The Deduction for State and Local Taxes

BRUCE BARTLETT for the NY Times writes: The federal deduction for state and local taxes, in the tax world often called the Salt deduction, is among the largest in the tax code, reducing federal revenues $77 billion this year: $25 billion for property taxes on owner-occupied homes and $52 billion for state income and other taxes. Conservatives have long had special enmity for this deduction, and it is one that Republicans are likely to include in their tax reform plans.

The Salt deduction is among the oldest in the tax code. The first income tax law enacted 100 years ago this year provided a deduction for all state, county, school and municipal taxes paid within the last year. It is not known why it was adopted, but lawmakers may have felt that it was fundamentally unfair to tax a tax.

A crucial reason that the Salt deduction is on the tax reform radar is that Congressional leaders have promised to maintain the current progressivity of the tax code and also reduce the top income tax rate to 25 percent. This means that they have to go after those deductions that primarily benefit the well-to-do.

As one can see in this table from Congress’s Joint Committee on Taxation, the vast bulk of returns claiming the Salt deduction and the greatest proportion of the dollars deducted are from those with higher incomes. Almost half the dollar amount of the deduction is claimed by those with incomes above $200,000.

Joint Committee on Taxation

This stands to reason, because those with incomes below $30,000 are largely exempt from federal income taxes; the value of all deductions increases the higher one’s tax bracket; tax rates rise with income; and the wealthy are more likely to be homeowners.

Another important factor is that the wealthy are more likely to live in the so-called blue states, those generally governed by Democrats, with big governments and high taxes. The table from the Tax Policy Center lists the top 10 states in terms of claiming the Salt deduction. Texas is the only red state; the rest are blue except for Ohio and Virginia, which are now considered purple – partly red and blue.

Tax Policy Center

The impact of removing the Salt deduction would be to raise the burden of state and local taxes by one’s marginal tax rate. Thus if one is in the 35 percent bracket and paying $10,000 in state and local taxes, the after-tax burden would be $3,500 greater without the deduction. Even if the top rate fell to 25 percent, one would be $2,500 worse off if the Salt deduction were removed.

Not surprisingly, leaders from blue states have long been among the strongest supporters of the Salt deduction. When the Reagan administration suggested curtailing it in the mid-1980s, Gov. Mario Cuomo of New York was thestrongest critic of the idea and helped kill it. He was attacked by the president’s communications director, Patrick Buchanan, as being a “glib, fast-talking lobbyist for a reactionary liberalism that would kill tax reform in its crib.”

Conservatives like Mr. Buchanan have long hated the Salt deduction because they believe it subsidizes liberalism and encourages states to impose higher income tax rates than they would without deductibility. They say it prevents states and localities from using more efficient fees, rather than taxes, to finance activities like trash collection and discourages privatization and the contracting-out of services. Fees paid to governments and private contractors for governmental services are not deductible; only taxes are deductible.

Conservatives also believe that the Salt deduction in effect allows blue states to export some of their tax burden onto the red states. As The Wall Street Journal recently put it in an editorial:

We believe in federalism, and if affluent liberals want to pay 13.3 percent of their income to live in San Francisco, that’s their foolish privilege. But it becomes everyone’s problem if some of that tax burden is effectively borne by residents of Knoxville, Lubbock and Orlando because of the federal tax deduction.

Some conservatives go further and advocate a tax policy explicitly targeting the blue states to punish them for their liberalism, including elimination of the Salt deduction. As Jim Geraghty of National Review Online put it in a Dec. 5, 2012, column:

Since the election, many conservatives have grumbled that they wish there was some way to raise taxes on only the 50.9 percent of Americans who voted for the president in November. This may be the option that comes closest to that.

While those in the blue states will undoubtedly fight any proposal to eliminate or limit the Salt deduction, one thing that should be kept in mind is that the deduction is already sharply limited by the alternative minimum tax, a separate tax system primarily affecting the wealthy that eliminates certain tax preferences, including the Salt deduction. Thus those covered by the A.M.T. have already lost the Salt deduction or had it curtailed, whether they realize it or not.

If tax reform is to be successful, it is important that everyone keep an open mind and not focus too much on any one tax preference. It is possible that other tax changes adopted simultaneously might significantly mitigate the negative effects of a particular tax change viewed in isolation.