As New Jersey sues over cap on local tax deductions, Congress keeps arguing

The battle over what state and local tax deductions New Jersey homeowners can claim on federal taxes is now winding through the courts, but the debate is also taking place among federal lawmakers and IRS officials.

Initially, Republican leaders in Washington wanted to scrap the state and local mortgage tax deduction altogether in their overhaul of the tax code, but many in the GOP rebuffed that effort — and they were able to convince party leaders to cap the deduction at $10,000 annually.

While that compromise won over some representing the Northeast, it wasn’t enough for many.

South Jersey Republican U.S. Rep. Frank LoBiondo put it bluntly.

“I think New Jersey was screwed,” he said.

He said he’s still dumbfounded by that provision in the $1.5 trillion GOP tax package, even though Garden State lawmakers came up with a workaround.

New Jersey’s Legislature and governor created a law that allows school districts, municipalities and counties to create their own charitable funds. Homeowners give to the fund and get a credit toward their property tax bill.  And, since deductions for charitable contributions aren’t capped, they can get a deduction worth more than $10,000.

Now there’s chatter on Capitol Hill about blocking New Jersey and other states from using this “fix.”

LoBiondo, who’s retiring after this term, said that would fly in the face of his party’s longstanding support of state’s rights.

“By not having that deduction, which has been forever, and the fact that we might want to do something at the state level and have it blocked [in Washington] I think would be really wrong,” he said.

But South Jersey Republican U.S. Rep. Tom MacArthur said it was state lawmakers and Gov. Phil Murphy who stepped over the line.

“What New Jersey is doing is nothing more than a game. You can’t make a charitable contribution, get something of value in return and call it a charitable contribution, it doesn’t work that way,” he said. “Why not buy a car and pay for it with a charitable contribution? Everyone knows, intuitively, that it’s just a gimmick.”

MacArthur said the solution is simple.

“I think New Jersey would be far better off — instead of fighting federal law — figuring out how to reduce New Jersey’s tax burden on its citizens,” he said. “That’s the answer, it’s the only answer.”

The cap is controversial because, according to the New Jersey Division of Taxation, the average property tax bill in the state was $8,413. There are a handful of towns where the average bill is more than $20,000 and in the tiny borough of Tavistock (with just five residents, according to the 2010 Census), the average is $31,424.

Central Jersey Republican U.S. Rep. Leonard Lance, who supported much in the tax bill, voted against it because of the deduction cap. Trenton should decide New Jerseyans’ taxes, not Washington, he said.

And Garden State taxpayers already send more money to Washington than the state gets back, Lance added.

“New Jersey is a sending state, not a receiving state. And if we’re going to look at these provisions in the code, we have to do it across the board,” he said. “I assure the people across the United States that New Jersey sends a great deal of revenue, more to Washington than we receive back.”

The easiest solution would be allowing New Jersey and other states to permit their residents to deduct whatever the state wants them to deduct, Lance said.

“I think that we should continue to have the deductibility of state and local taxes at 100 percent. That has been in our tax code since 1913 , the advent of the modern code. And I’m sorry that it was reduced in the tax bill. I want it fully deductible,” he said. “The original tax proposal was to not be able to deduct any amount. It’s at $10,000 now, and I want it restored to where we can deduct the full amount.”

Still, MacArthur stands by the tax overhaul he helped get over the finish line. He has argued most of his constituents will end up ahead. Especially with the standard deduction doubled in size, he said he thinks fewer people will be itemizing their deductions.

“They’ve been wrong, wrong, wrong on these declarations. Jersey businesses are growing, they’re paying more in salaries, they’re investing in new plants and equipment and people,” he said. “And so the Legislature and the governor can fuss all they want, but the reality is federal tax policy is leaving more money in families and businesses in New Jersey, it’s time for New Jersey to do the same thing.”

Jersey Democrats see it differently.

“The average increases in home mortgages are going to go through the roof, and there’s no two ways about it. It’s been a great attraction to buying homes, usually being able to sustain yourself in the home after you buy it is very very important. That is crippling New Jersey’s economy,” said U.S. Rep. Bill Pascrell of North Jersey.

Now that New Jersey has joined New York and two other blue states in a lawsuit saying capping deductions at the federal level is unconstitutional, Pascrell said he’s not as worried about the potential for federal lawmakers to undercut Jersey.

“We’ll see if they stand up. I think New Jersey is right on course to be challenging. If not this, we’ll go to something else. We have a variation of what New York is doing. So we’re not going to back off,” he said.

Still, Pascrell and other New Jersey Democrats are making the case for restoring those state and local tax deductions central to their pitch to voters as they aim for House control. And they say, if they’re in power, they have a plan to overturn the policy — even if the courts rule in the GOP’s favor.