SALT Deductibility, Hypocrisy and Good Government

The Trump tax reform imposed a $10,000 ceiling on state and local tax (SALT) itemized deductions for federal income taxes, paired with a doubling in the standard deduction. Ever since, Democrats with higher income residents and higher state and local taxes have been pushing to undo the SALT cap (while ignoring the benefits of the standard deduction expansion, which were far more balanced across citizens).

Governors of high tax blue states have opposed the SALT limit because “the cap on SALT deductions established a system of double taxation, where 11 million Americans were forced to pay taxes on the amount they paid in State, local, and property taxes,” according to six Democratic governors writing in April. Ways and Means Committee member Rep. Bill Pascrell (D-NJ) called it “critical middle-class relief,” asserting that “SALT benefits flow to all communities.” Now a group of congressional Democrats is threatening to hold the latest mega-tax-and-spend proposal hostage to get what they want.

The campaign turns a deaf ear to the hypocrisy of Democrats wanting to give tens of billions of dollars of federal tax expenditures to a very lopsidedly high-income group, while pushing a punish-the-rich tax proposal justified as making them pay their “fair share.” But what is more important, and has received even less discussion, is that SALT deductibility does not follow from “good government” principles.

The effort to resurrect SALT deductibility focuses on taxes paid to state and local governments, while ignoring the services those taxes are supposed to provide in return. But any balanced consideration must incorporate both what is paid and what is received in exchange.

Here, the central “good government” principle is that to advance citizens’ well-being, the services provided by state and local governments must be worth more to them than they cost, since representing people does not just mean draining their pockets.

In that case, citizens’ tax and benefit bundles would leave them better off. For example, an increase in your taxes funding school improvements that provided benefits in excess of costs would leave you better off, not worse off. The same is true of other state and local services worth more to citizens than they cost, including citizen-supported public assistance, effectively provided to others. In such cases, SALT deductibility, which presumes damage to, rather than enhancement of, citizens’ well-being, is just special pleading.

SALT deductibility does create serious issues, however. SALT was the largest itemized deduction, allowing itemizers to export a substantial portion of their burdens onto other Americans through the federal tax code. If I faced a 30percent federal marginal tax rate, paying $100 more in SALT lowers my federal tax bill by $30. It only costs me $70. Because that subsidy rises the more property is owned and the higher the income of the owner, the distortion overwhelmingly favors the richest, with the middle-class (who own less property, earn less, and face lower marginal tax rates) getting far smaller benefits, and non-itemizers getting no subsidy at all. In the process, it also subsidizes high state and local tax states at others’ expense.

Even when citizens do not feel they get their money’s worth from SALT-financed services, federal deductibility still subsidizes those governments, increasing their incentives to act in ways contrary to citizens’ interests. No wonder Democrats in high budget/high tax states are so strident in supporting deductibility. In the example above, federal income tax deductibility means that as long as a local citizen believes such spending provides more than 70 cents of value per dollar of spending, and they don’t take into account the added federal burdens they must bear from those similarly subsidized elsewhere, they think they gain. That encourages those governments to do more of what they should not do and more of what they do badly, not more of what their citizens find worth doing.

SALT deductibility also allows high tax states to effectively create a cartel against their citizens’ interests. Inefficient or ineffective government can be escaped by people “voting with their feet” into more favorable jurisdictions if they can. But when multiple states impose high taxes relative to the benefits received, citizens’ ability to “dodge” excessive burdens is reduced. And it is far harder to vote with your feet out of federal taxes, which must cover the budgetary cost of SALT deductibility, enabling higher tax burdens to be imposed at that level than states could by themselves.

In sum, SALT deductibility suffers from several policy disabilities. If state and local governments benefit their citizens, they offer them more valuable services than costs, so no deductibility is warranted. If they provide fewer valuable services, they harm their own citizens, with SALT deductibility exporting a substantial chunk of the costs onto other Americans through the federal tax code, which puts a thumb on the scale toward too much state and local government everywhere. Benefits are dramatically skewed in favor of those with higher incomes (Brookings Institution found that 57% of all tax savings from removing the cap would go to the top 1% of earners). Consequently, neither Democrats’ tax the rich rhetoric nor good government principles make a case for restoring full SALT deductibility.

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