U.S. tax bill may face lawsuits with long odds but political payoffs

[December 21, 2017]  By Jan Wolfe

(Reuters) - Democratic-leaning states may take legal action to challenge the cap on deductions of state and local taxes under the sweeping overhaul of the U.S. tax code, and even though such lawsuits would face long odds they could help galvanize Democrats for next year's mid-term election.

The U.S. tax bill, passed by Republicans in Congress on Wednesday, limits deductions of state and local income and property taxes, known as SALT, to $10,000.

The provision hits hardest Democratic-leaning states with high incomes, high property values and high taxes, like New York, New Jersey and California.

Law professors said legal challenges would likely rest on arguing that the provision interferes with the protection of states' rights under the U.S. Constitution.

Some political strategists see a win for Democrats regardless of how courts ultimately rule, saying that lawsuits could be used to keep the issue front and center for voters already largely disenchanted with the Republican party.

"It’s a no-brainer for them to do this," said Democratic political consultant Phil Singer. "Failing to aggressively pursue a remedy would be political malpractice."

New Jersey Governor-elect Phil Murphy said during an appearance on CNBC on Wednesday that "everything is on the table" for New Jersey to oppose the bill, including challenging its "legality and constitutionality."

The governors of California and New York, Jerry Brown and Andrew Cuomo, have both previously said they were exploring legal challenges to SALT deduction limits. Their offices did not return requests for comment on Wednesday.

Since President Donald Trump took office, blue states have aggressively used the courts to attempt to block the president's agenda, suing over his proposed travel ban, environmental policies and other measures.

William O'Reilly, a conservative political consultant in New York, said the SALT deduction issue would likely add to Republicans' "suburbia problem" among college-educated voters ahead of the 2018 midterm elections.

"They already had one because of this president’s style," O'Reilly said.

Darien Shanske, a tax law professor at the University of California Davis School of Law, said the governors would probably argue that restricting the SALT deduction, which dates back to the introduction of the federal income tax in 1862, violates the U.S. Constitution's 10th Amendment that protects states' rights.

Shanske and other tax experts said the federalism argument would need to overcome the U.S. Supreme Court's historically broad interpretations of Congress' 16th Amendment power to impose taxes.

"As a general matter, nothing prevents the federal government from changing the SALT deduction," said David Gamage, a professor of tax law at Indiana University's Maurer School of Law.

In a frequently cited 1934 decision, the Supreme Court called tax deductions a "legislative grace" rather than a right, and said Congress has broad leeway to abolish them. The court reiterated this view in a 1988 decision allowing Congress to remove a federal tax exemption for interest on some state and local bonds.

Kirk Stark, a professor of tax law at the University of California, Los Angeles School of Law, said there is a slight possibility that a federalism argument against limiting the SALT deduction could gain traction.

"Courts create new law all the time," he said, noting that decisions on matters this sweeping tend to become political.

But some legal experts noted that the state's rights argument is more typically a conservative position. Using it to challenge the SALT provision could be a move that Democratic governors come to regret in the future, said Daniel Hemel, a professor at the University of Chicago Law School.

"The progressive agenda depends on the federal government being able to raise revenue and the Supreme Court not getting in the way of that," Hemel said.

(Reporting by Jan Wolfe; Editing by Anthony Lin and Leslie Adler)

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