The Vermont Legislature went home having spent an unprecedented windfall of about half a billion dollars in federal Covid aid funds. But by declining to advance a seemingly obscure tax reform proposal, lawmakers left a smaller pot of money on the table.
The proposal relates to when Republicans in Congress changed the federal tax code at the end of 2017. Before then, taxpayers could deduct an unlimited amount of state and local taxes from their federal income taxes, a deduction referred to as SALT. After the change, they were limited to deducting $10,000 a year — which disproportionately impacted Democratic states with high income and property taxes, such as Vermont.
“The SALT cap was meant to be a punitive measure on blue states,” said Austin Davis, lobbyist at the Lake Champlain Chamber.
Since then, 24 states, including New York and Massachusetts, have enacted a workaround to allow residents to recover at least some of the federal tax deductions they lost.
That workaround is called a pass-through entity tax.
Pass-throughs are businesses that are not taxed at the corporate tax rate but are instead “passed through” a business owner’s personal income tax. In other words, owners and part-owners of these businesses pay the tax on their business income as part of their personal income tax.
These owners include self-employed people, partnerships, and S corporations. (S corporations are like partnerships, but they may not have more than 100 shareholders, and they may not be owned by another corporate entity. An S corporation may have one or more shareholders.)
Danforth Pewter, in Middlebury, is one of the tens of thousands of Vermont businesses that could have benefited from the tax break.
“You take a company like Danforth Pewter that is a pass-through entity, and typically, we pass through all of our income to our shareholders and they pay full federal and state tax on that,” said CEO Bram Kleppner.
But if Vermont changed its law to allow pass-through businesses such as Danforth Pewter to pay their owners’ state and local taxes, then the income the owners would get from the business would already have their state and local income taxes taken out. They would pay only federal income tax on the business income minus the state and local taxes.
As far as the state of Vermont is concerned, the owners would already have paid their state and local taxes from their business, and so they would not owe any more, except for one small proposed change in the law. Vermont would not give a full tax credit to the business owners. It would give them a 90% tax credit on their personal income tax for the tax paid by the business, and tax them on the other 10%.
So while the business owners would pay less federal income tax, they would pay a little more in Vermont income tax. But they would pay less in taxes overall.
How much more revenue the state would take in is not clear.
Legislative economist Graham Campbell told lawmakers earlier this month that his office believes the state would collect more income if it passed this tax, but could not say how much more.
Speaking to a panel of legislators finalizing S.11, the workforce and economic development bill, Campbell said Vermont business owners could save up to $20 million in federal taxes a year under the proposal.
At that same hearing on May 9, Vermont Tax Commissioner Craig Bolio agreed that his office could not calculate how much the state would reap in additional taxes, but he guaranteed that it would be positive.
“It sounds like all the states that were targeted to be hurt by this have enacted this workaround,” said Sen. Alison Clarkson, D-Windsor.
But the proposal received little enthusiasm from the outgoing chair of the House Committee on Ways and Means, Rep. Janet Ancel, D-Calais.
“Nobody on (Ways and Means) expressed a lot of interest in pursuing it, so we sort of put it aside,” Ancel testified to the conference committee on S.11. “It doesn’t feel to me that this is really the time to be taking this step. I feel really strongly that we shouldn’t enact our tax policy in response to what the feds do.”
One of the co-chairs of the conference committee, Rep. Michael Marcotte, R-Coventry, chair of the House Committee on Commerce and Economic Development, was also skeptical.
“One thing that I can see, right or wrong, is that this is helping the upper-income-level people in the state,” said Marcotte. “It comes down to, the whole question throughout the country is, the rich get richer and the poor get poorer. People that are making $300,000, $400,000, $500,000, $600,000, a million dollars a year are now going to get another tax cut.”
Supporters of the tax workaround argue that it would also have saved small businesses federal income tax.
“The Legislature’s failure to enact language that would have saved Vermont small business owners millions in federal taxes certainly is perplexing,” said Catherine Davis, president of the Lake Champlain Chamber. “Why continue to have our state’s small businesses send money to D.C. that could otherwise be put to work in Vermont? I can’t come up with a good reason.”
Davis, the Chamber’s lobbyist, said the organization would continue to push for the tax change in the next legislative session.
Correction: An earlier version of this story gave an incorrect party affiliation for Rep. Michael Marcotte.