In the end, despite repeated Republican promises to simplify the tax code, most deductions will remain in place when President Donald Trump signs into law the GOP’s tax overhaul as expected, later this week.
But there was one sort-of victory in the Republican quest to get rid of carve-outs and special rules in the tax code, and it centers on one of taxpayers’ favorite deductions: the state and local tax deduction.
The so-called SALT deduction, which allows taxpayers to deduct state and local income and property taxes from their total taxable income, costs the federal government about $100 billion per year, and is a major tax break for residents of states, counties, and cities that impose high taxes.
The bill lawmakers are voting on this week will contain not a cut, but a cap of SALT — under the legislation, taxpayers can choose to deduct a maximum of $10,000 of either property or income taxes. Under current law, taxpayers can deduct all of what they paid to local governments in property taxes, and what they paid in either income or sales tax to states.
Republican leadership had worked hard to kill the deduction outright: Beyond looking for ways to add revenue to pay for a tax plan that can’t add more than $1.5 trillion to the deficit over a decade under Senate rules, most in the party are philosophically opposed to a deduction that they believe subsidizes states and localities that tax and spend too heavily.
This change could affect not just millions of taxpayers, but anyone who uses government services in a high-tax jurisdiction: By offering a break on dues to local governments, the SALT deduction works as a sort of indirect federal subsidy, giving local officials room to impose higher levies, raising more money for services like education, public safety, and transportation, among other things.
In Minnesota and in other higher-tax jurisdictions, officials on the state and local levels are concerned that this bill’s cap on the SALT deduction will, in turn, cap their ability to provide the level of social services they had before. Republicans argue that everyone will be better off in the long run — and that it might be a good idea, anyway, for states and local governments to reconsider how much they tax and spend.
Capping, not killing, a key deduction
A deduction for state and local taxes has existed as long as the federal income tax has. From the beginning, it was conceived of as a kind of indirect subsidy to state and local governments to help them provide services.
Professor V.V. Chari, a tax expert at the University of Minnesota, illustrated how that works with the example of a Minnesotan who makes $1 million a year, subject to a 9.85 percent state income tax rate and a top federal income tax rate of 39.6 percent.
That person can deduct $100,000 in state income tax alone from their federal tax liability, thanks to SALT. Their total taxable income drops to $900,000, which means “your federal tax liability is $40,000 less than it would have been if your state and local taxes were not deducted,” Chari explained.
“It’s as if the federal government is paying $40,000 to the state of Minnesota on your behalf.”
When factoring in local property taxes, Washington is doing even more subsidizing. The proposed 2018 budget for Hennepin County, for example, aims to rake in $800 million in net revenue from property taxes, a 5 percent increase from the previous year.
Republicans’ plan to do away with the SALT deduction didn’t sit well with Republican U.S. House members representing affluent corners of high-tax states like California and New York, where large numbers of filers claim the SALT deduction.
Eliminating the entire deduction would have saved the federal government $1.3 trillion over the course of a decade, which would have funded a significant chunk of the overall GOP plan. The $10,000 cap will still do a lot of work to pay for the plan: The Tax Foundation, a right-leaning think tank, estimates that it will save the government roughly $500 billion in the coming decade.
The cap will also have a significant effect on how state and local governments tax and spend. With the federal government paying less to states and counties on taxpayers’ behalf, they will feel the weight of a tax burden that to this point had been shared by Washington.
Minnesota ranks in the top third of all states by share of taxpayers who claim the SALT deduction: 32 percent of Minnesotans do, which is a lower rate than states like Maryland, Connecticut, and New Jersey, but a greater one than Minnesota’s neighbors. According to the National Association of Counties, the average deduction across Minnesota is $12,000; in Hennepin County, it is closer to $17,000. A total of $12.25 billion is deducted from Minnesotans’ tax liabilities through SALT.
If the legislation passes, the average taxpayer in Minnesota, Hennepin County, and several other counties around the state will be unable to deduct thousands of dollars from their taxable income, increasing their liability. As a result, Chari predicts “there’s going to be political pressure from affluent taxpayers to reduce property and income taxes.”
‘Punishing’ states and counties
As the new cap on SALT hits taxpayers, it will be up to states, counties, and cities to decide if, or how, to adjust their tax rates and spending levels accordingly.
At this stage, advocates for local governments are not making predictions about how exactly they will respond to what amounts to a subsidy reduction from the federal government, but they are broadly pessimistic about the effect the policy change will have.
Jack Peterson is an assistant director at the National Association of Counties, an umbrella group for county governments that has been lobbying against changes to the SALT deduction. “Candidly,” he says, “we’re still working through all the different ways different pieces of the bill will interplay together.”
But he explained that the SALT deduction preserves the ability of county governments to have control over the services that residents are provided. “Anything that inhibits local ability and control of raising revenue has a pretty direct tie to local services,” he says. “There will be decisions across the country about what to do with potentially lower revenues.”
Jim McDonough, a member of the Ramsey County Board of Commissioners, will be on the front lines of that discussion if the GOP tax bill passes as expected — the average SALT deduction claimed in his county is about $13,000.
“As a county commissioner, I’m making decisions on taxes based on the need for services, what the community expects, how to balance that with the property tax to homeowners, businesses in the community,” McDonough told MinnPost. “With the capping of SALT, it makes us be much more aware.”
“They’re taking dollars folks have already paid to state and local governments as taxes. That’s not good policy, in my opinion.”
Fourth District DFL Rep. Betty McCollum said the GOP tax bill “punishes Minnesota taxpayers and makes it harder to sustain our important public investments.”
What kind of effect would the policy change have in real terms? The U of M’s Chari forecasts a 5 to 7 percent decrease in spending at the local and state levels as a result of the GOP tax bill.
“People are talking about doomsday scenarios that are overselling the importance of the state and local tax deduction in terms of taxpayer willingness to fund local public services,” he said. “The 5 percent is serious business, but it’s certainly a cut that is not going to lead to a giant reduction in services.”
Republicans: Governments need to make the case for high taxes
Republican backers of the tax legislation, like 2nd District Rep. Jason Lewis, maintain that eliminating the SALT deduction will help most households, and will spark an overdue discussion in some states about high tax and spending rates.
Lewis, whose district has the second highest rate of SALT-claiming taxpayers of any Minnesota congressional district, said if capping the deduction forces local governments to explain and justify tax and spending to constituents, all the better. “The idea that we’re going to raise your taxes and, oh, deduct it over here so we subsidize $1.2 trillion over 10 years did let bigger-spending states off the hook,” he said.
Lewis said he didn’t know if states, counties, and cities might lower spending or taxes in response. Whatever happens, he said, “they’re going to have to explain it, and get [taxpayers] to buy in.”
Nudging state and local governments to reduce spending and taxes by cutting the SALT deduction has been a popular idea among Republicans for decades. President Ronald Reagan tried to kill the deduction during his presidency, but failed. Bruce Bartlett, an aide to Reagan, wrote in 1985 that cutting SALT could rein in state and local spending by as much as 14 percent and put “spendthrift lawmakers” on notice around the country. In October, Speaker Paul Ryan said the SALT deduction “props up big-government states” and has given them an incentive not to get their act together.
To McDonough, this line of argument is inconsistent with the principles of a GOP that counts federalism and local control as foundational principles. “I think they’re trying to tie our hands,” he says, by making it harder to pay for services that local governments have invested in.
He cast the debate as one of fairness, arguing that cutting the SALT deduction rewards conservative states that have low taxes but take a high share of federal dollars for programs, while punishing jurisdictions that have invested locally with higher taxes.
“This move punishes states that have chosen to take on investments in their community by making it more costly for constituents,” he said. “Not all of us want to be Mississippi or South Carolina. We want our businesses to succeed, provide an educated workforce … to do that you have to have an education system, infrastructure, all things taxes pay for.”
The other side casts the issue as a question of fairness, too. “The law is the same in Wyoming as it is in California or New York or Minnesota,” said Lewis. “Anyone that feels they’re paying more anywhere, it probably isn’t federal law, it’s the local government spending too much and taxing too much. That’s not good governance.”
The tax bill is up for final votes in the House and Senate on Tuesday, and it’s expected to arrive on President Donald Trump’s desk by the end of the week. Its passage into law would be a blow for advocates of the SALT deduction, but the fact that it is just capped, and not entirely killed off, provides a glimmer of hope.
“The principle behind the SALT deduction is accepted in the legislation,” NACO’s Peterson says. “So we’ll continue to work to make that as accessible to middle-income families and as many counties across the country as possible.”