Tax is a constantly shifting field, twisting and adapting to the needs of both the individual and the state. Very often we see that state laws and state budgets are crafted in reaction to changes made at the federal level. This observation applies to the most recent state budget of New York: the New York State budget for 2018-2019 contains a number of changes which are responsive to changes made in the Tax Cuts & Jobs Act (TCJA).
One of the key changes made in response to the TCJA is the optional payroll tax for New York employers. Spearheaded by NY Governor Mario Cuomo, this controversial change was implemented specifically to counteract the negative financial implications of the reduction to the deductibility cap for state and local taxes (SALT). While this optional payroll tax system may end up financially benefitting many New York taxpayers, there’s uncertainty regarding the some of its potential wider ramifications. The 2018-2019 New York budget also includes charitable entities which are designed purposely to help individuals offset the SALT deductibility cap reductions.
While many may suppose that this payroll tax change is a purely localized development, there’s a good chance that this system may ultimately influence things on a wider scale. The strategies used by one state government can impact the conduct of other state governments throughout the nation, but the nature of the impact depends on the success of those strategies. If Cuomo’s payroll tax system turns out to be successful, this will almost certainly shape the behavior of other states as they grapple for ways to improve the financial lives of their residents. The state of Colorado, for instance, implemented its Job Growth Tax Credit which refunds state payroll taxes for the purpose of promoting economic development, and many feel that Colorado’s approach is the superior one.
As we’ll see, there’s conflicting views on the efficacy of payroll taxation, and so there will be quite a bit of waiting before state governments can draw any sort of useful conclusions.
New York State Payroll Tax Mechanics
The mechanics of Governor Cuomo’s voluntary payroll tax system are simple: employers in New York State can choose to institute a 5% payroll tax which would exempt their employees from state income taxes. This offset would allow more New Yorkers to stay under the newly created deductibility cap for SALT and minimize their federal tax liability. Under Part V, Section 11042 of the TCJA, individuals may deduct up to $10,000 for state and local taxes – $5,000 for a married person filing separately. This deductibility cap does not include state and local taxes related to operating a business or generating investment income.
Potential Drawbacks of the Payroll Tax System
Some experts, not only New York tax attorneys but tax experts from across the country, contend that this new system will have some significant drawbacks. One of the possible drawbacks of the payroll tax system is that New York workers will see a drop in their wages as employers seek to balance their books after implementing the payroll tax. Some New York employers will absorb the 5% additional cost by making other adjustments, but some employers will undoubtedly choose to depress wages. This reduction in paycheck size may end up overshadowing the potential benefits of the payroll tax system. Most employees will dread seeing any kind of reduction in their regular pay, and some may be unable to cope with the change at all. In any case, it’s clear that passing the cost onto employees in the form of wage reduction will not be a solution without its share of complexity.
Another possible drawback is slowed economic growth as a consequence of the increased cost for employers. Suppose that employers choose not to lean on their employees to absorb the 5% additional cost – what is the most likely outcome of such a decision? Increased labor costs may ultimately result in less hiring and less overall economic growth. Another downside to this new system is its effect on nonresident commuters. Experts at the Manhattan Institute, for instance, claim that the new tax will negatively impact commuters from New Jersey and Connecticut. Other experts, notably E.J. McMahon of the think tank Empire Center, have speculated that the tax will disproportionately benefit top-earning residents and generate very few benefits for middle to lower-earning workers. Middle to lower-earning employees are less likely to itemize and more likely to take advantage of the new, higher standard deduction written in the TCJA.
Whether the payroll tax system created by Governor Cuomo will be a success or not is unclear. Analysts will need to examine the results, being careful to properly disaggregate the data and apportion causality correctly, as they become available. This new payroll tax may produce unintended negative consequences which outweigh its benefits, or it may become a staple of New York taxation. Only time will tell whether the Governor and the State of New York made a prudent financial decision.
Jorgen Rex Olson is a graduate of Washington State (B.A., cum laude, 2008) and the Indiana University (McKinney) School of Law (J.D., 2012). He writes for Sammamish Mortgage, a PNW mortgage company, and for ...