As is well-known now, the tax bill that President Trump recently signed into law largely eliminated federal deductibility of taxes paid to cities and states. With deductions now limited to $10,000 per earner, what used to be a way for citizens of high tax states to shrink their federal tax bills has been taken away - by the Republicans no less.
The GOP erred. While it’s easy to characterize the state and local tax (SALT) deduction as a substantial loophole that fosters prodigality within high-tax blue states, the reality is much more nuanced. Near-total repeal of SALT will arguably only succeed insofar as it encourages more federal waste, while at the same time placing the commendable policy objective of empowering states even further in the rearview mirror.
To see why, it’s useful to clarify what’s true: SALT previously existed as a way to reduce the flow of dollars into Washington. Conversely, near-total repeal of the state and local tax deduction amounts to a sizable federal revenue grab. This is problematic simply because every dollar that reaches Treasury gives Congress ever more control over the U.S. economy.
The predictable reply to the above assertion is that in its previous form, the tax code favored earners in high tax states. Since it did, near-repeal of SALT will remove a tax subsidy that largely benefited citizens of those states, at the expense of everyone else. Except that such an argument makes little sense.
Seemingly forgotten by Republicans who pay lip service to the worthy goal of decreasing the size and scope of government is that we all benefit when the federal government collects fewer dollars. A tax hike on “others” is a tax hike on all of us. ]
When Congress has less money to spend, it by definition has a reduced ability to dictate the direction of the goods, services and people that comprise the economy. No one gains when federal tax collections increase. Those revenue increases amount to a tax on private economic activity that reduces opportunity for everyone. This is particularly true when the tax hits the highest earners the most. They, by virtue of being the highest earners, logically have the most to invest. There are no companies and no jobs without investment first.
Which brings us to the supposedly moral argument in favor of SALT repeal: it’s unfair that well-to-do citizens of high tax states have their state and local tax payments subsidized by citizens of low tax states. Getting right to the point, why should taxpayers in Florida, Tennessee and Texas pay higher federal rates of taxation so that California, New Jersey and New York residents can enjoy a federal deduction on the taxes handed over to endlessly wasteful governments in Sacramento, Trenton and Albany? The argument is somewhat compelling until we remember that when it comes to federal tax collections by state, high-tax ones like California, New York, Illinois, New Jersey and Massachusetts already rank #1, 3, 4, 6 and 9.
And while zero state income tax darlings Texas, Tennessee and Florida respectively receive $1.40, $1.75, and $4.50 in federal dollars for every dollar transferred by their citizens to Washington, each of the high tax states listed actually takes in less than a dollar for every one that it sends to Washington each year. Perhaps more than proponents of SALT repeal would like to acknowledge, taxes and spending are highest in the states that receive the least from Washington. So if we ignore the certain truth that federal spending is a massive tax on growth that harms us all, the statistical reality is that even before SALT repeal, high tax states were largely subsidizing those known to tax income very little. After repeal, what was unfortunate will only get worse.
All of which brings us to seemingly the most compelling argument of all in favor of ridding the tax code of the SALT deduction: near-repeal will bring certain taxation pain to citizens of the high-tax states, and as such, it will force reform in them. On its face, this too seems like a good thing. Use national tax reform to bring it about in states. Except that it’s arguably the worst argument in favor of repeal of all. It is because the whole point of the federalism broadly embraced by Republicans is that the federal government should do very little, and in the process leave the policymaking and spending to cities and states. Crucial here is that some will choose very little government, some will choose a lot, but the main thing is that government spending should largely take place on the city and state level. Taxes are logically supposed to be high in some states, and low in others. More broadly, we’re supposed to hand over the majority of the taxes we pay to the cities and states we live in as a way of expressing our policy values.
At the same time, federal tax collections should be very low to reflect a federal government that does very few things passably well. In modern times both political parties have turned the federalist scenario on its head, but in their near-repeal of SALT, Republicans are speeding up the process whereby states have little choice but to tax very little so that the federal government can tax a lot.
That’s what we face right now. Though Republicans have promoted a “huge” tax cut on the federal level, their clear goal is to make up for revenues lost by removing the deductibility of taxes paid locally. In do doing, they’re fueling our ongoing rush away from local taxation; all of this favoring a more muscular federal government.
So while Trump has already signed the much-vaunted GOP tax bill into law, tax at the federal level is a fluid concept. Since it is, it would be wise for Republicans to revisit SALT. As the alleged party of wealth creation, states’ rights, and a limited federal government, near-total SALT repeal reveals itself as a very real barrier to each laudable outcome.
John Tamny is a Forbes contributor, editor of RealClearMarkets, Director of the Center for Economic Freedom at FreedomWorks, and a senior economic adviser to Toreador Research & Trading. He’s the author of Popular Economics (Regnery Publishing, 2015), Who Needs the Fed? (Encounter 2016), and then his next book, The End of Work (Regnery) about the ongoing explosion of jobs that don't feel like work, will be released in 2018.
