State of Play State and Local Deduction
The Trump administration’s fiscal policy is either difficult to discern or exists only in default. The elimination of the state and local tax deduction appears to be the only substantial revenue-generating proposal under consideration.
The proposal is unlikely to pass the Congress. No Democrat would embrace it. Neither would all but a few Republicans from high-tax states. What’s up, besides taxes? More below.
If you’re on high-tax Martha’s Vineyard this weekend, drop me a line and we can discuss in person.
Budget Battles: Deficits and Growth
President Trump and his administration’s fiscal policy proposals generate very little federal revenue. Treasury and OMB have sent mixed signals suggesting they’re ambivalent at best about budget deficits. The most ambitious effort at fiscal balance is the elimination of the State and Local Tax (SALT) deduction. Eliminating the deduction would raise $1.3 trillion in federal revenue over ten years.
The Trump team says growth will compensate taxpayers for losing the SALT deduction. Former deficit hawk on House Budget, now Office of Management and Budget Director Mick Mulvaney, explained that “deficits are not driving the discussion, at least in this White House, about the tax plan…Growth is driving the discussion on the tax plan.” This suggests confusion about the dynamic relationship between growth and deficits. Additionally, with interest rates as low as they are, an argument could be made that increasing the deficit at the present moment may be beneficial if necessary to finance national priorities.
History of the SALT
As a fundamental piece of the US tax code, existing since almost the origins of the federal income tax itself, SALT is a big and sacred cow to take on. It benefits wealthy individuals and effectively subsidizes the efforts of state governments to raise revenue. SALT disproportionately benefits high-tax blue states with dense urban areas.
A State Case
Illinois has failed to balance its budget this year and is now at a deficit north of $1 billion. State officials have tried to chip away at the state’s massive deficit by raising the state income tax rate. A budget proposal to close the gap was vetoed by Gov. Rauner, strongly opposed to the tax rate hike. Several Republicans broke away and voted with Democrats to pass the budget, sparing the state the cost of being reduced to junk status by credit rating agencies. If SALT gets eliminated, this would reduce government income for states like Illinois and could throw their more fragile budgets into disarray.
The Price of SALT — Who Gets Hit?
One of the longstanding principles of taxation is that the same income shouldn’t be taxed twice — hence the federal income tax deduction for state and local income and property taxes. A progressive tax system — another policy pillar from the inception of the code — means high income taxpayers will benefit the most from the deduction. States with higher income tax rates often have more liberal-leaning voting populations (California, New Jersey, New York, etc). These states generate the most revenue from the SALT. The Tax Policy Center estimates that repealing the SALT deduction would raise $1.3 trillion over 10 years.
SALT benefits higher-income taxpayers who fall below the Alternative Minimum Tax level and prevents them from having to pay income taxes twice over to the state and the federal government. It favors those earning over $500k per year more than anyone else. Given that states with higher income tax rates are the ones with more liberal-leaning voting populations in general, it will come as no surprise that the incentive provided by SALT means that strong liberal states (California, New Jersey, New York, etc.) are the ones which generate the most revenue from SALT, and so protecting the deduction is generally seen as a Democrat cause.
Over 30 percent of filers in California and New York claim the state and local tax deduction. Over 40 percent of filers in New Jersey, Maryland, and Connecticut claim the deduction.
In wealthier and competitive Congressional districts where Republican members have a more tenuous hold on their voters, eliminating SALT is a dicey proposition. The average voter nationally would see a tax hike of thousands of dollars, probably fatal to the proposal’s prospects. In the high-tax states, the hit would exceed $5,000 a year per taxpayer. Both Democrats and Republicans in these states have been rallying to voice their opposition to eliminating the deduction.
GOP Rep. Leonard Lance of New Jersey is leading the charge, with a letter to Treasury Secretary Mnuchin: “New Jersey residents pay the highest property taxes in the United States. Eliminating this deduction would increase taxes on the average New Jersey taxpayer by $3,500 per year.” Other notable Republican names speaking out against the elimination of the SALT deduction include: NY Reps. Dan Donovan, Peter King, John Faso, Lee Zeldin, John Katko, Elise Stefanik and Claudia Tenney, as well as Rep. Tom McClintock of CA. If Sec. Mnuchin can’t get all the House Republicans to vote for the elimination of the SALT deduction, it’s unlikely that such a bill would even reach the Senate.
Rubbing SALT into the Economy
In today’s debate about the deduction, some conservatives argue SALT encourages states to inflate their tax rates to get more of a benefit from the deduction. The Tax Foundation observes that rural states end up paying for the state subsidies of higher-income states and don’t see the benefit of their tax dollars directly. This is an argument for the elimination of the deduction as a stimulus for growth. But smaller rural communities hoping to benefit would lose dollars in tax payments at the federal level on a net basis.
The National Governors Association and nearly a dozen organizations representing state and local interests oppose the elimination of SALT. NGA says that losing the SALT deduction would reduce disposable taxpayer income and hurt the economy more than help. The National Association of Realtors has also issued their own statement in support of the SALT deduction, observing that eliminating it would reduce incentives for taxpayers to own their own homes. But it only matters if deficits do.