Here's how the payroll tax change, which New York Gov. Andrew Cuomo mentioned his State of the State speech, would work.
Let's say your employer pays you $100,000 a year and you pay $5,000 in state personal income taxes, leaving $95,000 before federal taxes and other charges.
What if instead your employer paid you $95,000 in wages and also paid a $5,000 payroll tax to the state? Your employer would be no worse off, with its out-of-pocket cost still totaling $100,000, and the new tax law preserves an employer's ability to deduct payroll taxes from their own tax bills.
And you generally would be no worse off either, as you would still have $95,000 before dealing with your federal tax bill.
Indeed, you would most likely fare better financially once federal taxes are factored in. The federal government would tax you on $95,000, whereas you would be taxed on the full $100,000 if the state did not adopt the payroll tax workaround and if you could not claim a SALT deduction.
That would be the case if you claim the standard deduction – as at least nine-tenths of taxpayers will – or if you hit the $10,000 SALT cap based on property taxes alone. Depending on your federal tax bracket, the savings could increase your after-tax income by anywhere from 0.6 percent to 3.1 percent.
States adopting this approach do not need to repeal their personal income taxes entirely. Their income taxes still would apply to earnings from sources other than wages, such as investment or self-employment income. But they would not tax workers on wages that already have been subject to an employer-side payroll tax.
Implementing this change would be relatively straightforward in states like Illinois, Massachusetts and Pennsylvania, which have flat personal income tax rates. It would be somewhat more complicated to pull this off in states such as New York and California, which have highly progressive rate structures.
But this can almost certainly be done through a system of refundable credits, and the potential savings for state residents would be dramatic. In New York, for example, an average household might save around $1,200 per year on its federal taxes.