As an analyst at OverTraders.com, I like to immerse myself in the financial environment. All my assessments are based strictly on facts and evidence. Today, I want to address a topic that often gets lost in the shuffle of tax policy debates: the State and Local Tax (SALT) deduction. While it is indeed a complicated issue, this is a critical issue that impacts state economies and individual taxpayers. I believe that doing so is absolutely necessary in order to achieve a balanced and fair fiscal future.
The SALT deduction allows taxpayers to lower their federal income tax liability by deducting certain state and local taxes. This is true for property taxes, income taxes, and sales taxes. The SALT deduction was passed more than a hundred years ago in order to relieve some of the burden of double taxation. It enables the recognition that taxpayers should not have to pay federal taxes on money they have already paid to state and local governments. Furthermore, it encourages fiscal decentralization. This provides flexibility for states and localities that allows them to raise revenue for critical services without placing a heavier tax burden on their residents.
The Tax Cuts and Jobs Act (TCJA) of 2017 added a $10,000 ceiling on the SALT deduction. This change posed a particular burden to residents of high-tax states, with taxpayers in the Northeast and on the West Coast bearing the most severe brunt. These states tend to have more expensive properties and stronger public goods, paid for with higher local tax burdens. The cap effectively raised taxes on many middle- and upper-middle-class families in these areas, reducing their disposable income and potentially dampening economic activity.
In my view, the rationale for the SALT cap arose mainly from a desire to produce revenue. To raise its own tax revenues, the federal government capped that deduction. This strategic cut went a long way in providing cover for other, more expensive tax cuts paid for with the TCJA. This revenue increase helped some sectors of the economy rebound tremendously. It ended up punishing states that rely on local taxes to fund education, healthcare, infrastructure and other critical services.
Retrofitting the SALT cap starting in 2024 costs an extra $867 billion. The cap would go up to $200,000 for married filers, with all other filers set at $100,000. Removing the SALT deduction cap completely starting in 2024 would add another $1,116 billion to this cost. Removing the SALT cap marriage penalty starting in 2024 for filers with AGI less than $500,000 would cost an additional $107 billion over the budget window under this scenario. Eliminating the marriage penalty starting in 2024 with no AGI cap would be an added $163 billion expense. Those are big numbers.
The ramifications of the SALT cap go far beyond taxpayers it affects directly. The SALT cap limits the deductibility of all state and local taxes. It further weakens the already negligible incentive for states and localities to make investments in public goods and services. If taxpayers cannot deduct these taxes then they will be more reluctant to endorse higher spending at the state and local levels. That can create hesitance in supporting funding increases. It could mean a general decline in the quality of public education, infrastructure, and other essential public goods. This decline can have dire long-term consequences for state economies.
Further, critics contend that the SALT deduction only serves to disproportionately benefit the highest-income taxpayers, who happen to be the most likely to itemize their deductions. To be sure, high-income filers likely claim much larger SALT deductions. This deduction is a huge boon to middle-class families in high-tax states. Eliminating or capping the deduction can exacerbate income inequality by effectively shifting the tax burden from the federal government to state and local governments.
Here are some possible, yet more equitable, solutions to the SALT cap problem. The simplest approach would be to just repeal the SALT cap, bringing back full deductibility of state and local taxes. This change would be a huge win for taxpayers in high-tax states. It would represent an enormous cost to the federal government.
Or, as an alternative, the House could increase the cap to an even higher level, like $20,000 or even $30,000. This bipartisan change will provide much-needed relief to millions of taxpayers living in high-tax states. At the same time, it protects the federal government against as much revenue loss. Many of these proposals have already surfaced. One proposal would leave the individual and business TCJA deduction cap unchanged, but increase the married filers cap to $20,000. Here’s what Senate Minority Leader Chuck Schumer (D-NY) proposes to do. He favors allowing the SALT cap to expire at the end of 2025 and raising the corporate tax rate. House Republicans have already signaled interest in raising the SALT cap from $10,000 to $20,000-$60,000, at least for married couples. Mike Lawler (R-NY) has introduced a bill retaining a SALT cap but increasing it to $100,000 for single filers and $200,000 for married couples.
A third alternative would be to limit the SALT deduction to certain kinds of taxes, or certain kinds of taxpayers. Legislators could limit the deduction to property taxes paid on primary residences. Or instead, they could provide a larger refundable tax credit to low- and moderate-income filers. This could help to ensure that the deduction is targeted to those who need it most while limiting the overall cost.
Future SALT deduction reforms would have a major effect on domestic migration rates. Policymakers should explicitly consider how any changes to the deduction will affect taxpayer mobility. Raising the SALT cap would do much more to decrease outmigration. By comparison, that would encourage residents in the highest taxed states to stick around longer since their higher deduction would be larger. The SALT cap has added one more potential state-level revenue source. Consequently, the return to residing in highly taxed areas has shrunk. Changes to the SALT deduction might incentivize these high-income taxpayers to relocate to states with lighter or no state income tax burden. We experienced this effect when the SALT cap was implemented, forcing many of these high earners to move to states with lower tax liability.
Determining how to treat the SALT deduction – whether to maintain, modify, or repeal – isn’t straightforward. This policy decision will have significant impacts on future state economies and taxpayers. As a former analyst, it’s exceedingly clear to me that keeping the state and local tax deduction is necessary to an honest and fair fiscal system. It understands the importance of fiscal decentralization. It strongly encourages more infrastructure investments in under-invested public services while avoiding punishing taxpayers in states that already invest heavily in public services. Without substantive, legislatively mandated reforms, we will never solve cost and equity problems. Legislators need to proceed very carefully and be much more mindful of the potential effects of their actions. On the other hand, we need to raise taxes in a way that’s equitable and economically efficient. It should further promote economic development at state and federal levels.
