The SALT Deduction is Good.
Everyone hates the state and local tax deduction except me. Everyone else is wrong.
If youâre following the debate around President Bidenâs Build Back Better initiative, then you might have heard about something called the SALT deduction, which is a federal tax break for State And Local Taxes (the s-a-l-t in SALT). If you have heard of it, youâve probably heard that itâs another one of these awful tax breaks for the rich. And if you heard that, you have an equal chance of having heard it in the New York Times or on Fox News. Thatâs because everyone hates the SALT deduction. Brookings Fellow Richard Reeves tweeted at me that every âevery single sensible tax policy scholarâ opposes the SALT deduction.
Well, thank God Iâm neither sensible nor a scholar. Itâs us versus the world, folks, and youâre with the good guy.
To start, let me acknowledge that this mix of acronyms, tax deductions, and multiple tax jurisdictions might sound a bit wonky and boring. I wanted to write about this because it is a really good example of where many well-intentioned progressives have gone in the wrong direction, forgetting the importance of public investment at the state and local level and stepping into a pretty rudimentary conservative trap. I promise the content is not as wonky as it sounds and if you stick with me on this, I think you might come away with a new and useful perspective on some important public finance questions. Youâll also hear about a lot of people who think Iâm a faux-progressive moron, so thereâs something for everyone.
To first explain how the SALT deduction works: Filers are allowed to reduce their federal taxable income by the amount they pay in state and local taxes. So, if a family making $150,000 pays $15,000 in state and local taxes, their federal taxable income is reduced to $135,000 and they save the $3,600 they would have paid in federal income taxes on that $15,000. Importantly, however, this benefit is only available to filers who itemize their deductions, which is a pretty wealthy group; in 2017, the SALT deduction cost roughly $100 billion (i.e. saved people $100 billion in federal taxes) with 71 percent going to filers making over $200,000 and another 22 percent going to those making between $100,000 and $200,000. Thatâs a lopsided benefit but hear me out.
The deduction, which has existed in the federal tax code since the creation of the income tax in 1913, was capped at $10,000 as part of Trumpâs 2017 Tax Cuts and Jobs Act. At the time, the cap was labeled a diabolical attack on blue states that have higher taxes and thus benefit more from the deduction. By limiting the amount that could be deducted, the cap increased effective tax rates on the rich living in high tax states and shrunk the total cost of the deduction to around $22 billion per year. It also made the benefits slightly less lopsidedâfilers earning more than $200,000 now get 56 percent of the benefit and those earning between $100,000 and $200,000 get 33 percent. The current debate centers on whether to raise or eliminate this cap, or ditch the deduction altogether.
The fact that the SALT deduction benefits mostly rich people is the main strike against it, and a legitimate gripe. Rich people do not pay enough in taxes and as a result we suffer from both low revenue and staggering income inequality. Top-heavy deductions like SALT contribute to after-tax inequality by allowing the wealthy to lower their taxable income. We can and should increase taxes on the rich, but if we want to do that we would be much better off looking at the preferential rate on capital gains, unlimited tax-free retirement accounts, or the income cap on payroll taxes. The fact is that the SALT deduction is the last tax break we should think about ending because it is the only tax break that actually encourages valuable public investment. Subsidizing state and local spending is something we should do more of, not less.
By offsetting state and local taxes, the SALT deduction creates âfiscal spaceâ for non-federal taxing jurisdictions. Practically speaking, when people know their state and local tax bills will lead to a break on their federal taxes, state and local governments have have an easier time raising tax revenue. Itâs worth repeating that the SALT deduction encourages the best kind of public spending: State and municipal governments pay teachers, they build hospitals, and they keep clean water flowing out of our taps. The SALT deduction is a way of extending the federal governmentâs enormous budgetary power to support these important state and local investments.1 Thatâs a good thing.
Importantly, the SALT deduction not only eases and rewards state and local investment, evidence shows that it also increases the degree to which state and local governments fund investments out of more progressive revenue streams such as income or property taxes, as opposed to more regressive non-deductible revenue streams like sales taxes or user fees like tolls, which are not deductible. So the SALT deduction encourages state and local governments spend more and burden their low-income residents less. With so many other progressive revenue-raisers available, thatâs a pretty compelling case for the SALT deduction.
The precise extent to which the SALT deduction increases progressive funding for state and local investment is unclear, but the positive relationship is a basic fact included in any unbiased coverage of the policy. With that said, I am going to do something annoying and use my personal experience to make an argument I canât fully defend with available research: I think the SALT deduction matters a lot. The expectation that your state and local taxes will be offset by federal savings is meaningful to people, especially voters in wealthy purple suburbs that exist in every swing state in the country. In my work in Minnesota I hear about it all the time and folks I work with in the state legislature unanimously agree that limiting the deduction has made their jobs even harder. Simply put: SALT deductibility increases tolerance for higher levels of funding among some vocal and influential voters. To me, the fact that Republicans and other austerians have targeted the provision with so much vitriol suggests they believe the same thing. Only confused progressives seem to remain lost on what is really going on here.
Indeed, the fact that the SALT deduction rewards states that raise and spend more progressive revenue is exactly why Donald Trump and the Republicans sought to cap the deduction in the first place. By shrinking the SALT deduction, Republicans not only struck a blow against state and local investment, they also discouraged more equitable funding of state and local programs. Why would Republicans oppose a tax break for the wealthy? Well, perhaps they suspect the same thing I am asserting: That what SALT deductibility gave in the way of a tax break for their wealthy base was less than what it generated in higher progressive taxes and spending at the state and local level. Likely they also saw there would be plenty of other tax breaks left for their voters to take advantage of.
So while I agree the rich should pay more in taxes, I donât see why that canât be accomplished with higher rates or by addressing one of the dozens of other policies that lower effective tax burdens for the rich. Not only would that be a better way to raise revenue, but increasing marginal rates would do more to fight pre-tax inequality, by discouraging runaway wages and/or investment gains for the wealthy. Somehow, progressive TTRers have joined the far-right in opposition to the SALT deduction and seemingly not a single one of them has considered any of the broader implications discussed here.
One important question at work is, do we want the rich to pay more even if it is at the expense of how much we spend? To me the answer is âof course not.â With so many other ways to tax the rich, why would we do anything to discourage state and local governments from raising more money for schools, Medicaid expansion, or any other number of worthy state and local budget priorities? Perhaps some on the left who oppose the SALT deduction disagree and think shrinking post-tax incomes is paramount, but to me it seems more like they just havenât thought it over.
To be fair to my wayward anti-austerity allies, the context of this debate occurring alongside a major federal spending bill alters the calculus. Because changes to the SALT deduction are being considered as part of one big federal package, advocates have been weighing the cost of the deduction against what it could buy in federal programs. The possibility that an expansion of the SALT deduction could cost us, for example, some amount of child tax credit certainly makes an anti-SALT deduction argument more understandable. But I think the idea of a one-for-one trade-off is fanciful. The likelihood that the $100 billion needed for the full SALT deduction is the same $100 billion that would otherwise fund something wonderful is extremely lowâthese policies are living and dying by their own momentum and as a result of opaque insider politics.
There is also a general sense that the Build Back Better plan will be the last big thing that Democrats do before the election, and that a top-heavy tax cut would be a bad legacy politically. I agree that SALT doesnât make for great politics, but from another point of view, setting states up for more favorable budget fights in the years to come would not be a bad strategic move. The bottom line is that the SALT deduction is a good and longstanding method of providing assistance to state and local budgets. For nearly one hundred years it lightened the burden of state and local spending and only came under attack as anti-tax politics reached its current crescendo and progressives lost their bearings on certain budgetary issues.
Rather than eliminate or continue to cap the deduction, progressive should work toward a refundable state and local tax deduction for everyone. They should also extend greater support for state borrowing to fund productive investments in infrastructure, transit, housing, and more. In short, progressives should be looking at every possible option for supporting state and local investment.
The fact that such a broad coalition of centrist and conservatives are united against SALT should be raising red flags with good progressives who are thinking about the issue, especially when so many of the same think-tanks that advocated top-heavy corporate tax cuts are now crying inequality in an effort to stymie the SALT deduction. How is it that we can have tax breaks for second homes, charitable contributions, and all manner of business expenses, but the state and local governments that fund our schools and libraries are not a worthy cause?
The problem is that progressives have gotten so caught up in trying to demonstrate they hate the rich, they have seemingly forgotten about the redistribution side of the budget altogether. Still, itâs a bit confounding. Of all the horrible tax breaks out there, how on earth could progressives let their focus fall to the one tax break that actually supports some essential functions of government? I genuinely do not understand how so many well-intentioned policy advocates are willingly lining up alongside the âbudget hawksâ that are our ostensible anti-investment opposition.
Admittedly, one problem with a subsidy for state and local spending, is that not all state and local spending is equitable. Property taxes, for example, are the primary source of revenue for public schools, but they are not always shared between districts. This means that the SALT deduction would disproportionately benefit some wealthy school districts and do relatively less for lower-income areas where there are fewer itemizers benefiting from the deduction. Thatâs a reasonable concern, but ultimately I donât think itâs a good enough reason to write off all of the SALT deductionâs potential benefits. First of all, if we take the argument that far, we must take it a little farther and consider that high-tax states like California and New York make efforts to redistribute property tax revenue to equalize funding between school districts. That means that, in practice, SALT benefits will flow to a wide range of communities.
Furthermore, the idea that a few top-notch public schools are a major problem is some pretty silly, zero-sum thinking. If weâre concerned about the concentrated benefits of well-funded public schools, then school integration would be a much more fruitful avenue of discussion. Real rich people send their kids to private school, anyway, so I think we want more well-funded magnet schools, not less. And I would say the same about prosperous cities implementing innovative programs and new public benefits. Outliers in public investment will encourage more of the sort of public leadership and experimentation that we need and that is notably absent at the federal level.
Thatâs my main caseâI think the SALT deduction helps state and local governments far more than it increases inequality, and I think it is a useful (but all too small) extension of federal monetary power to the states. If you remember anything from this, I hope that is it. But I also want to mention one technical issue that I feel strengthens my position considerably: In truth, a lot of taxpayers are still receiving the full, uncapped SALT deduction by filing their taxes as businesses. You see, when Trump capped the SALT deduction, he did so only for individual filers. Businesses also pay state and local taxes and those filing as corporations are still able to deduct them from their federal taxable income. This is something you donât hear in the SALT deduction debate because, again, everyone is too busy have an ill-considered knee-jerk âtax the richâ reaction.
The existence of the corporate SALT loophole means we are paying a sizable portion of the cost of the deduction, but arbitrarily limiting who benefits from it. Not every taxpayer is able to pull-off the complicated maneuver of filing as a corporation, so the SALT deduction is now available only to the most adamant tax avoiders. As a result, state and local governments receive none of the political benefit of a broadly shared understanding that state and local taxes are subsidized, but they still lose a chunk of revenue. Thatâs pretty much the worst of both worlds and to my knowledge none of the current SALT plans address this issue.
Ok, Iâve gone on long enough for one post. I think that if you center the importance of state and local spending and step back to consider the myriad of options for taxing the rich, itâs pretty clear that strong opposition to the SALT deduction can only be motivated by either a misplaced populist instinct or a reactionary opposition to public investment. We should be expanding the SALT deduction and other policies to support state and local investment, not fighting it. My arguments here wonât persuade the deficit hawks with whom I have a core disagreement, but progressives should reconsider their position.
[Note: I had this post all teed up and then the Democrats floated a retroactive SALT cap repeal, which would refund rich taxpayers for the SALT tax break they didnât get since the Tax Cuts and Jobs Act. This is a terrible idea that I do not support.]
I have been confused by some of the same people who think that federal borrowing power makes tax revenue largely unnecessary coming out against the SALT deduction on the grounds that it will eat up federal revenue. If the federal government can and should spend whatever it wants (something I agree with) then why on earth donât we want it footing the bill for a chunk of state and local spending? This isnât relevant to all critiques, but it is definitely relevant to some.