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Repeal of State and Local Deduction Is a Poor Trade for Tax Cuts for Wealthy

October 24, 2017 at 4:45 PM

The tax plan from President Trump and congressional Republican leaders would end the federal deduction for state and local taxes (SALT) — which allows taxpayers who itemize deductions on their federal income taxes to deduct state and local property taxes and either state and local income taxes or general sales taxes — and use the revenue to pay for marginal income-tax rate cuts. Our recent paper explains why that trade would be a bad deal for most Americans, especially low- and middle-income people, for two reasons, neither of which likely would be negated by only partially repealing the SALT deduction, as is reportedly under consideration.

First, while eliminating the deduction would — by itself — make the federal income tax more progressive, that ignores the actual tradeoff that the GOP tax plan proposes, which is to eliminate the SALT deduction and use the revenue to pay for net tax cuts that are heavily tilted to the top. That’s part of the reason why by 2027 (when key elements of the plan would be fully in effect), 80 percent of its net tax cuts would go to the top 1 percent of Americans, the Tax Policy Center estimates.

Second, the SALT deduction helps state and local governments fund public services that provide widely shared benefits. That’s because, with this deduction, higher-income filers are more willing to support state and local taxes. Repealing the deduction would almost certainly make it harder for states and localities — many of which already face serious budget strains — to raise sufficient revenues in the coming years to invest in high-quality education, infrastructure, and other priorities crucial to the nation’s long-term economic prospects. State borrowing costs could also rise as bond rating agencies react to the reduced capacity of states to raise adequate revenue, making needed infrastructure projects more expensive. States and localities could also respond by raising taxes or fees that fall less heavily on the higher-income residents most affected by the deduction’s loss. That would push more costs to middle- and low-income people, and make state and local tax systems even more regressive overall than they already are.

Further, the proposal to end the SALT deduction, and thereby make it harder for states and localities to fund current programs, comes as the President and congressional Republicans propose in their ten-year budget plans to shift substantial new costs to states, by sharply cutting Medicaid and other health funding and potentially cutting federal support for state and local services such as education, transportation, environmental protection, and low-income housing.

Republican lawmakers reportedly are also considering proposals to partially, rather than entirely, repeal the SALT deduction as a way to secure the votes of Republicans from states that would be particularly hard hit by full repeal. Partial repeal, however, could still jeopardize states’ and localities’ ability to raise adequate revenues. For example, the most prominently discussed “compromise” approach — capping the deduction — likely would be nearly as harmful to state finances as full repeal. If the deduction is capped at a level that’s less than what many taxpayers using the deduction currently receive, an additional dollar of state or local revenue would, for many households, no longer generate an additional federal tax deduction. That would be true whether the cap is set on the size of the deduction allowed or on the income of taxpayers allowed to claim the deduction.


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