Second Circuit Rejects Blue States’ Challenge to Cap on SALT Deduction

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Yesterday a unanimous panel of the U.S. Court of Appeals for the Second Circuit rejected a constitutional challenge to the cap on state and local tax (SALT) deductions on the federal income tax. The court’s decision in New York v. Yellen shows that Red States are not the only ones filing weak, politically motivated lawsuits against the federal government.

Congress capped the income tax deduction for state and local taxes as part of the 2017 Tax Cuts and Jobs Act. This limitation primarily effects wealthy taxpayers, which is why some have argued for eliminating it altogether. It also has a disproportionate impact on Blue states because they tend to have higher property taxes and income taxes.

Having lost the effort to keep the SALT deduction in Congress, several Blue States (New York, Connecticut, Maryland and New Jersey) did what states do these days: They filed suit in federal court.

The states’ claims did not fare well in district court. Although the court rejected the federal government’s effort to dismiss the suit on standing or Anti-Injunction Act claims, it made quick work of the substantive claims.

On appeal to the U.S. Court of Appeals for the Second Circuit, the Blue States obtained about the most favorable draw possible (Judges Sack, Chin and Lohier), but no matter. The states’ legal arguments–that a SALT deduction is constitutionally mandated or, in the alternative, that a cap is unconstitutionally coercive–were weak and easily dispatched.

In yesterday’s decision, the Second Circuit panel unanimously rejected the blue states arguments.

The Plaintiff States argue that principles of federalism protect each State’s “sovereign authority to raise revenue and determine their own fiscal priorities” and bar the federal Government from crowding States “out of traditional revenue sources.” Appellants’ Br. 31. But they have not demonstrated how the 2017 cap on the deduction unconstitutionally undermines their state sovereign authority over fiscal matters or their ability to raise revenue. The Plaintiff States fail to plausibly allege that their taxpayers’ total federal tax burden is now so high that they cannot fund themselves. And while they argue that the SALT deduction lowers “the effective cost of state and local taxes,” … they point us to nothing that compels the federal Government to protect taxpayers from the true costs of paying their state and local taxes.

In a clever twist, the Blue States tried to argue the SALT deduciton cap contravened the Supreme Court’s decision in Shelby County v. Holder. This argument did not work either.

Finally, the Plaintiff States complain that Congress unfairly targeted them. Given our discussion of the statutory history, it is obviously true that members of Congress were aware that the SALT deduction cap would adversely affect some States more than others. But the SALT deduction cap is not unlike the countless federal laws whose benefits and burdens are unevenly distributed across the country and among the several States. As noted above, “Congress may use its spending power to create incentives for States to act in accordance with federal policies,” as long as “pressure [does not] turn[ ] into compulsion.” NFIB …. At most, Plaintiff States’ allegations reflect that lawmakers were focused on the permissible legislative purpose of influencing tax policy. Nothing in Shelby County suggests that the equal sovereignty principle bars such a purpose.

The plaintiff states may seek to continue this litigation, spending taxpayer dollars on a petition for en banc rehearing or certiorari, but the result will be the same.


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