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The SALT Deduction: Giveaway To The Wealthy?

(edited from a Bloomberg article)

Some call the SALT deduction a giveaway to the wealthy. The optics are bad. But the deduction for state and local taxes (SALT) actually serves a purpose. That’s why it’s been law since the first federal income tax under President Abraham Lincoln in 1861. 

* The SALT deduction combats–imperfectly—tax competition, which is a destructive race to the bottom in taxes and government services. A state that slashes tax rates and balances its budget by simultaneously reducing services to the poor wins two ways: It gets an influx of businesses and residents from higher-tax states, and it chases away poor people, who make their way to those high-tax states that are losing their tax base, an unsustainable dynamic. 

* The SALT deduction restrains tax competition by subsidizing high-tax states: the pinch that taxpayers in those states feel from high state and local taxes is eased by the break they get on their federal returns. 

* Voters in low-tax states sometimes ask why the federal government should be subsidizing states that choose to impose high taxes: some of the benefits of high-tax states’ higher spending are shared by people in low-tax states. The safety net for the poor. The roads and other public infrastructure available to residents and visitors alike. When you add up all the flows, high-tax states on average contribute more to the federal coffers than they get in return.

* Restoring full SALT deductibility would reduce federal tax revenue a lot making it less popular. It’s also true that most of the benefits would go to high earners, but that’s not necessarily a permanent condition. State governments constantly weigh how much they can tax their richest residents without driving them away. Since the revised tax law enacted in 2017, the effective state and local tax burden on rich people in so-called ‘blue’ states has gone up.
* Some rich people are bailing out of their states although Congress wisely left the full deduction in place for corporate income taxes because corporations are more mobile than individuals. 

* If the SALT deduction cap remains in place, state governments are going to be forced to stanch the bleeding by cutting taxes on their rich residents. Rich people can move; they will be OK whether the cap stays or goes. Restoration of full SALT deductibility isn’t for their sake and wouldn’t make much difference to them in the long run. It’s the high-tax states like New York and California that need help. 

“It’s wrong for people to be taxed on the federal level for money they no longer have because it was taxed away at the state or local level. This adverse consequence of double taxation between 
federal and state tax systems in a federal system has not received proper attention.  Mitigating double taxation has been a fundamental building block of both the international and interstate tax order.” – William Barker, Penn State Dickinson Law School.  Barker asks whether it wouldn’t be better if Congress went beyond restoring full deductibility of state and local taxes from their taxable income and give taxpayers an outright credit on their federal taxes for whatever they paid in state and local taxes, limited to some percentage of their total federal tax liability? 

Personally, I believe that if the full SALT deduction is not re-instated, those who may be short-term beneficiaries will regret the long-term consequences. When tax laws don’t factor in cost-of-living differences ultimately they will fail. Killing the goose that lays the golden egg is never wise. Collecting more taxes on less almost always nets less.

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