In 2021, we’ve seen Congress and the White House push to enact legislation that was not possible under the Trump Presidency. The big spending bills have been obvious — even though 2020 was definitely not a year of limited government spending, nor was it that way at any point in Trump’s term in office — but, like the Republicans who controlled Congress in 2017-2018, Democrats have also called for changes to tax laws. This includes calls to eliminate the tax deduction cap on state and local tax payments — often referred to as the “SALT Deduction.”
The SALT Deduction allows taxpayers who choose to itemize their deductions, usually the richest Americans, to include state and local taxes to offset their federal tax liability. A key component of the tax reform bill passed under President Trump in 2017 capped the amount of state and local taxes a person could deduct from their federal income taxes at $10,000. It reduced the SALT Deduction, meaning that somebody who paid $50,000 in state and local taxes in 2016 would now have their deduction on their federal taxes cut to a fifth of that. Prior to the change, they could deduct all $50,000.
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Politically, this change was contentious. The reason being, those who reside in states with high property and income tax rates were disproportionately impacted by the SALT cap. And, according to TurboTax, nine of the top ten states/jurisdictions affected were “blue” states — states that voted for the Democratic candidate in the past two presidential elections.
Taking a step back from the politics, however, there are two key reasons why the cap on the SALT deduction is sound public policy and, more broadly speaking, good for society.
- The Federal Government shouldn’t subsidize state and local taxation
One of the most basic lessons from any economics course is that incentives matter. With SALT deductions, taxpayers are given a deduction when local and state governments implement higher taxes. This means the federal government is actually subsidizing, and therefore incentivizing, states and local governments to enact higher taxes, because they know their constituents won’t pay the full price.
This means the federal government is actually subsidizing, and therefore incentivizing, states and local governments to enact high taxes.
If you subsidize higher tax rates, you’ll likely see higher tax rates. Limiting the SALT deduction incentivizes fiscal restraint at the state and local level. It also makes local officials more directly accountable to voters for their spending decisions.
- The SALT Deduction gives tax breaks to higher income earners
What is the fairest tax code? If you asked 1,000 economists — or 1,000 people in general — you probably would get 1,000 different answers. But most agree on one thing — those who earn more should pay more in taxes. (How much more — that’s a different story.) The SALT deduction — when no cap is in place — is a highly regressive tax policy, meaning its benefits go to the wealthiest taxpayers who regularly write off over $10,000 on their taxes. It allows those with the most expensive mortgages and, by extension, the highest incomes, to deduct the most — reducing their federal taxes by much more than those of the average homeowner. A deduction because you earn more money doesn’t make sense to me — or just about anybody.
While the SALT deduction cap has been politically controversial, it is promising to see that support for this policy is steadily gaining bi-partisan support. Indeed, the Brookings Institute — a left-leaning public policy organization — recently advocated not to keep the current cap, but for the complete elimination of the SALT tax deduction. This is a positive development, as the SALT Deduction caps are something that shouldn’t be politically contentious. There is no reason for federal taxpayers (all of us) to subsidize high earners in spendthrift states.
Matt Rousu is dean of the Sigmund Weis School of Business at Susquehanna University. Views do not necessarily represent his employer. @MatthewRousu