TED'S TAKE: TAX PHILOSOPHY (and why you need to know about it)

 With all the recent negotiations in Congress related to the new One Big Beautiful Bill, I thought I would offer an outline of the various tax strategies and complexities of what Congress is dealing with.

For context, states deploy a wide variety of taxes that are levied on both individuals and corporations through a wide variety of mechanisms. The proportions of the tax burden across these mechanisms vary, as there is no systematic or uniform approach across all states. Over time, this has led states to cobble together a variety of different taxation approaches that get them the monies they need.

The same is true at the federal level, which is what leads to  issues arising when these differing taxation approaches intersect. For federal income tax purposes, the tax codes begins with premise that “everything” is income for tax purposes. In some circles this is called the “shotgun” clause. That is baseline and then the rest of the tax code deals with defining what are deductions, exclusions, exemptions, etc. 

The inherent structure of Congress also factors into this process. The House of Representatives is basically an “urban” body as the seats are distributed based on a state’s population, while the Senate is basically a “rural” body as each state gets two seats regardless of size. Thus, when determining or “reconciling” federal budget and tax structures this often comes into play in a big way and underscores the great variability that exists across states.

So, you have each state deploying a variety of different tax strategies to fund the needs of their particular state. In addition, various instrumentalities of government like counties and cities have deployed additional strategies to fund their governments.  Many states do not have an income tax. Some are funded mostly by a sales or use tax applied to products or services within a state or county. Other states that have no income tax are funded by real property taxes, personal property taxes, sale or use taxes, or a combination. Revenue also comes from taxes paid by corporations of varied industries. Again, significant variability state by state.

Separately, there are select programs like Medicaid that is a joint federal/state funded program administered by the states under a federally prescribed structure. There is a limit on how much each state’s Medicaid program funding is matched by the federal government. There is and has been a dynamic tension between the federal and state governments as states attempt to shift more of their Medicaid funding burden (as well as other activities such as education) to the federal government, leading to the federal government enacting limits on Medicaid funding.

Following the same theme of variability, some states fund Medicaid via direct funding transfers for a certain portion of the total Medicaid budget while other states require the instrumentalities of government to contribute to Medicaid funding. Others have requirements to operate and fund hospitals and/or nursing homes to satisfy these requirements and in some instances these funding requirements are even required by a state’s constitution.

Over time, some states have funded Medicaid via taxes on Medicaid providers like hospitals, nursing homes or other providers of health care services and therefore levy taxes on such providers. The federal Medicaid program has placed limits on the level of such taxes and other requirements.

Other states have predominantly funded the state activities through real property taxes and/or state income taxes (referred to a State and Local Taxes – SALT) and therefore have high SALT taxes as a percentage of personal incomes. However, SALT taxes can be a deduction from federal income which means that in states with a high SALT burden, taxpayers (and therefore that state) benefit from the SALT tax deduction. This in turn means that other federal taxpayers are subsidizing the high SALT states who get the deduction.

This has led to a debate on the SALT deduction level and if limits need to be applied.  Allowing this type of deduction to certain states that have funded a larger level of their government through particular taxes but not allowing federal deductions to other states who base their tax burden elsewhere, causes disproportionate shifts the tax burden and it becomes asymmetrical across different states.

Hopefully by understanding more about the tremendous variability between different states and their unique tax policies, you can better decipher some of the discussions that are taking place at the federal level. In short, the debate continues to be about which taxpayers (and taxpayers within states) should pay which proportions of the federal tax burden. Clearly, the wide variability and inconsistency of tax policy, the structure of Congress and the politics across various states contributes greatly to the process and debate.