[H]ouse Democratic leaders have agreed to close the state’s $113 million budget gap with $35 million in new revenue, and the most likely vehicle for the lion’s share of that money is two changes to the income tax code that have nonprofits and real estate groups on edge.
Lawmakers are considering a cap on itemized state income tax deductions at 2.5 times the standard deduction, or $15,500 for an individual and $31,000 for couples filing jointly. The plan also calls for eliminating the deduction for the previous year’s state and local taxes — currently capped at $5,000.
That leaves the House Appropriations Committee looking for $78 million in cuts, with the budget and miscellaneous tax bills expected to move “in tandem” out of committee on Monday, according to House Speaker Shap Smith, D-Morristown.
The tax-writing House Ways and Means Committee is likely to take up the income tax proposals as part of the miscellaneous tax bill Friday, according to Rep. Janet Ancel, D-Calais, and she and the speaker have voiced their support for the changes.
That’s raised the hackles of real estate trade groups and nonprofits who worry the caps will affect charitable giving and home buying, because two of the most popular deductions — accounting for 46 percent of all deductions — are for mortgage interest and charitable giving.
Stuart Comstock-Gay, president of the Vermont Community Foundation — an umbrella organization for charitable foundations and nonprofits in the state — said that individual donations are crucial to organizations that provide important services in Vermont. They oppose any changes to the tax code that “remove incentives or increase barriers” to giving, he said.
“While not the primary reason that most people give, tax incentives matter to enough donors that reducing or eliminating charitable deductions will have an impact,” Comstock-Gay said.
Isaac Chavez, CEO of the Vermont Association of Realtors, said an overall cap is less objectionable than one that targets the mortgage interest rate deduction directly — a proposal that lawmakers have considered in the past — but it still has the potential to create “winners and losers” when individuals are forced to weigh one deduction against another.
Most mortgage payments are interest-heavy in the first years of the agreement, and regardless of whether a home costs $200,000 or $1 million, the buyer is likely to hit the deduction cap during those years. That will have an impact on middle-income homebuyers who may be limited in “the amount of home they can afford” as a result, Chavez said.
Smith said their concerns are overblown. Vermont residents will still be able to claim federal income tax deductions. In states that don’t allow any state income tax deductions, people still donate money and buy homes.
“I think charitable giving is largely driven by the federal deductions, and in many other states they don’t actually allow deductions for charitable giving and people do still give,” Smith said, adding that the same is true for homebuyers in states that don’t allow the mortgage income tax deduction.
Vermont uses federal taxable income as the starting point for its state income tax, not adjusted gross income. Federal taxable income is the AGI amount minus either the federal standard or itemized deductions, plus federal tax exemptions.
John Killacky, executive director of the nonprofit Flynn Center, said in testimony to lawmakers that at least three states that capped charitable deductions have since reversed course. In Hawaii, charitable deduction caps went into effect in 2011. Unlimited state tax deductions were reinstated last year because the $12 million in state revenue generated by the cap resulted in a reduction in donations to nonprofits of $60 million, Killacky said.
Rep. Bob Canfield, R-Fair Haven, a member of Ways and Means, said he’s undecided on the proposal, but worries about its impact on nonprofits, and for the reasons articulated by Killacky, he called it “pennywise and pound foolish.” But for some Republicans and fiscal conservatives, the income tax changes are the best among bad options to raise revenue.
“If I were looking for revenue, I think broadening our tax base by reducing deductions is better public policy than creating a new tax,” said Rep. Adam Greshin, I-Warren, who sits on Ways and Means Committee.
Rep. Jim Condon, D-Burlington, a fiscal conservative who has joined with Greshin and Republicans in the past, called it a “reasonable compromise” given the state’s “dire need” for revenue to fill its budget gap. Condon said he voted for a similar proposal that passed the House in 2013, and he’d likely vote for it again.
Rep. Carolyn Branagan, R-Georgia, Ways and Means vice chair, agreed with Greshin that the tax code changes are more palatable than new taxes — though she was explicit that she believes the state has a spending problem that needs to be addressed before it asks residents to pay more in taxes.
Democrats and other left-leaning lawmakers like that the changes would introduce more progressivity into the tax code. Ancel said earlier in the session that [the cap on deductions is good policy] whether it’s used to generate revenue or not. She championed a revenue neutral version of the measure in 2013.
The average value of state income tax deductions for people earning $1 million or more is more than $200,000; for people making $75,000 or less, the average value of deductions is just over $15,000 — right at the proposed individual cap and well below for joint filers.
There are roughly 93,000 filers who itemize deductions on their returns, which is just below 30 percent of the total. Of those who itemize, 88,000, or 95 percent, would be affected by the proposed changes.
That figure drops to just 20,000, or 21 percent, because most people who itemize won’t deduct enough to meet the cap, according to figures from the legislative Joint Fiscal Office.
