In 2017, when a Republican-led Congress made a tax policy more restrictive, New York Governor Andrew Cuomo, a Democrat, called it “an economic dagger aimed at the heart of New York.” Several months later, New York and three other states unsuccessfully sued the federal government over the change.
At issue was the state and local tax deduction on federal returns, which was capped at $10,000 as part of the Tax Cuts and Jobs Act. Taxpayers in higher-cost areas like New York, California and Illinois had long depended on the ability to deduct such taxes — and the mostly Democratic states where they live had budgeted based on that deduction, as well.
The cap was “a clear and politically motivated punishment of blue states,” said New Jersey Governor Phil Murphy, also a Democrat, at the time, “who already pay far more to the federal government than we receive.”
Now the deduction, familiarly known as “SALT,” is back in the spotlight. Multiple blue-state representatives have recently announced they’ll withhold support from President Joe Biden’s infrastructure spending bill, legislation they’d normally favor, unless the $10,000 cap is repealed, even as policy analysts increasingly acknowledge that the deduction’s moment might have passed.
If all politics is local, and the proceedings in Washington are taking place in one of the most fractious moments in American history, then changes to the tax code that pit geographic areas against each other in a way that can feel zero-sum is perhaps the natural consequence.
“I’m surprised that it just continues to come up,” said Tracy Gordon, acting director of the Urban-Brookings Tax Policy Center. “In Washington there seems to be this broad consensus that repealing it would be a bad idea and yet people in affected areas feel it in a visceral way.”
A “bad idea,” analysts say, not only because it would result in a loss of revenue, of about $100 billion this year, according to the Institute on Taxation and Economic Policy, but because of the optics of the situation.
“We live in very polarized times, with high income inequality,” Gordon said in an interview. “The fact that this predominantly affects people at the top and in very blue states gets peoples’ attention on both sides. Some folks feel targeted by (the 2017 tax changes) and some would say those people are just complaining.”
It’s also unavoidable that the same states claiming the cap has caused hardship are those that appear to have done well through the COVID crisis: their larger share of white-collar workers have been able to work remotely, a larger share of people with a greater stake in the stock market’s DJIA, +0.70% fortunes have been lucky, and so on, Gordon pointed out. There is also not much evidence that substantial numbers of higher earners have left higher-tax states as a result of the cap — at least so far.
Despite that, it’s also the case that higher earners in higher-cost areas may have more of their wealth wrapped up in their homes, and may feel more “middle-class” than wealthy, said Garrett Watson, a senior policy analyst with the Tax Foundation.
The Tax Foundation calls itself “independent,” but media reports often describe it as center-right, while the Tax Policy Center, Gordon’s organization, is often labelled left-leaning. On SALT issues, however, there’s a great deal of consensus.
For his part, Watson is watching not just the specific maneuverings around SALT, but also the broader landscape within which it lives.
Between additional tax-law changes that are being discussed, like capital gains tax hikes, as well as more generous support from the federal government, SALT might be better discussed as part of a holistic package, Watson told MarketWatch.
There are several compromise measures floating around, including doubling the cap to $20,000 for married couples, or imposing income limits on the deduction, Watson said. “Do folks who support removing the cap feel comfortable with that kind of compromise?”
The cap is due to become permanent in 2025, he noted, so some of the jockeying going on now may have that date in mind. And while SALT may always be a lightning rod, Watson and other tax-watchers think the time might be right for some big-picture changes.
“There’s a lot of discussion, but hidden within it is an opportunity to talk about reform,” he said. “There is a lot of opportunity for simplicity there.”
Traditionally, tax policy has been considered in the context of its impact on taxpayers, not regions of the country, Gordon mused.
“The federal tax system is not indexed for higher cost-of-living places,” she said. “SALT and the mortgage-interest deduction helped incentivize people to live there. They were a back door subsidy for helping people live there. But high-cost cities like San Francisco or New York City are also places where people are very productive. It’s good for the economy for people to be concentrated there.”