The politics of tax policy can be as hard to understand as the tax system itself. The latest case in point is the current push from Democrats to lift the cap on the federal tax deduction for state and local taxes (SALT)—which would be a massive tax cut for the rich.
Before the 2017 Tax Cuts and Jobs Act (TCJA), taxes paid to state and local governments could be deducted against Federal income taxes. But the TCJA capped this benefit at $10,000 a year, hitting the wallets of high earners living in high-tax cities and states.
Former Research Analyst - Center on Children and Families
Richard V. Reeves
John C. and Nancy D. Whitehead Chair
Senior Fellow - Economic Studies
Senate Minority leader Chuck Schumer of New York said of the cap: “I want to tell you this: If I become majority leader, one of the first things I will do is we will eliminate it forever….It will be dead, gone and buried.” House Majority leader Nancy Pelosi of San Francisco has attempted to remove the cap as part of the Congressional packages to blunt the impact of the pandemic. Presidential hopeful Joe Biden is also in favor.
Schumer and others argue that lifting the cap will help cushion the impact of the pandemic. As he stated: “The SALT cap hurts people affected by the virus.” But this is unlikely, since it is the most affluent who are hit by the cap—and they are not, in general, in the front lines when it comes to COVID-19. In fact, the richest neighborhoods of New York emptied out as the pandemic hit. In the Upper East Side, the West Village, SoHo, and Brooklyn Heights, for example, the residential population decreased by 40 percent or more by May 1. This is a tax cut for people with secure jobs and excellent health insurance, working from expensive homes. Rather than reversing the cap, there is a strong case for building on the progress made in the TCJA and eliminating the deduction altogether.
Here we present data, drawn from work by our colleagues at the Tax Policy Center, to show that:
- Lifting the cap on the SALT deduction would massively favor the rich, with most of the benefit going to the top one percent
- Lifting the cap would in fact give almost three times as much, as a share of the cut, to the top one percent as the TCJA cuts did as a whole (of course the absolute amount is very much less)
- Even with the cap, the SALT deduction remains pro-rich, with around three-quarters of the benefit going to families in the top fifth of the income distribution
1. Lifting the SALT cap would be massive tax cut for rich
Who would benefit from removing the cap on the SALT deduction? The rich – especially the very rich. Almost all (96 percent) of the benefits of SALT cap repeal would go to the top quintile (giving an average tax cut of $2,640); 57 percent would benefit the top one percent (a cut of $33,100); and 25 percent would benefit the top 0.1 percent (for an average tax cut of nearly $145,000). The remaining four percent of the benefit of removing the cap would go the middle class (i.e. middle 60 percent), for an average annual tax cut of a little less than $27.
2. Lifting the SALT cap much more pro-rich than Trump’s tax bill
It is useful to compare the distributional impact of SALT cap repeal to other tax policies or packages. One obvious point of comparison is the TCJA package as a whole, which skewed strongly towards the rich. Sen. Schumer described it as “a cynical one-two gut punch to the middle class.” Certainly, it was a pro-rich bill overall. Most of the benefits of the TCJA went to the top fifth, and 20 percent went to the top 1 percent. But lifting the SALT cap would be much more favorable to the rich—with almost three times as much of the benefit going to the top one percent (57% vs. 21%):
How the benefit of a particular tax change is shared across the distribution gives a good sense of how the pie is divided but is silent on the size of the pie itself. An alternative is to consider changes in actual income levels—and so below we show percent change in after-tax income as a result of the TCJA and of lifting the SALT cap:
The after-tax income of the top one percent rose by almost 3.5 percent as a result of the TCJA; for the rest of the top quintile, it meant a 2.5 percent increase. The middle class saw a smaller income boost, with increases of 1.2 percent, 1.6 percent, and 1.9 percent for the second, third, and fourth quintiles, respectively.
But lifting the SALT cap would give essentially no benefit to the middle class. The second and third quintiles would see no change in after-tax income, on average. The fourth quintile would see a miniscule 0.1 percent change in after-tax income. Even the 80th to 99th percentiles would not get much—a 0.4 percent increase in after-tax income. The top one percent, in contrast, would see a 1.9 percent increase in after-tax income.
It is worth emphasizing that lifting the SALT cap is just one tax change, while TCJA changed myriad elements of the tax code. It is therefore striking that the value of repealing the cap would deliver more than half as big an income boost to the top one percent as the TCJA did in its entirety. Given a renewed focus on racial inequalities, it is also worth pointing out that families at the top of the income distribution are disproportionately white, both for the top fifth and especially the top one percent—which is 90 percent white.
3. Even with the cap, the SALT deduction is most valuable to affluent
As we have shown, the introduction of the cap on the SALT deduction significantly reduced its value to the richest families; its repeal would therefore be very favorable to the richest Americans. But even with the cap in place, the deduction still largely benefits families towards the top of the distribution. Around three-quarters of the benefit goes to families in the top fifth of the income distribution; 26 percent to the 95th-99th percentile; and over 12 percent to the top one percent:
By capping the benefit, the TCJA reduced the huge sums that the very rich could claim—hence the drop in the share of the benefit now going to the top one percent. But by definition, most of the value of a deduction on income taxes will go to those paying most of those taxes, i.e. higher earners. There is in fact a strong case for eliminating the deduction. (As our colleague Bill Gale has shown, a similar case can be made for the mortgage interest deduction).
The main argument from some on the political left for the SALT deduction is that it encourages states to spend more by making it easier for them to tax more. Rep. Mike Thompson (D-Calif.), the chairman of the House Ways and Means Committee’s tax-policy subcommittee, argues that it “protects state and local governments’ ability to raise revenue to fund these [public] services.” It is important to note that government spending does tend to be broadly redistributive, as scholars like Edward Kleinbard have argued. This is a useful reminder not only to examine specific tax policies, but the overall package of raising revenue and providing public services.
But if the goal is for the federal government to provide additional support to state and local governments, far better to do so directly, rather than by the roundabout route of offering a tax break to the rich. As Josh Bivens at the Economic Policy Institute writes:
“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.”
At best, the SALT deduction is a warped way to do social policy; at worst it is a politically-motivated handout to the richest people in the richest places. Either way, it is bad policy—especially at a time of rising inequality. Rather than seeking to remove the cap on the deduction, policymakers would do better to consider steps towards the removal of the deduction itself.