The Trump tax proposal includes the elimination of state and local tax deductibility from federal taxes. We wrote last week about the potential effects of this change on the municipal bond market. See, Quick Take on Munis and the Trump Plan.
From a local taxation standpoint, the other potential large effect of the bill is the elimination of property tax deductions from federal taxes. If passed as constructed, this bill will hit towns and cities with high property taxes right in the jaw. It will be particularly onerous for townships that rely on local property taxes for the majority of their revenue and hurt those towns that do not have much in the way of ratable business properties.
Currently, someone in the current top marginal federal tax bracket of 39.6% and paying property taxes of $25,000 can deduct them on their federal taxes. This makes the EFFECTIVE tax approximately $15,100 ($25,000 *(1 - .396)). The EFFECTIVE tax bill jumps to the full $25,000 without the deductibility effect – a 65% increase from the current effective level.
Clearly these types of EFFECTIVE property tax increases will impact the Northeastern states and California the most – those are the areas with the high property taxes. The long-term relationship between the federal government and the states regarding the deductibility of state and local taxes was discussed by my colleague Patricia Healy last month. See www.cumber.com/taxation-of-municipal-bonds/.
Here is the list of the top ten states, ranked by median property taxes as a percentage of home value. (Source: Taxrates.org)
| 1 | New Jersey | 1.89% |
| 2 | New Hampshire | 1.86% |
| 3 | Texas | 1.81% |
| 4 | Nebraska | 1.76% |
| 5 | Wisconsin | 1.76% |
| 6 | Illinois | 1.73% |
| 7 | Connecticut | 1.63% |
| 8 | Michigan | 1.62% |
| 9 | Vermont | 1.59% |
| 10 | North Dakota | 1.42% |
Other notable states are Pennsylvania – 1.35% (rank 13), New York – 1.23% (rank 17), Massachusetts – 1.04% (rank 20), and California – 0.74% (rank 32). It’s important to remember that California has had property tax growth restrictions, established by Proposition 13, for a number of years.
It is also important to note that there is great variation WITHIN states. Low relative property taxes in upstate New York are offset by very high property taxes in Long Island and Westchester County. Low relative property taxes in Western Massachusetts are offset by high relative taxes in the Boston area. Another example is Northern NJ near New York City (high) versus Southern NJ (lower).
The offset to the removal of state and local tax deductibility is the proposed doubling of the standard deduction (currently $6,350 for individuals and $12,700 for married couples). This adjustment will mean that many more people will NOT be itemizing, and certainly tax simplification is another goal of the Trump tax plan. However, many families living in the wealthier parts of the high-property-tax states will find themselves facing much higher EFFECTIVE property taxes.
In our view, this tax proposal has issues that will affect municipalities in high-tax states in general and public finance particularly. Many municipalities will face a backlash as citizens wrestle with the effects of the higher EFFECTIVE taxes. The GROWTH of these local property tax bases will slow, quite possibly dramatically, as the subsidization of property taxes by the federal government is removed. At the margin, projects that are financed by general obligation pledges of communities will be looking to users to finance them – perhaps in the form of fees that are pledged by users of a project. This may mean fees in areas that are not used to seeing them: recreation programs, local libraries, local public transportation, garbage collection, etc. The higher EFFECTIVE property taxes will reinforce a trend that we have seen in public finance since the recession: There are fewer and fewer projects subsidized by governments, and instead these projects are subject to market-based rates. The higher rates will also spur local cities and townships to seek corporations and businesses to locate in their jurisdictions to increase the tax ratables in their tax base and thus relieve some of the pressure from the increase in EFFECTIVE property taxes.
It is clear that there will be a lot of legislative wrestling regarding the final form of the tax bill and we will keep investors informed. But there is no question the first shot across the bow of removing Federal government subsidization of state and local taxes has been fired.
