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Tax Reform Law Induces Sticker Shock For Millions Of Taxpayers

Tax season is upon us and many taxpayers are discovering the changes to the tax code that were generated by the tax reform bill passed in December 2017. While most taxpayers will find at least modest savings from the new tax law, a growing number of filers are learning that they will pay more this year and they aren’t happy.

The tax reform law contains several features that lowered taxes for many Americans. The law kept the seven tax brackets that existed previously but lowered the tax rates. The new law also almost doubled the standard deduction and increased the child tax credit. The problem for many taxpayers, especially in blue states, is that the lower rates and higher standard deduction are not enough to offset the caps that were placed on the deductions for state and local taxes (SALT) and mortgage interest.

Under the old law, state and local property, income, and sales taxes were generally fully deductible. Tax reform capped the deductible portion of those taxes at $10,000. The new law also lowered the amount of mortgage interest that can be deducted from a principal amount of $1 million to $750,000. The new limits to these deductions are hitting middle and upper-class taxpayers in blue states hard.

Many of the irate taxpayers are blue collar workers who claim to have voted Republican. For example, Nycgirl tweeted to the White House:

Dennis Jordan, a veteran and Catholic, tweeted angrily to the GOP:

These tweets and others like them are easy to find as people get their W-2s and start to work on their 2018 tax returns. Especially for taxpayers in states with high property taxes and home values, many are finding that, with no other changes, tax reform has eliminated their tax refunds and left them with tax bills due. For many taxpayers, the list of deductions lost is greater than the increase in the standard deduction.

For example, in California, the median house value is now more than $600,000 which means that almost half of California homeowners cannot deduct all of their mortgage interest. If a home buyer takes out a mortgage for $1 million at five percent interest, the interest payments for the first year would total just under $50,000. Under the new tax law, more than $10,000 of that interest would no longer be deductible.

The problem is compounded by state and local property taxes. California doesn’t have the highest property tax rates (the state is actually 35th), but due to the high price of housing there, the average property tax is $4,783 per USA Today. Northeast and Rust Belt states have even higher property tax rates. New Jersey has both the highest rates and the highest average tax at 2.31 percent and $8,477 respectively. New Jersey’s property tax alone almost reaches the cap for state and local tax deductions.

But wait, as they say, there’s more. Only a handful of states don’t have their own income taxes. In many cases, the states that have high property taxes also have high income tax rates. In addition, there are taxes on other personal property, such as cars, as well as income taxes levied by cities and counties. There is a long list of cities, many in red states, that take their own share of income from workers.

When all these taxes are added up, the tally is more than $10,000 for many Americans. These taxpayers have just lost thousands of dollars in deductions and that drives up the federal income tax that they owe. Last September, the General Accounting Office warned that as many as 4.5 million taxpayers could end up having to write checks to the IRS unless they increased the amount of the tax withheld from their paychecks.

There is a tendency for conservatives to dismiss concerns about the loss of these deductions because they primarily affect blue states, but that is not necessarily a safe assumption. The Tax Foundation published an interactive map that shows which areas benefit most from state and local tax deductions. As it turns out, even swing and red states have pockets of high tax areas.

While California was a large beneficiary of the deductions, Fulton County, Georgia had a higher average SALT deduction claimed ($5,814) than Los Angeles County ($5,405). Delaware County, the home of Columbus, in the must-win swing state of Ohio had an average SALT deduction of ($7,674). Other counties in Rust Belt states carried narrowly by Donald Trump in 2016 are also heavily impacted by the loss of the deduction. These include the Philadelphia suburbs of Montgomery and Bucks Counties, the Milwaukee suburbs of Waukesha and Dane Counties, and the Detroit suburb of Oakland and Washtenaw Counties.

The big question is whether the Republican tax increase on blue state voters would be enough to affect the outcome of an election. The answer is that it may already have. The Republican rout in the suburbs last year may have been at least partly due to those voters who were aware that their deductions for taxes and mortgage interest would be curtailed this year. Among the Republican losses in 2018 were six seats in the Los Angeles suburb of Orange County where the average SALT deduction was $6,569, among the highest in the nation. A Republican stronghold just a few years ago, Orange County is now completely dominated by Democrats. Many other suburban districts, often characterized by high property values and high-income voters, flipped from Republican to Democrat as well.

The tax reform bill was well-intended and provided a boost to the economy, but an unintended consequence was raising taxes on millions of voters in swing states and districts. That policy error may have combined with other factors to make 2018’s blue wave a reality even before most voters knew that they were paying more in taxes. If the error isn’t corrected, things could get worse in 2020 with millions more who saw their tax refunds turn into tax bills. Even though the assumption is that the 2020 election will be a referendum on Donald Trump, many swing voters may turn out to vote their pocketbooks against the party that increased their taxes.

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