NFL playoffs have begun, and Wild Card Week featured some real competition. On Saturday, the red-state Tennessee Titans barbecued the red-state Kansas City Chiefs, 22-21, and the red-state Atlanta Falcons defeated the blue-state Los Angeles Rams, 26-13. On Sunday, the purple-state Jacksonville Jaguars pounced on the blue-state Buffalo Bills, 10-7, and the red-state New Orleans Saints marched past the purple-state Carolina Panthers, 31-26.
Now, if you’re like most people, you’re wondering why we’re polluting your NFL news with red state and blue state political references. You wouldn’t think politics matter on the gridiron! Unfortunately they do, now even more than before, thanks to the Tax Cuts and Jobs Act of 2017. Huh?
Here’s the deal. Blue states, as a group, tend to have higher income and property taxes than red states. (That’s not always true — Washington, for example, has no state income tax at all — but it’s a fair rule of thumb.) Those higher taxes make blue states slightly less attractive for athletes who play home games subject to income tax there. If you’re a first-round draft pick wide receiver, would you rather pay a 13.3% top tax rate to catch passes in Los Angeles, or a 0% state tax rate to catch them in Jacksonville?
Does this really matter? Surprisingly, yes. Erik Hembre, Assistant Professor of Economics at the University of Illinois at Chicago, took win-loss records from the last 40 years of professional sports, then overlaid them with state marginal tax rates. He found that “state income tax rates significantly impact team performance.” In the NBA, where the effect is greatest, moving a team from high-tax Minnesota to tax-free Florida should yield 4.7 more wins per year. In baseball, where there’s no salary cap and the tax effect is lowest, the same move would still add 1.6 Ws per year.
The new tax law actually magnifies this effect. Under the old rules, a hypothetical utility infielder, grossly overpaid to bat .260 for the Yankees, could at least deduct the 13% he pays in state and local income tax from his federal return. That effectively reduces the tax by about 40%. But the new law caps the deduction for state and local income, sales, and property taxes at just $10,000, no matter how much an athlete actually pays. That means sports fans in high-tax New York will have even more to grouse about!
The new rules will be expensive for lots of blue-state taxpayers, not just athletes. The Government Finance officers Association found that in 2015, over one-third of taxpayers in California, New Jersey, and New York claimed the deduction, with an average amount over $17,000.
Blue state officials aren’t taking the change lying down. Legislators in California and New Jersey are considering encouraging taxpayers to make gifts to the states in exchange for credits against their tax. This would let them sidestep the new law by deducting those amounts as charitable contributions. New York Governor Andrew Cuomo has threatened to challenge the constitutionality of the law and switch from income to payroll taxes. Only time will tell if those strategies are practical and pass muster with the IRS.
Until then, there’s a time-tested strategy that works better than any legislative Hail Mary. That strategy is planning. If you don’t have a tax plan yet, 2018 really is the time to get one. And if you do, now may be the time to update it. So call us for the coaching you need to make the most of this new law!