Note to Bernie: The 8 arguments for restoring the SALT deduction, and why they’re all wrong

Senate Budget Committee Chairman Sen. Bernie Sanders (I-VT) gives an opening statement during a hearing to discuss President Biden's budget request for FY 2022, at the U.S. Capitol in Washington, D.C., U.S., June 8, 2021. Greg Nash/Pool via REUTERS

Senator Bernie Sanders appears to have changed his mind on the deduction for state and local taxes (SALT). Chairman of the Senate Budget Committee, Sanders previously has come out quite strongly against lifting the cap, saying in May: “It sends a terrible, terrible message…you can’t be on the side of the wealthy and powerful if you’re going to really fight for working families.”

But the Senator’s draft budget document includes money for partially lifting the SALT cap. No further details are available at this point, but Sen. Sanders has also said in a TV interview: “There are middle-class families in states where property taxes are very high, that are paying a whole lot in state and local taxes. And I think we have to support them. On the other hand, if you got some billionaires who own a massive mansion, should they be able to write off their state and local taxes? The answer is no, they should not.”

No doubt there are political considerations at play here. But from a policy perspective, Sen. Sanders was right in May and is wrong now. Any relaxation of the cap will necessarily benefit people towards the top of the income ladder. If the cap was lifted to $20,000, for example, over 95 percent of the benefit would flow to the top income quintile. Not billionaires, perhaps – but hardly the neediest in our society.

Keep the cap

We have argued against lifting the $10,000 cap in the New York Times, the Washington Post, and in a short analysis for Brookings. Our case is quite straightforward: the benefits of repeal would flow to the rich and affluent, who now have a disproportionate influence on the Democratic Party. To be specific, the top 1 percent would get an average tax cut of over $35,000. The middle class would get an average tax cut of about $37 (note that our analyses here relate to full repeal, since we do not know yet what alternative Sen. Sanders has in mind):

This is not a good way to spend $70 billion each year, especially for politicians committed to fighting inequality. Over the past several decades, the top of the income distribution has dramatically pulled away from everyone else. The top one percent’s income more than tripled from 1979 to 2017. They do not need a tax cut.

Arguments have ensued. Emails have been received. Tweets have been tweeted. A SALT caucus has formed. And many questions have been asked. Here we set out, as fairly as possible, what we think are the strongest counters to our position, perhaps some of which have influenced Sen. Sanders – and why we don’t find them persuasive.

  1. “Democrats want to lift the SALT cap because it was enacted by Republicans who wanted to unfairly punish blue states. Why are you supporting a dirty political move by the GOP?”

We don’t deny the politics here. But good policy is good policy even if the political motivations behind it were questionable. The motivation of legislators is not a good measure of the quality of the policy itself. Good policies can result from bad motivations, as well as the other way around. One of the casualties of political polarization is to adopt a stance towards policy based largely on its provenance. The view that a policy must be good or bad because it was pursued by Obama or Trump is a dangerous one indeed. Two wrongs do not make a right.

  1. “Lifting the SALT cap is good because blue states are ‘donor states’ to red states. It is only fair for blue states, who are net contributors to federal coffers, to get a break on their taxes.”

The idea of a “donor state”—or even a “moocher state”—often emerges in arguments over SALT. The impression given is that the Treasurer of New York State writes a big check to the Secretary of the Treasury. But of course, that is not what is happening. The IRS taxes people, not states. And rich people pay more taxes. So, a “donor state” is just a state with lots of rich people living it. If there is an unequal geographic distribution of income, then a progressive tax and transfer system will have so-called “donor states” by design—it means the system is working.

Further, there is no strong argument that rich people living together in a place with high taxes should be taxed less by the federal government than equally rich people in another state. Why should a New York millionaire contribute less than a Las Vegas millionaire towards national goods from which they derive equal benefit, for example national defense, or infrastructure, or AmeriCorps? The argument sometimes made here is that the New Yorker is contributing more to government services overall (through the New York tax system), and that some of the benefits of this spending might spill over to the residents of other states. This is an empirical question, however, and to our knowledge, there is not a definitive answer. These spillovers are almost certainly second-order effects in any case. Given the strong first-order distributional effects, that $70 billion a year does not look justified in the least.

  1. “The SALT deduction protects against double taxation. Why are you in favor of double taxation of U.S. citizens?”

This is not a case of double taxation. Citizens receive government services at the local, state, and federal levels. Sure, some functions overlap, but the separate levels of government often provide different types of services. As a citizen, you benefit from all three levels, thus you should fund all three. People are not being “taxed on the same money twice,” they are simply funding different entities out of their income. To call this double taxation is like complaining about paying for a burger from one store and paying for a muffin from a different one. And as Josh McCabe has pointed out: other countries with federal systems do not have anything like a SALT deduction. Of course, we might be getting it right, while Canada, Germany, and Australia are screwing it up: but we do not think so.

  1. “The SALT deduction allows states the fiscal room to spend. Without SALT, there would be a ‘race to the bottom’ in terms of state tax rates and a decline in state spending—netting a regressive result.”

This is a reasonable argument. It raises two questions: 1) What is the empirical evidence for this? 2) If the concern is valid, is SALT the best policy to address it?

Leaving the cap on the SALT deduction may result in state and local governments moving away from income taxes and towards sales taxes. The evidence here is mixed, but the shift in revenue is plausible, especially in the long run. Frank Sammartino and Kim Rueben, our colleagues at the Tax Policy Center, summarized the literature thus: “Several empirical studies have found a measurable effect of the SALT deduction on the mix of state and local taxes, but only a few of them also have found an effect of the deduction on either total state and local revenues or expenditures.” Regardless, these effects are almost certainly small, which means that on net, the SALT cap is still a progressive reform. As Jason Furman, chair of the Council of Economic Advisers under President Obama, puts it, “I like calling SALT [cap] repeal the Democratic version of trickle-down economics. It is *slightly better* trickle down but slightly better than terrible is, well, pretty bad.”

Even if the SALT deduction does slightly increase the “fiscal space” for states to raise revenue, it is then hardly the optimal approach. If the goal is to support state spending that hopefully helps the disadvantaged, trying to increase that spending by giving the rich and affluent a federal tax break is, to put it kindly, a convoluted policy design. It is like entering your house by climbing over the back fence, onto the garage roof and through the upstairs bathroom window. It can be done, but it is easier to walk through the front door. Similarly, it is far more efficient for the federal government to support states through direct spending. As Josh Bivens at EPI puts it:

“The SALT deduction is one tool for redistributing tax revenue, but most working people don’t have access to it, because they don’t itemize their tax deductions to be able to qualify for it. We should transfer federal aid directly to states to allow them to use the money on targeted healthcare, infrastructure, and education spending, which would more progressively distribute the money and allow states to be more responsive to recessions.”

We have pointed to some alternatives to lifting the SALT cap. One is to establish a State Macroeconomic Insurance Fund (SMIF), as proposed by Len Burman, Tracy Gordon, and Nikhita Airi. This fund would act as an automatic stabilizer for state revenues during downturns. Another idea is to restructure the Temporary Assistance for Needy Families (TANF) block grant to be more generous and equitable. Josh McCabe thinks we should look to Canada as an example, where the funding formula is on a per capita basis and includes automatic annual increases. While the specifics of any of these plans can be debated, there are multiple alternatives to help state spending without reverting to a regressive tax break.

A related question involves the political feasibility of federal support for state spending. In other words, even if we are right in theory, in practice politics may require a second-best solution—the SALT deduction. Since the other policy options are not currently on the table, the argument goes, let’s restore the full SALT deduction as a least-worst option. To follow this line of argument is to treat public policy as a truly dismal science, and to adopt a deeply pessimistic view of political possibility—especially given the big shifts in policy over the past year and a half. Keeping the cap on the SALT deduction is an opportunity to put better alternatives in place, even if these cannot be enacted immediately. But we should be clear. Even if the deduction was not going to be replaced, ever, with an alternative form of state support, we would still oppose lifting the cap. Even if the goal is worthy, the policy approach is so shoddy that it does not deserve the $70 billion annual price tag—especially when there are so many better candidates for that spending.

  1. “Democrats need to win as many rich suburban voters as they can. I would much rather lift the SALT cap than risk the Republicans winning votes in these areas.”

This is the purely political argument, and likely the one really driving the policy agenda here. The thinking goes: even if lifting the cap is bad and regressive policy, it is a small price to pay if it helps the Democrats to hold on to the Senate and/or House in 2022, or the White House in 2024. Perhaps lifting the SALT cap will in fact win some votes for Democrats in affluent suburbs of expensive cities—but of course it is impossible to know for sure how big a political factor this one issue will really be.

These are partisan political calculations that are of course well outside our scope here, though it would be naïve to assume that bad policy can never be good politics. Our role here is simply to point out that lifting the SALT cap is really bad policy, and against the stated progressive goals of many of those proposing it and leave it to others to judge what kind of politics we want.

  1. “Millionaires will flee from high tax states like New York and California and hurt state revenues—leading to less money for progressive state spending”

This concern is overstated. The most recent data suggests no discernable change in the net migration of adjusted gross income from high-tax to low-tax states due to the SALT cap. Of course, the data is yet to be subject to rigorous causal analysis, but based on the descriptive trends and previous studies, we think the conclusion is likely to hold.

The literature is very mixed on how responsive rich taxpayers are to state taxes. Several papers find small migration effects. Two papers examine top tax rate increases in New Jersey and California, respectively, and each find small migration effects with substantial net revenue gains. Another paper looks at administrative tax data of millionaires across states and finds that higher state taxes have small effects on migration. This paper emphasizes the theory of social embeddedness of elites over the “transitory millionaire hypothesis.” In other words, even the richest among us choose where to live based on more than just the tax code—social networks matter too.

Several papers find larger migration effects but come with important caveats. One study finds that state estate taxes have a large effect on migration, but in almost every case, states benefit on net from having an estate tax. In other words, the revenue collected from the estate tax exceeds the missed remaining lifetime income tax revenue from the movers. Two prominent papers that find large mobility effects are based on specific populations: European soccer stars and star scientists. These are likely upper-bound estimates on migration effects and are unrepresentative populations anyways.

  1. “Money doesn’t go as far in expensive cities. The people who would benefit from lifting the SALT cap really aren’t that rich.”

Well…yes and no. This is more a problem of what one of us has called the “Me? I’m not Rich!” problem, consisting of people failing to understand their relative affluence—often by pointing to their considerable outgoings. But according to the Census Bureau, only 16 percent of households have incomes of at least $200,000 in the New York City area. In the San Francisco area, 26 percent of households do. Even by comparison to the other people living in these cities, these folks are squarely upper middle class.

The point here is that the income distributions of these cities are different to the U.S. as a whole—but not wildly so. Of course, it is more expensive to live in the New York City or San Francisco metro areas than in most other parts of the U.S. But this is in no small part because these are desirable places to live with robust public services, cultural amenities, rich labor markets, etc. And of course, wages are higher too. It is not clear why high demand is a sufficient reason for lifting the SALT cap. There is also something of a vicious cycle at work here. The high cost of living (especially in the Bay area) is driven in part by exclusionary zoning, too: but policymakers have repeatedly failed to make more progress on that front. The basic point here is that most of the people who would benefit most from lifting the SALT cap are rich, even by New York and San Francisco standards.

  1. “We can just lift the SALT cap and pay for it with progressive revenue raisers, such as higher marginal rates.”

This is a bad argument for at least two reasons. First, and most fundamentally, there is only so much revenue the government can feasibly raise and a long list of important social problems that need to be addressed. We should prioritize scarce resources to pay for far more important policies, like making the expanded child tax credit permanent and addressing the racial wealth gap, among many others. Of course, raising marginal rates should be on the table—but let’s not waste our limited tax dollars by simultaneously giving a handout to the rich and affluent.

Second, lifting the SALT cap and paying for it with marginal rate increases would actually make the SALT deduction even more regressive. Deductions get more valuable as marginal rates increase. If someone is in the top marginal tax bracket under current law (37 percent) and the SALT cap is lifted, the marginal dollar deducted is worth 37 cents. If the SALT cap was lifted and the top rate is raised to, say, 40 percent, then that marginal dollar deducted is worth 40 cents. This approach puts SALT deduction advocates in the awkward position of paying for a regressive tax change by making that same tax change even more regressive; the fiscal equivalent of going round in circles.

Don’t do it, Dems!

So, there are some arguments for lifting the SALT cap, and not all of them are silly or specious. But even the best arguments for raising the cap are weak. Any of the goals listed by those arguing for its removal could be reached more efficiently and equitably in other ways. Far from seeking to restore the deduction, even if only in part, Congress should be moving towards its abolition.