The sneaky tax move Democrats are planning
Democrats swallowed the tax cuts for businesses and high earners that President Trump and his fellow Republicans passed unilaterally in 2017. They may even have tacitly supported reforms such as the elimination of the unpopular alternative minimum tax.
But Democrats loathed the new limit on state and local tax deductions Republicans passed as part of the Tax Cuts and Jobs Act. The so-called SALT deduction used to have no limit, but the TCJA capped it at $10,000. Deducting state and local taxes from your federal income tax bill has more value in states and cities with higher taxes, which is why it disproportionately hit taxpayers in Democratic strongholds such as the east and west coasts—as Republicans were fully aware. Ever since the $10,000 SALT limit passed, some Democrats have vowed to repeal it.
They now have their chance. With Democrats in slim control of both houses of Congress, some form of repeal of the SALT deduction cap seems likely. But Democrats want to draw as little attention to this move as possible. While affecting blue states more than red, the $10,000 SALT cap is also a de facto tax hike on wealthy Americans. Repealing or curtailing it would benefit the wealthy with little or no benefit for the working- and middle-class Americans Democrats say they truly want to help.
For starters, the SALT deduction only benefits taxpayers who itemize instead of taking the standard deduction, and that’s only about 14% of tax filers. Among the top 10% of earners, more than 90% itemize, according to the Tax Foundation. Among the bottom 60%, fewer than 20% do.
If Congress fully repealed the SALT cap, 96% of the tax savings would go to the top 20% of earners, according to the Tax Policy Center. That would be a bad look for Democrats who at the same time want to raise income taxes on business and the wealthy. So what are they likely to do?
The only formal hint so far is an agenda for Democratic senators working on a so-called reconciliation bill that will be a top priority when Congress returns from its summer recess. A Senate reconciliation bill will be the legislation likely to contain President Biden’s laundry list of priorities, which could total as much as $3.5 trillion in spending. Unlike the recent infrastructure bill that passed the Senate with some Republican support, the reconciliation bill will be a partisan effort likely to get no GOP votes. Democrats may even have trouble getting all their own members to sign off on it, given the huge price tag.
Partial repeal
The Democratic outline for the reconciliation bill says only that it will include “SALT cap relief.” That probably won’t be a full repeal, which would be expensive. Congress’s Joint Committee on Taxation says full repeal would cost the Treasury $89 billion in foregone revenue per year. That’s a lot. Biden’s plan to raise the corporate tax rate from 21% to 28% would only raise about $70 billion per year, and that's going to be a giant political fight. With the pressure on to come up with new revenue to pay for extensive environmental and social-welfare plans Democrats want to pass, it will be difficult to effectively cut one tax, giving up revenue, while imposing other taxes to raise revenue.
A partial repeal is more likely. “Full repeal is so expensive that some increase in the cap to $20,000 or $30,000 is probably the most likely outcome,” says Jeff Ziarko, founder of research firm Economic Policy Strategies. “I don’t think anyone knows what the right number is right now. The political optimization lands between what people want, which is for the cap to go away, and what's feasible.”
Another option would be to fully repeal the SALT cap for taxpayers below some income threshold, such as the $400,000 minimum Biden has drawn as a starting point for tax hikes. But that would create new complexities, such as efforts to hide or offset income to sneak under the cap. Raising the cap, by contrast, wouldn’t give taxpayers any new reasons to hide or defer income.
Tax experts generally support the GOP change that reduced the SALT deduction, and some would be fine killing the deduction completely. That's because it’s a “regressive” tax break that helps the wealthy most. A SALT deduction of any size also subsidizes state and local taxes, since the federal government essentially rebates some amount of those taxes back to taxpayers, or at least those who itemize. That's inefficient and it creates an incentive to overtax at the state and local level.
There are a couple of reasonable counterarguments. The first is that any tax change targeted at Americans of one party or another is noxious and abusive. Democrats are justified in being just as political repealing the SALT cap as Republicans were imposing it. Another counterargument is that the real cost of state and local taxes ought to be relatively stable over time, because people make long-term decisions about where to live and what size of house to buy based on those factors. Congress should never undermine household decision-making for political reasons, especially when those decisions are difficult or costly to reverse.
If Democrats do pass “SALT cap relief” as part of a reconciliation bill including many other big changes, the political popularity of the move will come down to messaging. Republicans will try to flip the script and argue Democrats are the ones sucking up to wealthy constituents at the expense of Joe Six-Pack. Democrats will point to other tax hikes on the wealthy to say it ain’t so. If blue-state 1 percenters do get a break on the SALT cap, they may not notice it in their tax payments.
Rick Newman is the author of four books, including "Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman. You can also send confidential tips, and click here to get Rick’s stories by email.
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