Why a $10,000 Tax Deduction Could Hold Up Trillions in Stimulus Funds

In 2017, congressional Republicans capped a tax break that benefits America’s highest-earning households and people with multimillion-dollar homes. Coastal Democrats have been trying to get it back ever since.

The break, the state and local tax deduction, known to policy wonks as SALT, does what it says it does. It allows people to deduct payments like state income and local property taxes from their federal tax bills. The deduction, previously unlimited, was capped at $10,000 as part of the 2017 tax bill, which was President Donald J. Trump’s main domestic achievement.

Republicans added the cap to reduce the cost of a tax package that gave more than $1 trillion in breaks to corporations and wealthy families, while increasing the federal deficit despite claims that the cuts would pay for themselves. But the move also struck many Democrats as punitive, because its greatest impact was felt by a very specific kind of taxpayer: People who live in heavily Democratic areas.

The debates over SALT are a case study in the age-old conflict between constituent politics and national policy. They are also emblematic of how the Democratic Party’s increasing reliance on high-income professionals and suburbanites has complicated its longtime difficulty bridging its progressive and moderate wings.

Almost since the law was passed, lawmakers from high-tax states have made various attempts to get one of their voters’ favorite tax breaks back. A bill to restore full SALT deductions was introduced in 2019 after Democrats regained a House majority, but it went nowhere in what was then a Republican-controlled Senate. Proposals to raise or undo the cap have since been discussed as part of the stimulus packages passed during the Covid-19 pandemic.

Four states sued the federal government arguing that the cap is an “unconstitutional assault” on their sovereignty, but were unsuccessful. And in recent weeks, legislators from high-tax states like California, New Jersey and New York have formed a SALT Caucus to further champion a full repeal of the provision, particularly as Democrats contemplate significant changes to the tax code to pay for Mr. Biden’s infrastructure plan.

The most vocal of them are from New York State — where voters claimed the nation’s highest SALT benefit before the tax cuts — who wrote an open letter to Speaker Nancy Pelosi saying they “reserve the right” to oppose any new tax legislation, including Mr. Biden’s infrastructure bill, that doesn’t include a full repeal of the SALT cap. It’s the issue that refuses to die, and with slim Democratic control of both chambers of Congress, even a small amount of dissent would be significant.

“I want to get all this stuff done, but no SALT, no deal,” said Representative Tom Suozzi, a New York Democrat and former certified public accountant. “This is existential for my state.”

As the Democratic Congress moves to raise taxes on capital gains so that the wealthiest pay their “fair share,” SALT could imperil more progressive priorities. Noticeably absent from the 17 New York Democrats who signed the recent letter was Representative Alexandria Ocasio-Cortez.

“I think it’s a giveaway to the rich,” she told reporters last month. “So, I do not believe in holding the entire infrastructure package hostage for a full repeal and abolishing the cap. I think we can have a conversation about the policy, but it’s a bit of an extreme position, to be frank.”

There’s no debate that the SALT deduction goes mostly to wealthier taxpayers. About 85 percent of its benefits accrue to the richest 5 percent of households, according to an analysis by the Institute on Taxation and Economic Policy in Washington. Were the cap to be repealed, about two-thirds of the benefits — about $67 billion — would go to families making over $200,000 a year.

Exactly how that is distributed is subject to an overlapping crosscurrent of tax policies whose effects vary from place to place. Since the 2017 tax cut broadly lowered taxes, even for residents of high-tax states, the $10,000 cap meant that affluent people in blue states ended up with smaller tax cuts than those in lower-cost red states.

But the political bottom line is that capping a very visible benefit angered the sorts of voters on whom high-tax states rely — families in a place like Long Island or Orange County, Calif., who might make a six-figure income, own a home and pay tens of thousands a year in state income and local property taxes. In the psychology of paying taxes, a slightly smaller savings might seem worse than no savings at all, particularly if you feel singled out, as blue state taxpayers clearly were.

Giveaway or not, there is political logic in trying to restore the unlimited benefit. Affluent suburban voters helped Mr. Biden win the White House, and there is even some evidence to suggest that anger over the lost deduction helped Democrats flip a handful of Republican seats during the 2018 election.

Though the debate affects Democratic districts disproportionately, SALT is less about rote partisanship than about representing voters from wealthy areas with high housing costs. The handful of Republicans who voted against the 2017 tax cuts mostly did so because of the loss of tax breaks like SALT, and today Representative Young Kim, a California Republican from Orange County, supports a repeal of the cap.

There’s also little doubt that the cap falls much harder on blue states. Before the 2017 tax cuts, the average SALT deduction in New York was $22,169 — twice the national average of $10,233 — according to data compiled by the Government Finance Officers Association. It was $19,664 in Connecticut, $18,437 in California and $17,850 in New Jersey.

It’s also true that the cost — about $90 billion in lost revenue if the full break was restored — could imperil other policy choices. The $90 billion is roughly the amount it would take to finance another Democratic priority: expanding the Section 8 housing program, which gives low-income tenants a voucher to help with rent, so that it covers everyone who qualifies for it, a move that would provide affordable housing for the roughly 9 million families who are eligible for vouchers but cannot get them because the government has not allotted enough funding.

“When you look around at the world, it’s hard to come up with the idea that this is best use of $90 billion,” said Carl Davis, research director of the Institute on Taxation and Economic Policy, of proposals to remove the SALT cap.

Today’s debates over SALT recall earlier, equally fractious debates over taxing employer health plans, which inflamed unions whose members often have high-cost health insurance, or President Barack Obama’s proposal to tax college savings accounts. That was also opposed by Democratic legislators from high-income cities.

Such benefits are known as “tax expenditures,” or tax breaks that flow mostly to the highest-earning households and consume about $1.4 trillion a year. Christopher Faricy, a political science professor at Syracuse University, wrote a 2015 book criticizing many of these breaks. Its title is “Welfare for the Wealthy.”

Taxes finance the government, but they are also used to shape behavior. Tax breaks encourage people to buy homes and health insurance, send their children to college, save for retirement and give money to charity. An old argument in favor of SALT is that it subsidizes programs like public schools and state health departments. Now, in the aftermath of the pandemic, it is being framed as a way to help high-cost states hold on to high-income workers.

Over the past year, as remote work has untethered millions of white-collar employees from geography, migration out of high-cost regions like New York and San Francisco has surged. Lawmakers and governors pay the necessary lip service to SALT as a middle-class tax break — governors who wrote to Mr. Biden urging him to repeal the cap said it would help “middle-class families” — but the fear that high earners might not return has become the larger concern.

“Even if they’re wealthy people, we can’t afford them to leave, because they subsidize the cost of government in our state,” Mr. Suozzi said.

Whether that will happen is another matter. Tom Kozlik, a municipal credit analyst at HilltopSecurities in Dallas, said a repeal of the SALT cap would be unlikely to stop an exodus of high earners from those states.

“There are many reasons why workers move, and an overall tax burden may be one variable, but the SALT cap is unlikely to be the reason, especially for high earners,” he said.

The fear is still real. Find a state whose residents benefit greatly from the SALT deduction and you’ll find a state that is more than normally dependent on rich people. The top 1 percent of New York City earners — a group that combined made about $133 billion in 2018 — pay a little over 40 percent of the city’s taxes.

With numbers like that, even a small increase in out-migration would have a large impact on the budget. It’s not the sort of money that could finance a large infrastructure package, but maybe enough to halt it.

Emily Cochrane contributed reporting.

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