On Monday the Heritage Foundation hosted a panel discussion on the importance of eliminating the state and local tax deduction as part of tax reform.
If you don’t want to watch the entire event, here are the basic highlights.
- Ending the SALT deduction will finance rate reductions and other pro-growth reforms
- SALT deduction benefits are concentrated, benefiting only itemizers (currently about 30% of filers, but will go down under the new plan), with a majority going to only 7 states
- It creates perverse incentives for state governments to overtax and overspend. As much as 5 percentage points of California’s top-in-the-nation 13.3% income tax is financed by the rest of federal taxpayers thanks to the SALT deduction.
- The Tax Cuts and Jobs Act would mostly eliminate the state and local deduction, keeping an allowance for property taxes up to $10,000 in order to secure votes from Republicans in high-tax states. Doing so leaves roughly $400-$500 billion less can be used to lower marginally tax rates, which are more important for driving growth.
- Keeping the property tax deduction could also harm some middle-class homeowners if it encourages states to shift taxes on income or sales to property taxes.
Jonathan Williams of the American Legislative Exchange Council relayed an interesting anecdote illustrating the deduction’s impact on state behavior. The Governor of Alaska, which is the only state to ever eliminate its personal income tax as it did 40 years ago, is seeking to enact an income tax to close a budget hole. A part of his selling point is that state taxpayers will be able to write-off part of the cost of the federal taxes.
This fits with a key CF&P objection to the SALT deduction. Namely, that it interferes with tax competition–and its role in keeping taxes lower than they otherwise would be–between the states. Not only does it encourage states to raise taxes, but it directs them toward particular taxes and thereby reduces experimentation and the opportunity to compare how different systems fare in the 50 laboratories of democracy.
Pro-growth tax reform requires the elimination of deductions and carveouts in order to reduce overall rates and simplify the code. Unfortunately, every deduction has its beneficiaries, who are lobbying hard to ensure that theirs is the one allowed to stay. And while some compromises may need to be made for political expediency, just for its sheer destructiveness the SALT deduction needs to go.
