The tax bill provision capping federal deductions for state and local taxes at $10,000 could pose a long-term threat to the Connecticut, New Jersey and New York, according to credit analysts.

New York Gov. Andrew Cuomo, New Jersey Gov. Phil Murphy and Connecticut Gov. Dannel Malloy announced on Friday plans to file a lawsuit challenging the constitutionality of the so-called SALT provision.

Laura Porter, managing director of public finance at Fitch Ratings, said Monday that the low SALT deduction limit means all three states face competitive challenges in the years ahead with stiffer political obstacles to raising taxes on high income earners. She said the states also face risks of residents relocating, which would lead to further revenue losses.

Connecticut governor Dannel Malloy
“In so many ways, these changes discriminate against our state, against our economy, against the individual citizens that live in our state," says Connecticut Gov. Dannel Molloy. Bloomberg News

“The negative impact is very concentrated,” said Porter of the SALT changes hurting Connecticut, New Jersey and New York more than other states.

Malloy said during a conference call Friday announcing the lawsuit that the SALT change would impact 171,118 tax filings in Connecticut.

“What is happening here is a frontal attack on the ability of our state to pay for things like education, most particularly, and other services that our citizens receive,” said Malloy. “In so many ways, these changes discriminate against our state, against our economy, against the individual citizens that live in our state.”

Kroll Bond Rating Agency released a report Monday saying the tax code changes will prove most consequential for the high-tax east coast states of New York, New Jersey, Connecticut and California out west.

Kroll analysts Harvey Zachem and Karen Daly wrote that the SALT deduction cap along with other aspects of the bill such as limiting the mortgage interest deduction on new loans to $750,000 will constrain the revenue-raising ability of states that are historically reliant on property taxes.

“It is KBRA’s belief that the curbing of unlimited state and local tax income and property tax deductions will create a more challenging operating environment for these entities,” said Zachem and Daily in their report. “Capping SALT deductions at $10,000 will more than offset the benefit of newly implemented federal tax rate reductions for a large proportion of residents of these states, while not directly affecting state and local tax receipts.”

Robert Mujucia, Cuomo’s budget director, said during a Jan. 24 forum hosted by the Citizens Budget Commission that 3.3 million New Yorkers utilize the SALT deduction, representing about one-third of state tax filers. He said the average SALT deduction is $22,000.

Cuomo has explored restructuring the state’s tax code with new payroll taxes to combat the congressional legislation. The Democratic governor has also proposed authorizing local governments to set up charitable funds that would enable taxpayers to receive credit for donations to offset tax payments.

Jessalynn Moro, Fitch’s head of U.S. public finance, said the speed of New York tackling changes to tax code is a concern from a credit perspective.

“What they are talking about is very, very quick,” said Moro. “It’s all very complicated to tease out, but if something is well researched and well executed and leaves them in basically the same place from a volatility perspective, we’re neutral on that.”

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