As the Senate debates the “One, Big, Beautiful Bill,” Americans should brace for a larger federal budget deficit and national debt. Were talkingtrillions of dollars.
One notable aspect of the House bill that suggests a major shift from the Tax Cut and Jobs Act is increasing the state and local tax (SALT) deduction cap from $10,000 to $40,000. Two Republican congressmen from New York – Mike LawlerandTom Suozzi – both argued in Congress and in the mainstream media that the current deduction was unfair to the citizens of high-tax states like New York.
However, increasing the SALT deduction cap subsidizes high-tax states and reduces the incentive for lawmakers in states to have to live with the consequences of their policy decisions. In a federalist society like America, U.S. states are laboratories of democracy. Individuals vote for policymakers who align with their own personal preferences, and relatively low barriers to migration within the U.S. allow people to move to areas that align with such preferences. The SALT deduction cap muddies these laboratories.
For example, lets take two individuals: one living in New York and one living in Tennessee, both earning the same income. The individual in New York can now write offmorefrom their federal taxes than an individual living in Tennessee. Sure, the individual in New York will still pay overall higher taxes when you include what they pay in state income taxes, but they receive the potential benefits of higher tax revenue.
So, the individual in New York receives the benefits from government spending on various programsandlowers their federal tax bill in the process. More fundamentally, the individual in New York voluntarily chose to live in that political environment. As Adam Michel of the Cato Instituterecently pointed out, the new SALT deduction would mean an implicit subsidy from low-tax states to states with higher taxes, which then biases state policy towards higher taxes and more state-level spending.
After the SALT deduction was capped at $10,000 in the 2017 TCJA, numerous states lowered their income tax rates. These include Iowa, Kansas, Louisiana, and Mississippi, plus several that already had flat tax rates, such as Kentucky, Michigan, and North Carolina. This provides some evidence that when one has to pay for the full extent of their policy decisions, local policies adjust accordingly.
Given the increasing concerns about our fiscal state, increasing the SALT cap would only further the problem. If the House bills supposed purpose is to provide both economic growth-producing tax cuts while maintaining fiscal prudence going forward, this is an easy place to start. According toTax Foundations estimates, eliminating the SALT deduction would raise $2 trillion over 10 years; keeping the $10,000 cap would raise $1.2 trillion in revenue. On the other hand, a full SALT deduction would cost the federal government $226 billion per year.
There is also an inherent regressive nature to proposed SALT deductions. The benefits go toward individuals who itemize, disproportionately benefitting the highest-income earners. Anotherrecent reportfrom the Tax Foundation estimated that, with the new proposed $40,000 SALT cap, the bottom 80% of income earners would see no changes in their taxes, while earners in the 95thto 99thincome percentile would have a relative income increase of 0.6%.
By making permanent many of the growth-enhancing Tax Cuts and Jobs Act provisions, individuals can continue to pay lower taxes. The SALT deduction cap would act as a double cut, but in this caseonlyfor the highest earners.
The Senate should strongly consider removing the SALT deduction altogether, or at least keeping it at the current $10,000 level. Keeping the higher threshold in the legislation would punish prudent state-level fiscal policies, further encourage higher state-level taxes and spending, and prolong a regressive tax structure.
Justin Callais, Ph.D., is chief economist at the Archbridge Institute and author of the Substack profile “Debunking Degrowth.”
