The 2017 tax reform imposed a $10,000 cap on state and local tax (SALT) deductions for federal income taxes. Ever since, Democrat lawmakers, particularly those with high income residents and high state and local taxes, have been pushing to undo it.
House Ways and Means Committee member Rep. Bill Pascrell, D-NJ, called it “critical middle-class relief,” asserting that “SALT benefits flow to all communities.” Others have also supported that reversal. Economist Stan Veuger argued that SALT deductibility “enables federalism,” rather than causing distortions, because it “expresses our preference for local solutions to local problems.”
And it seems to be coming closer to reality. Now, Pascrell and two other northeastern House Democrats (Josh Gottheimer and Tom Suozzi) have just come out against a public works bill unless the SALT cap is repealed, which could put party line approval for such a bill at risk.
However, that SALT argument must be taken with more than a grain of salt.
The central reason is that citizens’ taxes are supposed to buy services from state and local governments. To advance our well- being, they must be worth more to us than they cost, because it takes more than draining our pockets to be “for the people.”
In that case, those taxes leave citizens better off. An increase in your taxes funding school improvements worth more than they cost would benefit you. But then the claim that SALT should be deductible, which presumes they harm citizens, is just special pleading.
They do introduce distortions of their own. Those who itemize ( SALT was the largest itemized deduction) export a portion of their burdens onto others through the federal tax code.
And it is substantial. If I faced a 30% federal marginal tax rate, paying $100 more in SALT lowers my federal tax bill by $30. It only costs me $70. Further, because that subsidy rises, the more property is owned and the higher the income, 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.
If citizens do not get their money’s worth from SALT spending, federal deductibility allows state and local governments to export some of the burdens of their waste and inefficiency to others, increasing their incentives for such inefficiency. In my example, tax deductibility means that so long as local citizens get more than 70 cents of value per dollar of spending, and don’t recognize 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 and what they do badly, not more of what we want them to do; the opposite of what federalism is supposed to allow.
Bringing back uncapped SALT deductibility suffers from several policy disabilities. To the extent state and local governments benefit their citizens, they offer them more valuable services than what they pay, and no deductibility is warranted. To the extent they provide less valuable services, citizens are harmed by that fact, not a denial of deductions for what shouldn’t be done, and SALT deductibility exports large burdens on others to enable it.
That mutual imposition of burdens means SALT generates net costs, rather than benefits, that “flow to all communities,” putting a thumb on the scale toward too much state and local government everywhere.
Further, deductibility encourages the provision of additional services worth less than they are worth to citizens, including expanding special-interest largess. Deductibility benefits are also dramatically skewed in favor of higher income and wealthy individuals and states with higher tax rates.
While the familiar expression is to take questionable things with a grain of salt, it appears that in the case of restoring full SALT deductibility, we need to take them with a truckload of salt.
Gary M. Galles is a professor of economics at Pepperdine University.