Salt is a powerful modifier. With just a few teaspoons you can radically alter the flavor profile of a dish, hopefully for the better. Most of us have learned the hard way that even a half teaspoon too much can properly ruin even the most indelicate of foods. Concerning taxes, the State and Local Tax Deduction, or SALT deduction, has been a powerful piece of federal tax policy since 1862. But unlike the culinary arts, which can benefit from the seasoning, the State and Local Tax (SALT) deduction gravely complicates the crafting of fair tax policy.
In short, the SALT deduction allows taxpayers to deduct from their federal tax return the value of tax payments made to state and local tax authorities. The policy applies only to those who choose to itemize their deduction (as opposed to taking the standard deduction), and as such, was more commonly used in states with higher state and local tax burdens. Prior to the Tax Cuts and Jobs Act (TCJA), passed in late 2017, no limitation existed on the total amount of state and local taxes one could deduct from their federal return. Estimates placed the annual revenue lost due to the SALT deduction around $100 billion (about $1.8 trillion over 10 years). To offset some of the revenue lost from the broad-based tax relief in the TCJA, lawmakers placed a $10,000 cap on the total SALT deduction allowable per return.
Few provisions of the TCJA have received as much rancor and pushback as the capping of the SALT deduction. New York Governor Andrew Cuomo has gone so far as to call the limitation a “dagger at the economic heart of New York.” The governor has been one of the most outspoken critics of the policy, recently announcing his intention to launch a national campaign to repeal it.
Proponents of repealing the SALT deduction cap share one unifying trait: they are from high-tax, high-income states. This makes intuitive sense, as high earners located in high-tax states would be the most likely to take advantage of a policy that allows them to redistribute the burden of their state’s relatively higher taxes. A study of IRS data by the Joint Committee on Taxation bears out this hypothesis, finding that more than 88% of the benefits of the state and local tax deduction flowed to taxpayers earning over $100,000.
While lambasting the SALT deduction cap as an attack on high-tax states, Governor Cuomo and other left-of-center politicians continue to talk out of the other side of their mouths, decrying the tax reform as a giveaway to the rich. But this can’t be! The reform cannot simultaneously attack high-earners in high-tax states and be a carve-out for the 1% at the expense of the poor. This double-speak begins to get to the crux of the misunderstanding about the SALT deduction. At its creation, the policy was meant to prevent double-taxation—individuals being taxed on the same income twice by the same taxing authority—not to help high-tax states defray the costs of their tax burdens onto the federal government. Even so, the policy’s aims were based on a misunderstanding of taxation—paying both state and federal taxes on the same income is not double taxation, but rather, taxation of the same income at different jurisdictional levels—states and the nation are separate authorities.
Furthermore, insofar as the SALT deduction helps residents of high-tax states lower their federal tax burdens, it is a subsidy of high-tax states by lower-tax states. Prior to the cap, just six states, all with relatively higher taxes and higher incomes, accounted for 50% of all SALT deductions. Put another way, 6 high-tax states received subsidies equal to roughly $50 billion annually at the expense of lower tax states. These subsidies leave the onus for funding the federal government on poorer states with less extractive tax policy, especially those states without income taxes. For example, the unrestricted SALT deduction allowed top earners in California to reduce their federal tax bill, effectively redistributing it to California’s coffers, while earners in Tennessee or Wyoming cannot do the same. The unrestricted SALT deduction subsidized the tax-and-spend policies of a select few states at the expense of states that practice more responsible tax and fiscal policy.
Prior to the reforms, the highest federal income tax bracket was nearly 40 percent. The effect of the unrestricted SALT deduction meant that for every dollar a high-earning taxpayer sent to their state or local taxing authority, they could reduce their federal taxable income by one dollar. Therefore, at the highest tax bracket, filers saved roughly 40 cents in federal income taxes on every dollar they paid in state taxes. This policy was a perverse incentive in that it allowed some states to continue raising their taxes knowing their residents would be able to deduct the costs from their federal returns.
With proposals to repeal the SALT deduction cap at the top of Congressional Democrats’ agendas, understanding the impact and reasons behind its removal are now more important than ever. The limitation of the SALT deduction forces high tax and spend states to either bear the full political costs of their overzealous tax policy or reevaluate spending priorities. It should make sense now why capping this subsidy has politicians in high-tax-high-spending states in a tizzy. No longer can they mask the true economic cost of their largesse and force taxpayers from lower-tax states pick up the bill. Maintaining even a partial SALT deduction is dubious in terms of good tax policy, but reinstating an unlimited deduction would perpetuate an even larger injustice against low-tax states and lower-income taxpayers across the nation.