U.S. appeals court skeptical of ending cap on state and local tax deductions

NEW YORK, Dec 3 (Reuters) - A federal appeals court in Manhattan on Thursday appeared skeptical of arguments by four Democratic-leaning U.S. states to overturn Republican President Donald Trump's decision to cap federal deductions for state and local taxes.

The 2nd U.S. Circuit Court of Appeals was hearing an appeal from New York, Connecticut, Maryland and New Jersey over a law limiting to $10,000 the state and local taxes that households itemizing deductions could write off their federal returns.

That law, known as the SALT cap, was part of the $1.5 trillion tax overhaul signed by Trump in 2017 following approval on a party-line vote from the Republican-controlled Congress.

Democratic President-elect Joe Biden has not called for a repeal of the cap, which would benefit primarily people making over $100,000 a year, and it is unclear Congress would approve it despite support from many Democrats.

The cap disproportionately affects high-tax states, with New York estimating its taxpayers would pay $121 billion of extra federal taxes from 2018 to 2025. New York Governor Andrew Cuomo has called it an "economic attack on Democratic states."

While the SALT deduction's roots date to the 1860s, the three-judge appeals court panel seemed unconvinced that capping it was a means to coerce states to cut taxes and the services they pay for - such as hospitals, police, schools, and road and bridge construction - or that judges should get involved.

"The Senate and the House changed their minds because the American people spoke," Circuit Judge Raymond Lohier told a lawyer for the states. "When it comes to taxes, the Supreme Court tells us unless there is something explicitly in the Constitution ... we're going to step out of the way."

Caroline Olsen, the states' lawyer, acknowledged that Congress's taxing power is "quite broad," but that economic stresses caused by the cap "severely infringe" states' ability to exercise their own tax policies.

Lawyers for the Trump administration said the SALT cap did not target particular states.

The case "concerns a policy disagreement masquerading as a constitutional claim," Assistant U.S. Attorney Jean-David Barnea told the panel. "Congress' right to create and eliminate tax deductions is entirely a matter of legislative policy judgment."

Capping the SALT deduction helped pay for the 2017 tax law, which lowered taxes for wealthy Americans and slashed the corporate tax rate. U.S. District Judge Paul Oetken in Manhattan refused to block the SALT cap in Sept. 2019.

The case is New York et al v Mnuchin et al, 2nd U.S. Circuit Court of Appeals, No. 19-3962. (Reporting by Jonathan Stempel in New York; Editing by Marguerita Choy)