The Trump/Republican tax plan proposes to drop or reduce the state and local tax deduction (SALT). SALT lets taxpayers deduct from their federal income-tax liability the amounts they pay for state and local property taxes and either the state income tax or sales tax. SALT is a federal tax expenditure that subsidizes state and local governments. SALT will cost the federal government about $96 billion in foregone revenue this year.
The deduction appeared in the first federal income-tax act of 1862. It was included again in the Revenue Act of 1913, which created today’s federal income tax. A chief reason for the deduction was fear that the federal income tax might cripple the states by gobbling up their tax bases.
SALT survived previous challenges, but might not survive the current tax reform, although House Republican leaders pledge to retain the property-tax deduction because it benefits middle-income taxpayers more than does the income or sales tax deduction.
SALT critics argue that even though only about 30% of taxpayers use SALT, it subsidizes the rich. High-income taxpayers, especially those with incomes over $150,000, benefit the most. SALT also benefits high-tax blue (Democratic) states much more than low-tax red (Republican) states. The average SALT deduction in Connecticut was $18,900 in 2014—the highest in the nation—followed by $17,200 in New Jersey.
Critics say SALT compels residents of low-tax states, which are mostly Republican, to subsidize high-tax states, which are mostly Democratic. Proponents counter that SALT is equitable compensation for taxpayers in affluent high-tax states, such as California and New York, because they send more money to the federal treasury than they get back in federal spending. On average, Democratic states are net donors to the U.S. treasury; Republican states are net beneficiaries.
Critics say spending on state and local taxes is just like any other spending; hence, it should be taxed. SALT supporters decry this as double taxation. The federal government should not tax the amounts taxpayers have paid for state and local taxes. Further, taxes, unlike other spending, are not discretionary. Thus, money spent for state and local taxes should not count as disposable income.
Supporters say the SALT subsidy is crucial because state and local governments fund vital public services such as corrections, education, health care, infrastructure, transportation, and welfare. Opponents contend federal subsidies should be provided through grants and loans. Proponents
counter that SALT preserves the autonomy of states and localities to make their own tax decisions rather than depending on Congress’s capricious benevolence.
Proponents contend SALT encourages high-income residents to support higher state and local taxes. For example, if a state tax increases by $1.00, a taxpayer in the 28% marginal tax bracket actually pays only $.72 due to SALT. Eliminating SALT would make it politically more difficult for states and localities to increase taxes and politically more necessary to cut services. SALT critics view such outcomes as good things.
Supporters say SALT elimination would be a double fiscal whammy because the federal government also proposes to sharply cut federal aid for education, environmental protection, health care, low-income housing, transportation, and other vital services.
Supporters further argue the property-tax deduction, along with the mortgage-interest deduction, encourages homeownership. Opponents counter that Canada has no such deductions; yet homeownership is higher than in the United States.
SALT proponents argue that SALT encourages state and local governments to increase deductible taxes more than non-deductible regressive taxes such as those on alcohol, gambling, gasoline, and tobacco. Opponents counter that SALT has not prevented states from substantially increasing those regressive taxes.
The Government Finance Officers Association contends that SALT “reflects a partnership between the federal government and state and local governments. The deduction is fundamental to the way states and localities budget for and provide critical public services, and a cornerstone of the U.S. system of fiscal federalism. It reflects a collaborative relationship between levels of government that has existed for over 100 years. Currently, the SALT deduction is an accepted part of the tax structure that is critical to the stability of state and local government finance.”
For The Federalist’s views on federal versus state taxation, see John Kincaid, “The Federalist and V. Ostrom on Concurrent Taxation and Federalism,” Publius: The Journal of Federalism 44:2 (Spring 2014): 275-297.
By John Kincaid, fellow at the Center for the Study of Federalism and Robert B. and Helen S. Meyner Professor of Government and Public Service and Director of the Meyner Center for the Study of State and Local Government at Lafayette College, Easton, Pennsylvania.