 in annual state and local taxes. You won’t see any federal tax rebate from the additional state income tax you pay under Proposition 208.

Meanwhile, teachers face an additional federal income and employment tax on their pay rise.

The net effect: an annual profit for the US Treasury of over several hundred million dollars.

This means that residents of other low-income tax states like Texas will benefit indirectly from Proposition 208.

So now we’re losing to states like Texas

To fully appreciate the tax burden here, we need to compare the funding of public education in Texas to the way we pay for public schools in Arizona.

Texans do not pay state income tax. Texas funds public education in part through royalties it collects from oil and gas deals. These royalties go to the Texas Permanent School Fund and the Texas Permanent University Fund.

Over the years these funds have built enormous foundations. In 2017, the Texas Permanent School Fund was $ 41.4 billion. The revenue from these billions of dollars will finance schools in Texas.

What if Texas oil and gas dollars, which are now going straight to public schools, went to Texas taxpayers instead? And what if these taxpayers then sent checks for the same amount back to the state to fund public education? Nothing would change. Texas schools and taxpayers would be no better or worse off.

This shows us that in both states school funding comes from citizens’ income, directly in Arizona, indirectly in Texas. But Texans don’t pay federal income tax on their imputed income, which goes to the Texas Permanent School Fund to fund public education. Arizonans, whose deductions for state taxes are limited, pay federal taxes on dollars they spend on public schools.

Could we keep the SALT withdrawal cap and still balance the treatment of Arizonans and Texans? Yes, but only if we started taxing Texans on their share of state oil and gas fees. Good luck with it.

Restore the deductions for these payments

This comparison reveals the deceptive rhetoric used by politicians from low-income tax countries like Texas, the claim that the SALT deduction subsidizes states with higher taxes. The data actually shows the opposite.States with higher taxes usually pay more to the federal government than they get, low-income states less.

This reality should not surprise us. States that levy higher taxes use the resulting revenue to hire and pay government employees. These employees, in turn, pay federal income and labor taxes. And this reality before Donald Trump made the SALT withdrawal a neutral factor from the perspective of the federal government.

With the passing of Proposition 208, Arizona’s higher-income earners are now at the short end of the SALT Cap travesty. The Arizona Congress delegation should recognize the dangers here and join leaders from California, New York and other states in working to restore a full federal withholding for state and local tax payments.

Bob Lord is an Associate Fellow at the Institute for Policy Studies, a progressive think tank. He practices tax law in Phoenix. Reach him at bob@boblordlaw.com.