It's Time to Dump SALT

One of the fiercest debates occurring on Capitol Hill is whether to permanently extend the Tax Cuts and Jobs Act’s cap on the State and Local Tax (SALT) deduction. This one policy could be the iceberg that sinks the “One Big Beautiful Bill”. The anti-SALT representation will almost certainly cave in the end, permitting a larger deduction for high-tax state residents. In fairness, this is probably the wiser political maneuver. However, sound politics doesn’t always translate to sound policy, and in this scenario, the SALT deduction is not a good policy.

The central argument for the SALT deduction is that income should not be “double-taxed”. However, the principle of “double taxation”, like double jeopardy, is meant to apply to the same governing body. For example, the double-tax argument would be used to critique the federal government taxing your ordinary income and then taxing your contributions to an investment account. This is the rationale for why we do not tax cost basis. It is not meant to prevent the taxation of income by multiple governing bodies.

The virtue of federalism is that multiple social compacts can coexist simultaneously predicated on different interests. Your municipality has a representative government aimed at ensuring the local community is safe from crime, emphasizing the local culture, and meeting the socioeconomic needs of the various families within the community. The States have their own separate governments with different interests, including maintaining the infrastructure connecting the various municipalities, providing broader public safety, and managing public resource allocation. The federal government was designed to preserve the national security and the peaceful relations of the various states.

Each social compact carries a duty to the community to share the burden of supporting those public interests. The duty to the first social compact does not discount the responsibility to the others. This is why historically the state and local governments, in addition to Washington, assessed excises on alcohol, gasoline, and tobacco, and yet consumers could not deduct what they paid to one from what they paid to the others. This is only a concept that applies to the federal income tax code.

Beyond the fallacious nature of its central purpose, the SALT deduction is incredibly disproportionate in its application. Prior to the creation of the $10,000 cap in 2017, 91% of all SALT deduction benefits went to households earning over $100,000 with most of the benefits concentrated in only six states (California, New York, New Jersey, Illinois, Texas, and Pennsylvania). These two conclusions are precisely why the SALT deduction should be discarded.

The House of Representatives, in the spirit of compromise, passed an expansion of the SALT deduction cap to $40,000, while capping the eligibility to less than $500,000 of income. The Tax Foundation estimated that the bottom 90% of American households would not face any increase in after-tax income, while the 90^th to 95^th percentiles would see a meager 0.1% improvement. The benefit of a larger cap is entirely felt by the top 5% of income earners.

Moreover, taxpayers should not be treated differently by the IRS based on their state of residence. We are a union of fifty states that act in a collective national interest. We all have an obligation to support the union in upholding that interest. Yet, the SALT deduction creates disproportionate obligations for the same level of income depending on which state you live in.

The average effective total state tax rate (income, sales, and property) for a person living in Nevada is 6.11%, while for a person living in New York it is 17.75%. Even if we assume grace to the high-tax state that those average effective rates hold for higher income households (which is a huge grace) then a household earning $250,000 in Nevada would owe about $15,275 in state taxes, while the household in New York would owe $44,375. With no cap on the SALT deduction, the Nevadan will have a taxable income $14,375 greater than the New Yorker (factoring the standard deduction for the Nevadan), resulting in a higher tax liability (assuming a 22% marginal rate) of $3,162.50. Even with the higher cap, the New Yorker will enjoy $10,000 less in taxable income, or a $2,200.00 lower tax burden.

If we are going to subject ourselves to a federal income tax, then the Nevadan should not be subjected to a higher burden than the New Yorker just because the New Yorker lives in a state that places a heavier burden upon its citizenry. The New Yorker has representation within Albany and participates in determining that tax burden. If they don’t like it they can move to a state that doesn’t place as heavy of an obligation. Those who are outside the social compact of the state and municipalities of New York should not be responsible for subsidizing the cost of its democratically chosen expenditures. For the taxpayer above, the elimination of the SALT cap would effectively subsidize 7% of their total State and local obligations.

Two common counterarguments to this critique is that these “high-tax” states are also large contributors per capita to federal revenue. This is indeed true in most cases. However, that is predicated on exogenous factors. New York, California, and Illinois had major concentrations of financial capital long before they became epicenters of high tax obligations. They are beneficiaries to pre-American colonial positioning (New York was a major port for the colonies), or federal policy (National Banking Acts, Federal Reserve System) that led to rapid economic development. More recently the high levels of household income is a factor of inflated prices. Higher prices mean higher revenues for firms on a nominal basis. Higher nominal revenues means a higher marginal revenue product, meaning a higher demand for labor, meaning a higher equilibrium wage. Inflation begets higher nominal wages which begets higher tax obligations.

That’s not a good thing. It may be good for Washington coffers, but it isn’t a point of pride for these states, or at least shouldn’t be. That’s why $50,000 will buy you a comfortable middle-class life in rural West Virginia, but put you in effective poverty conditions in Brooklyn. The high cost of living in these areas is due, in part, to these high tax burdens on commerce. Providing a de facto subsidy for these high tax liabilities (particularly on the high-income tax base) is just dulling the pain and prolonging the suffering.

The other counterargument is the flip side of that coin. These high-tax states, particularly on the left, will argue that the low tax states receive a disproportionate amount of federal expenditures per capita and thus shouldn’t complain about the SALT deduction. Here they are misguided as well. The spending by the federal government is predicated upon the social compact of all states acting as one union. We all have a voice in how those dollars are distributed.

If the majority of Congress, alongside the president, agree to spend trillions of dollars on seventy plus different anti-poverty programs, alongside major entitlements, and a disproportionate number of those dollars are going to States that have high concentrations of impoverished citizens, again due to historical economic developments, then every State, and every citizen within those states, at least had a voice in determining that allocation.

However, if Congress sets a deduction that is predicated on the tax policy of the individual state, which is different than circumstances outside the democratic control, then the specific benefit of that deduction is going to be determined not by Congress within the social compact of the union, but by the democratic process of the individual states.

The people of New York can democratically decide to raise their tax obligations, and therefore effectively reduce their federal tax liability to be disproportionately lower than a citizen with equal financial circumstances in Iowa, Florida, or Georgia, and yet the Iowan, Floridian, and Georgian had no voice in that disparity.

The SALT deduction benefits only very high-income households in a select number of high-taxed states. According to the Congressional Budget Office, it subsidizes these high-tax States to the tune of $1.62 trillion over a decade. Congress should not increase the SALT cap, rather it should lower it to zero and abolish it entirely. It’s time to dump SALT.