The State and Local Tax Deduction is regressive. But eliminating it the way the GOP bills propose could be even worse for America.
On Monday, Congress started the process of hashing out differences in the Senate tax bill—passed early Saturday with last-minute changes scrawled by hand in its margins—and the House’s version from November.
The two bills contain plenty that city leaders may find unpalatable. But one feature that has them up in arms is the drastic rollback of the state and local tax (SALT) deduction. Taxpayers in well-off urban areas in Democratic-leaning states like New York and California have the most to lose from this provision. But cities, which levee taxes of their own to pay for goods and services that their constituents need, are also likely to see a negative effect on their bottom lines.
“It's important to start off by recognizing that while some of these federal changes in federal tax law may not affect each city and state as significantly, that we all still ought to be able to recognize bad taxing policy,” said Mayor Steve Benjamin of Columbia, South Carolina, who is vice president of the U.S. Conference of Mayors. The organization issued a statement condemning the tax bill.
Under current law, U.S. taxpayers who choose to itemize their deductions can shave off what they paid in state and local income tax or sales tax—whichever is greater—from their taxable income.
As a standalone feature, the SALT deduction is regressive—as deductions generally are—meaning it benefits wealthier taxpayers more. But it also has a systemic impact on cities and states, which must navigate the politics of raising local revenue from the same residents who also pay federal taxes. Scaling the deduction back in the manner the two tax bills propose is unlikely to make the tax code more equitable as a whole, critics argue. Instead, it might increase the burden on already-strained state and local budgets, jeopardizing funding for essential goods and services.
“Without a plan that seeks to redeploy assets and infrastructure or reinvest in America….it just makes zero sense,” Benjamin said.
The SALT deduction allows the federal government to pay for a portion of a person’s local taxes—it indirectly subsidizes city spending. Taking it away without an alternative mechanism of federal-local cost-sharing might result in cuts to infrastructure, health services, and education—things cities already have trouble paying for. Asking rich constituents for more money would be even tougher than it is now without the SALT deduction to take the edge off the local tax hikes.
Local funding is particularly stretched at a moment when the burden of global problems, from infrastructure to climate resilience, falls increasingly on cities. And that burden is compounded by the other component of the tax bill that the U.S. Conference of Mayors most strongly opposes: The loss of health insurance for 13 million people.
“Cities will need to do much more with far less—and, once again, Republican and Democratic mayors alike will have to step in and clean up Washington’s mess,” U.S. Conference of Mayors President and New Orleans Mayor Mitch Landrieu said in the statement on behalf of the U.S. Conference.
To compensate for the loss in revenue, cities might start moving away from income tax to other sources like licensing fees and fines—most prominently spotlighted in the St. Louis region after the death of Michael Brown—which experts say are not good for their growth in the long term. “Not only is that even more regressive but it's also not going to grow with the economy as well over time,”said Michael Leachman, director of state fiscal research at the Center of Budget and Policy Priorities (CBPP).
When the SALT deduction was codified into the tax code 100 or so years ago, the idea was that an individual would only be taxed once on their income in a federalist system of government. That notion enjoys bipartisan support. As Stan Veuger of the conservative American Enterprise Institute (AEI) recently argued in Newsweek:
State and local taxing power should precede federal taxing power; and, logically, state and local taxes paid should thus be excluded from the federal tax base.
Other conservatives policy organizations, however, such as the Heritage Foundation and the American Legislative Exchange Council, have been advocating for the elimination of this tax break. For one, it’s quite expensive—costing the federal government an estimated $96 billion in 2017.
The other big reason they provide is that only a third of all taxpayers claim this deduction, and they tend to be on the richer side. The coastal states (that lean Democratic) tend to have higher taxes and higher shares of such taxpayers. That’s why they receive a bulk of the benefit.
“It's a transfer from low-income and low-tax states and cities to high-income and high-tax states and cities,” said Jared Walczak, a policy analyst at the Tax Foundation who has authored a paper arguing against the deduction. “If you are trying to create a more neutral individual income tax code that doesn't pick winners and losers—particularly when those winners are already upper-income individuals, then you'd probably want to repeal the state and local tax deduction.”
But the SALT deduction rollback isn’t taking place in a vacuum. Its critics argue that the way it works together with other provisions in the GOP tax package mitigates any benefits it may have had.
“They're scaling back the deduction significantly to pay for rate cuts that are even more tilted toward the rich,” said Leachman. “And then they're coming back after the first of the year to cut funding for services and programs that especially help low-income families.”
(The $10,000 cap on local property tax deductions, which the Senate Republicans wrote in at the last minute to safeguard the interests of some of their own constituents, may not be a failsafe because of the way it interacts with other proposals in the bill, according to the Washington Post.)
At the heart of the argument in favor of eliminating the SALT deduction is the notion that it’s not fair for the whole country to pay for the needs of individual, high-tax cities and states. But that assumes that each local government is a closed, siloed system. In reality, locally-funded assets can have national and certainly regional utility. (Consider the fact that state and local governments own 90 percent of the nation’s non-defense infrastructure!) Tweaks may be warranted to better direct the subsidy; but its complete elimination without anything in its place that helps local governments meet their needs, research shows, may potentially have negative repercussions beyond the blue cities and states.