The Coming Battle Over Tax Reform

Tax cuts create economic growth. Government revenues soared to record levels during the Reagan Administration. Had Congress not gone wild with spending, we could have made serious progress on cutting our deficits. One of President Trump‘s campaign promises was to simplify the tax code and cut taxes. That is a fantastic idea that will encounter many obstacles. One of those obstacles is the federal deduction for state and local taxes, also known as the SALT deduction. The fight to eliminate this deduction is going to be brutal. Why? Because the SALT deduction essentially forces taxpayers in states with lower state taxes to subsidize taxpayers in states with higher state taxes. The states with ridiculous state taxes– for example California, New York, New Jersey, Connecticut, and Massachusetts–face less opposition to tax increases when their voters know their state taxes can be deducted on their federal tax forms. Residents of high-tax states get a break on their federal income tax because of the high state taxes they pay.

The Wall Street Journal posted an article about this on June 22nd.

The article reports:

An often overlooked but critical feature of Mr. Trump’s tax-reform proposal gives Democrats the perfect opportunity to meet him at the bargaining table. When Mr. Trump introduced “the biggest individual and business tax cut in American history,” he said he would “eliminate targeted tax breaks”—including the federal deduction for state and local taxes. Also known as the SALT deduction, this $100 billion annual tax break to state and local governments has been on the books since 1913, even surviving Reagan tax reform. But this time, threatening the federal deduction may seal a tax deal for the GOP. Here’s why:

First, it’s hard for Democrats to argue that the tax reductions in Mr. Trump’s plan are budget-busters when killing the SALT deduction would add $1.3 trillion to federal coffers over a decade, according to the nonpartisan Tax Policy Center. That would pay for a lot of personal and business tax cuts, even without factoring in the faster growth that could pay for those cuts over time.

Second, Democrats can’t say Mr. Trump’s plan isn’t real reform. The SALT deduction is a distortive subsidy to states. It encourages them to raise taxes, because voters can deduct those higher taxes from their federal tax bill.

Third, there’s little in this for red states, because they generally have lower tax rates to begin with. Therefore, according to the Internal Revenue Service, blue states with higher tax rates receive about two-thirds of this break. In fact, half of the $100 billion tax break goes to six deep-blue states: California, Illinois, Maryland, Massachusetts, New Jersey and New York. Democrats in favor of preserving the SALT deduction are simply self-interested.

There is no doubt that the SALT deduction is going to be a major bargaining chip when the discussions on tax reform begin. Stay tuned.