This week, the US House of Representatives is expected to vote on federal tax legislation proposed by House Republican leaders, with the support of President Trump, that calls for significant cuts to the federal deduction for state and local taxes (SALT). Meanwhile, the Senate is deliberating on its own version of a tax bill, this one calling for completely eliminating the SALT deduction.
Reducing or eliminating the federal SALT deduction would increase the personal tax bills of millions of Californians and would do so in order to help pay for major tax cuts that predominantly benefit the wealthiest households and large corporations. The proposed changes to the SALT deduction also would transfer tax dollars paid by millions of Californians to other states and make it harder for California’s state and local governments to fund vital programs and services in the future. What’s more, this all comes at a time when the President and Congress have proposed deep spending reductions that would harm many important public services and systems that improve the lives of families and individuals.
To shed light on what’s at stake with preserving the federal SALT deduction, this post describes how this deduction works and outlines five reasons why all Californians should be concerned about the proposed changes — and why we should be watching the votes of California’s 14 GOP House members with great interest.
What Is the SALT Deduction? And What Are the House and Senate Proposing?
The SALT deduction is a federal tax expenditure that allows taxpayers who itemize deductions on their federal income tax returns to deduct state and local property taxes and either state and local income taxes or sales taxes. The SALT deduction primarily benefits households who itemize their deductions in order to reduce their federal taxes owed — that is, people who own their homes, have significant medical expenses, have sizeable student loan debt, and/or have gains from investments, among other financial situations. Each year, over 5 million California households claim the SALT deduction on their federal taxes.
The House’s proposed tax legislation calls for eliminating the SALT deduction for state and local income and sales taxes while capping the deduction for property taxes at $10,000 annually. The Senate tax bill would go even further; it calls for completely eliminating the SALT deduction for all state and local taxes.
The following sections discuss five key reasons that all Californians should be concerned about the GOP’s proposed changes to the SALT deduction.
Reducing or Eliminating the SALT Deduction Would Result in Double Taxation That Would Raise the Taxes of Millions of Californians
The SALT deduction is built into the federal tax code out of recognition that any state and local taxes paid reduce the income households have available for paying federal taxes. In other words, the SALT deduction recognizes that taxing income that is already paid to state and local governments amounts to an unfair level of taxation. Reducing or eliminating the SALT deduction, then, would result in double taxation, thereby increasing the income taxes paid by millions of households in the US, including more than 5 million households in California.
California Households Would Be Particularly Hard-Hit by the Proposed Changes to the SALT Deduction, but Households in All States Would Lose
The SALT deduction particularly benefits households in states with more progressive income tax structures, since taxpayers are able to deduct these higher state and local income taxes from their federal taxes. For instance, California taxpayers deducted more than $80 billion in state income taxes paid in 2015. However, although GOP congressional leaders’ rhetoric about the SALT deduction changes is that they are specifically targeted to “blue” states like California and New York, the reality is that all states would lose because households in all states would no longer be able to deduct state and local taxes paid, regardless of a particular state’s levels of taxation.
Cutting or Eliminating the SALT Deduction Would Make It Harder for State and Local Governments to Fund Key Services
By raising the tax bills of millions of households, GOP congressional leaders’ proposed changes to the SALT deduction would make it more difficult for state and local governments to raise revenues to fund vital public services and supports. Part of the rationale for the SALT deduction is that it encourages state and local governments to raise their own revenues to fund and provide services. Reneging on this deal at the federal level means that state and local governments would have a much harder time raising the revenues needed to adequately fund schools, public safety, housing, and so on. For example, more than 90 percent of K-12 education funding in California comes from state and local sources, with the remainder coming from the federal government. However, the ability of the state and of local governments to maintain their share of California’s K-12 education funding likely depends on continued SALT deductibility. A recent estimate indicates that California K-12 schools could lose $4.6 billion per year, or more than $750 per student, if just the deduction of state and local income taxes were eliminated and the local property tax deduction were maintained. This is especially troubling at a time when GOP leaders are proposing cuts in federal support for education and other core services.
In addition, the reduced capacity for state and local governments to raise revenues would diminish their ability to fund infrastructure investments. This is especially true for investments that are financed with municipal bonds that are based on state and local revenue-raising capacity.
Under the Broader GOP Tax Plan, Middle-Income Households Would Bear the Brunt of the Hit
Taken on its own, eliminating or significantly scaling back the SALT deduction could make the overall federal tax system more progressive — that is, more reliant on households with a greater individual ability to pay. This is because most households claiming the SALT deduction are middle- and upper-income and also because the size of the deduction generally increases with income level. However, other elements of the GOP tax framework would provide significant tax breaks that specifically benefit higher-income households, such as by decreasing the income tax rate on some wealthier households, reducing or eliminating the estate tax, and slashing the corporate tax rate. As a result, under the GOP tax package as a whole, the households most likely to see an increase in their tax bills due to changes to the SALT deduction are actually middle-income households, as they are less likely to have these tax increases offset by the tax breaks in the GOP plan.
Reducing or Eliminating the SALT Deduction Would Increase Californians’ Taxes to Both Pay for Tax Breaks for the Wealthy and Benefit Other States
In its current form, the SALT deduction is projected to reduce federal revenues by approximately $1.3 trillion over the next decade. Scaling back or eliminating the deduction, therefore, would increase federal revenues, but at the expense of state and local taxpayers and, in turn, state and local governments. There are legitimate arguments to be made for changing the SALT deduction in ways that achieve certain policy goals. For instance, because the deduction increases with income level — with higher-income households receiving a greater benefit — one option would be to cap the income-eligibility level for the SALT deduction, and then use the resulting revenues to expand credits and deductions that predominantly benefit low- and middle-income families. Or, federal policymakers could scale back the SALT deduction and use these revenues to support and incentivize targeted state and local government investments, such as infrastructure.
In other words, the SALT deduction could be changed in ways that provide additional support to low- and middle-income families or that make possible new state and local investments. However, neither of these is the aim of the current GOP plans. Rather, GOP leaders are relying upon reducing or eliminating the SALT deduction in order to help pay for a set of tax cuts that are dramatically tilted to the wealthiest households and large corporations, and would also set the table for huge cuts to the federal budget that would result in reduced services — health care, food assistance, affordable housing supports, etc. — for families and individuals struggling to make ends meet.
Some GOP leaders argue that cutting or eliminating the SALT deduction would keep the federal government from subsidizing higher taxes at the state and local government level. But the current arrangement, which has been in place as long as there has been an income tax in the US, avoids double taxation and encourages state and local investment, as noted above.
What’s more, in states like California with more progressive tax structures, voters have often voted to tax themselves in order to pay for state and local services — education, health care, infrastructure, housing, etc. While all states would lose with the reduction or elimination of the SALT deduction, the GOP tax plans would, in total (with other cuts) result in some states benefitting, particularly Texas and Florida. In other words, California taxpayers, who already pay more in federal taxes than the state receives back in federal spending, would see the additional taxes they have agreed to pay be transferred to other states — in effect rewarding these states for having less progressive tax structures.
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California’s congressional delegation — most notably, the 14 Republican members of the House of Representatives, who all had previously voted to advance the overall GOP tax framework — is expected to vote later this week on a House tax bill that significantly scales back the federal SALT deduction. To put these votes in context, the following table shows the share of tax returns claiming the federal SALT deduction in each of these 14 districts. In many of these districts, greater than 1 in 3 tax returns take this deduction.
|CONGRESSIONAL DISTRICT||SHARE OF TAX RETURNS CLAIMING SALT DEDUCTION, 2014|
|1 – Rep. Doug LaMalfa||31%|
|4 – Rep. Tom McClintock||44%|
|8 – Rep. Paul Cook||29%|
|10 – Rep. Jeff Denham||30%|
|21 – Rep. David Valadao||17%|
|22 – Rep. Devin Nunes||30%|
|23 – Rep. Kevin McCarthy||34%|
|25 – Rep. Steve Knight||42%|
|39 – Rep. Ed Royce||40%|
|42 – Rep. Ken Calvert||42%|
|45 – Rep. Mimi Walters||46%|
|48 – Rep. Dana Rohrabacher||42%|
|49 – Rep. Darrell Issa||42%|
|50 – Rep. Duncan Hunter||37%|
|Source: Tax Policy Center|
Meanwhile, the Senate is expected to vote in the coming weeks on its own tax bill, which would completely eliminate the SALT deduction. And, given current differences between the overall House bill and that in the Senate bill, some version of the tax bill will very likely have to come back to the House for approval. In other words, California’s GOP House delegation will probably have two opportunities to put a stop to tax plans that, for all of the reasons outlined above, are a bad deal for California.
— Jonathan Kaplan and Chris Hoene