The Next Tax Fight: SALT

Alex Brill | AEIdeas

Much ink has been spilled either criticizing or praising the bipartisan, bicameral Wyden-Smith tax deal. Like most large tax bills, Wyden-Smith has faults. The bill makes many retroactive and mostly temporary changes, when sound tax policy should generally be prospective and permanent. Moreover, the additional expansion of the child tax credit (CTC) will further our fiscal reliance on nonparent taxpayers. (When first enacted in 1997, the CTC reduced federal revenues by $16 billion annually. By 2018, it had ballooned to $114 billion annually.) But Wyden-Smith has good policies as well. The bill reinstates a more pro-growth tax treatment of research and development costs and lowers the cost of capital generally. Critics of Wyden-Smith would do well to shift their focus to a new proposal that has emerged: the state and local tax (SALT) bill recently approved by the House Rules Committee and promised to blue-state Republicans in exchange for their support of Wyden-Smith. 

The SALT deduction offsets a portion of a taxpayer’s state and local taxes with a reduction in federal taxes. The Tax Cuts and Jobs Act (TCJA) of 2017 contained a provision that imposed a $10,000 cap on this deduction; previously there had been no limit. With the cap in place and the top rate of 37 percent, the maximum benefit available to a taxpayer (single or married filing jointly) is $3,700. By broadening the tax base, this cap raised hundreds of billions of dollars of revenue over the budget window to offset the cost of other TCJA provisions, including the reduction in statutory tax rates.

Now, H.R. 7160, the “SALT Marriage Penalty Elimination Act,” would raise the cap to $20,000 for married tax filers for the tax year 2023 if the taxpayers’ adjusted gross income is less than $500,000. In other words, this is another temporary and retroactive tax cut. What’s so bad about a tax cut for these nice taxpayers? Well, it’s both costly and bad economics. 

According to my calculations using AEI’s open-source Tax-Calculator, this bill would cost $12.5 billion, of which 87.9 percent would go to 7.3 million married taxpayers with incomes above $176,100 and 9.9 percent would go to 1.7 million married taxpayers with incomes from $113,600 to $176,100. If extended permanently, the provision would reduce revenues by more than $150 billion relative to current policy over the next 10 years.

Cost aside, the SALT deduction is just not a good policy idea, as I previously noted in testimony before the Senate Finance Committee. The Congressional Budget Office has been quite clear about the drawbacks of this policy, writing: 

The deduction for state and local taxes is effectively a federal subsidy to state and local governments; that means the federal government essentially pays a share of people’s state and local taxes. Therefore, the deduction indirectly finances spending by those governments when federal revenues could be used to fund the activities of the federal government.

Proponents of the SALT Marriage Penalty Elimination Act rightly note that the current $10,000 cap applies equally to all tax filers, regardless of marital status. This means that two single filers who each claim the full $10,000 benefit would be forced to share the $10,000 benefit in matrimony. As National Review noted recently, the marriage penalty could also be addressed by lowering the cap to $5,000 for single filers, an approach that would curtail rather than exacerbate the subsidy for state and local governments and raise about $5.5 billion per year. 

I have an even better idea: rename the bill “SALT Marriage Penalty Elimination Act” and set the cap at $0 for singles and twice that for couples.

Read here. Other articles on this topic can be found here.