The House Republicans’ plan to partially repeal the state and local tax deduction is barely a week old and already tax professors have found a number of gaping holes in the proposal. For excellent posts on the subject, read co-blogger David Kamin’s writing here as well as Manoj Viswanathan over at The Surly Subgroup. To pile on, I’ll add one more way that states could game the House proposal — a strategy that could come quite close to offsetting the effects of SALT repeal entirely. (Thanks to David for helping me think this through.)

While there is quite a bit of controversy about whether sole proprietors, partners, LLC members, and S corp shareholders will be able to deduct state and local income taxes attributable to a trade or business (see David’s most recent post for more), there is no controversy as to whether employers can deduct state and local payroll taxes. They can. The House bill does not touchthe deduction for state and local taxes other than real property, personal property, and income taxes. Payroll taxes are state and local taxes other than real property, personal property, and income taxes. When paid by an employer, they’re deductible under current law and remain so under the House bill. (The same is true with respect to the Senate bill released this evening.)

So if either the House or Senate bill becomes law, jurisdictions that now impose income taxes would be well advised to shift some of their revenue-raising to employer-side payroll taxes. For example, Illinois now imposes a flat income tax of 4.95%. Of the next $100 I earn in wages, $4.95 will go to the state and $95.05 will go to me (before federal taxes). Now imagine if instead the state imposed a 5.208% payroll tax on employers. My employer would pay me $95.05 and then pay 5.208% x $95.05 = $4.95 to the state.

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