How Dems can get out of the SALT mess and save $1 trillion

congressional hearing

The debate among Congressional Democrats over the $10,000 cap on the deduction for state and local taxes (SALT) continues. Here we offer a proposal that could give the SALT caucus something in the short-term; save almost a trillion dollars over the budget window; and put the tax system on a path to greater fairness.

The two options under consideration are apparently to eliminate the cap for two years or lift the cap to some higher amount over ten years.

These are both really bad ideas, wasting money on a highly regressive tax break. If forced to choose, we’d have to say the first is even worse than the second. Especially if cuts have to be made on other policy fronts, many of which would help less advantaged families, this will be hard to justify. Here we critique the proposals that seem to be on the table, before describing our own.

Full repeal of the SALT cap is the worst option of all

Repealing the SALT cap for two years would cost about $85 billion per year. As we and others have pointed out multiple times, this represents a massive windfall to the rich and affluent. Despite what the SALT Caucus claims, SALT cap repeal is no middle-class tax cut. Ninety-six percent of the benefit would flow to the top 20 percent of the income distribution with the top 0.1 percent getting a tax cut of $154,000 per year, on average. To be fair, the middle class does get something. The middle 60 percent of the income distribution would receive, on average, a tax cut of $37 per year. Even in high-tax states, the middle class gets little. In New York, the top 1 percent would get a tax cut of about $103,000, on average. For those in the middle class, the benefit is just $90, on average. So repealing the cap is regressive and delivers little to no social benefit. As the Democrats wrangling over the budget know, there are dozens of better ways for the federal government to spend $85 billion, for example:

  1. An array of social polices. We can’t put it any better than Maya MacGuineas, president of the Committee for a Responsible Federal Budget: “For the annual cost of the SALT cap repeal, policymakers could enact the President’s plans to offer universal pre-K, free community college, paid family leave, affordable child care, and an Earned Income Tax Credit expansion. Not just one of these policies, but all of them together.”
  2. A year of the expanded child tax credit (CTC). As part of the American Rescue Plan, the CTC was expanded and made fully refundable—meaning low-income families can receive the full benefit—for one year. The annual cost for this expansion is about $100 billion relative to the previous law. From June to July, the expanded CTC slashed monthly child poverty by 25 percent. The expanded CTC is also likely to boost social mobility in the long run, as we have argued previously.
  3. Doubling (or even tripling) Pell grants. Pell grants help students from low-income families pay for college. On our own pages, Philip Levine finds that doubling the maximum Pell grant amount is a rare win-win for policy: it promotes economic efficiency and social equity. Matthew Chingos of the Urban Institute estimates that this would cost about $35 billion per year, roughly doubling the current cost. A back-of-the-envelope calculation suggests that the maximum amount could even be tripled (with money left over) for the same price tag as SALT cap repeal.
  4. Universal baby bonds. The racial wealth gap and the Black-white gap in multigenerational poverty are alarming. Racist policies have helped to create these gaps, and intentional public policy is needed to ameliorate them. One option is baby bonds. Effectively a trust fund for children that will provide the most help to those from low-wealth families, this proposal would, on average, especially benefit Black beneficiaries. The government would seed money into accounts for children at birth, which would grow over time from continued government contributions and returns on safe investments. Upon turning 18, beneficiaries access these funds to pay for college or a down payment on a home, for example. With many potential structures, baby bonds would cost around $82 billion annually.

People can reasonably disagree about the pros and cons of these various policies. But it is hard to argue that any of them are a worse way to spend taxpayers money than on a tax break for the rich is a better use of this money.

Raising the cap is also a bad idea

The second option under consideration, lifting the cap to some higher dollar threshold, is still regressive. If the cap was raised to, say, $30,000 for couples and $15,000 for singles, more than two-thirds of the benefit would go to the top 5 percent of the income distribution, and less than 4 percent to the middle 60 percent. Even in high-tax states, the affluent reap most of the benefits. In New York, almost half the benefit would flow to the top 5 percent.

Recent reports indicate that Democrats are attracted to the revenue-neutral potential of raising the cap. Since the $10,000 cap is scheduled to expire at the end of 2025, keeping the cap in place for those later years would raise significant revenue, relative to current law. In other words, the up-front costs would be paid for by later revenue. It’s a good idea to think about the longer-term, but there is still a better approach; one that is not just revenue-neutral, but raises money.

Lift the cap then phase it out: a win, win, win?

If Democrats really must do something about SALT, they should consider raising the cap (not eliminating it), but then phasing it down to $0 over ten years. For example, they could raise the cap to $20,000 for married couples filing jointly and keep the $10,000 cap for singles. This would give some short-term relief for the families with state and local tax bills slightly above the current limit. Again, we don’t think this is necessary, but there is clear political pressure for something here.

Each of these caps could then be reduced annually by $2,000 and $1,000, respectively, eventually reaching zero. By 2032, while the SALT deduction would still technically be in the tax code, it would have effectively been removed altogether, which we have argued for previously.

The advantage of this approach is that rather than removing the cap overnight, it is phased out gradually. This allows time for households and the housing market to adjust. It would also provide time to put in place alternative, superior ways for the federal government to support states, such as the State Macroeconomic Insurance Fund proposed by the Tax Policy Center’s Len Burman, Tracy Gordon and Nikhita Airi. It’s worth noting that the UK took a similar approach with its version of the mortgage-interest deduction, cutting its value in successive years from 1994 to 2000 (and note there was a change of government in 1997).

Gradually reducing the value of the deduction over a full decade would provide some much-needed policy stability in an area that could otherwise become a political football for years to come. Contrast our proposal for a steady removal with the timeline of the SALT cap if Democrats decided on temporary full repeal:

  • No SALT cap up to 2018
  • A $10,000 SALT Cap from 2018-2021
  • No SALT Cap from 2022-2023
  • A $10,000 SALT Cap from 2024-2025
  • No SALT Cap from 2026 onwards

This sequence could appear on page one of a textbook titled On How Not to Make Tax Policy.

Our proposal would also raise money. We estimate that lifting the cap from $10,000 to $20,000, but then gradually phasing it out, would net about $900 billion over the ten-year budget window. The reason the savings are so great is that the SALT cap is currently scheduled to expire at the end of 2025, so our proposal to keep phasing it out instead results in some big savings.

Hopefully the approach we propose here, which takes the long view of how to deal with a regressive tax deduction, while recognizing current political pressures, could also find some bipartisan support.

In short, our proposal would provide some policy stability, give SALT-focused members a short-term win, make the tax code simpler and fairer in the long run, and raise lots of revenue for big ticket progressive goals. How does that sound?

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