The Best Argument Against the State and Local Tax Deduction

I’ve written a couple of times to explain why the deduction for state and local taxes should be eliminated as part of pro-growth tax reform.

One of my main arguments, as I pointed out at the beginning of this interview, is that Republicans are generally unwilling to finance pro-growth tax changes by restraining government spending.

And since GOPers are too timid on spending, that means “revenue offsets” are needed to finance the good provisions in tax reform (assuming the goal is to make such changes permanent).

But this second-best approach can still be very good if the right loopholes are targeted.

In other words, wiping out the deduction is a good idea as a general principle, but it’s a very good idea in today’s environment since it would produce a lot of revenue to “offset” the cost of lowering tax rates and making our awful tax system less onerous. Plus, the deduction is unfair and inconsistent with principles of good policy.

Many organization point out that generating revenues by getting rid of the state and local deduction would be a win-win situation.

The National Taxpayers Union is not a fan.

…the provision departs from principles of sound tax policy and unwisely abets the behavior of high-tax states, enabling big government.

And the Heritage Foundation doesn’t like the loophole.

The deduction for state and local taxes creates winners and losers within states. Higher-income taxpayers win; lower-income taxpayers lose.

The Tax Foundation has weighed in.

The deduction favors high-income, high-tax states like California and New York, which together receive nearly one-third of the deduction’s total value nationwide.

Along with the American Enterprise Institute.

…repealing the state and local tax deduction would be an important move toward broadening the tax base.

Americans for Tax Reform also opposes the deduction.

…this deduction actually subsidizes upper income earners in high tax states.

And the Center for Freedom and Prosperity has a fact sheet with lots of data.

…nearly all filers (~99.7%) would likely benefit from a lower rate and increased standard deduction notwithstanding the loss of SALT.

National Review rejects the loophole.

Getting rid of state-tax deductibility is…good policy. …deductions mainly benefit higher-income households. …The federal government…should not use the tax code to encourage or discourage.

But the most powerful and persuasive evidence for getting rid of the deduction is that organizations favoring higher taxes and bigger government openly admit that the loophole encourages and enables bad policy (what they would call good policy) at the state and local level. You don’t have to believe me. Here are some passages from a report by the Center for Budget and Policy Priorities.

…with this deduction, higher-income filers are more willing to support state and local taxes. …Ending the SALT deduction would strain state budgets over time by making it harder for states and localities to raise…revenues… The GOP tax plan…would threaten many states’ ability to raise…revenue.

What’s amazing is that the report openly acknowledges that the deduction overwhelmingly benefits the wealthy, something that CBPP normally doesn’t like because of their support for class-warfare taxation.

But if one’s goal is bigger government, you acquiesce to reverse class warfare when it makes life easier for tax-aholic politicians in states such as California, Connecticut, Illinois, New York, and New Jersey.

The lesson for the rest of us, though, is that if CBPP thinks this preference for the rich is worth preserving, the rest of us should want it abolished.

Let’s close with some analysis that is compelling to me. Here’s what Ronald Reagan said when he tried to eliminate this odious loophole back in the 1980s.

P.S. I still prefer the first-best option of tax reform financed by spending restraint. If Republicans simply limited federal spending so it grew by 1.96% per year over the next 10 years, that would enable both a balanced budget and a $3 trillion tax cut. And that’s even with static scoring!

P.P.S. Back during the debate on tax reform in the 1980s, Reagan also opposed the VAT. Helps to explain why I admire the Gipper so much.