As part of the next congressional response to the COVID-19 crisis, House Speaker Nancy Pelosi recently suggested rolling back a provision of Donald Trump’s 2017 tax bill that limits the ability of taxpayers to deduct state and local taxes (SALT) on their federal returns. Critics pointed out—correctly—that the chief beneficiaries of the deduction are relatively well off households who itemize deductions.
Normally, progressives oppose tax breaks for the wealthy and conservatives champion them, so why are the tables turned in this case? And why is Pelosi right?
A quick response might be that the SALT deduction tends to benefit wealthier residents in high-tax regions of the country, which tend to lean progressive, so it’s just a case of representatives protecting their constituencies’ financial interests.
But this analysis misses a much bigger point: it’s not who gets to claim the largest SALT deductions that’s important, but rather what that federal subsidy winds up supporting.
The ability to deduct the full amount of SALT on federal returns is one of the federal government’s most powerful ways to support localities in providing investments in public schools, public colleges, and state health care spending.
The ability to deduct the full amount of SALT on federal returns is one of the federal government’s most powerful ways to support localities in providing investments in public schools, public colleges, and state health care spending. That’s precisely why conservatives—from Donald Trump to Ronald Reagan—have consistently sought to limit the SALT deduction, and liberals have sought to maintain it.
How SALT Works
The origin of the SALT deduction on the federal return goes back to the enactment of the federal income tax in 1913. The deduction was seen as a way of avoiding double taxation. Moreover, it was argued that the federal government should support states and localities in their efforts to raise funds for vital public services.
Take the example of education. Federal officials want states and localities to continue to do their part in educating children, and want to reward states that do a good job of doing so. If federal aid to education—in the form of college Pell Grants, or Title I funding for the Elementary and Secondary Education Act—are coupled by deep spending cuts from states and localities for public schools and colleges, then the federal objective is undercut.
A federal tax deduction for state and local taxes, like the deduction for charitable giving, is meant to support this underlying activity. Take a married couple filing jointly who are in the 32 percent tax bracket. If they pay $50,000 in state and local taxes, and can fully deduct those taxes from their federal income, the deduction could reduce their federal taxes owed by $16,000, so the couple effectively pays $34,000 to support education and other state services and the federal government chips in $16,000. The same principle applies to the couple’s $50,000 charitable donation.
The main difference between these two tax deductions is that while charitable giving often goes to the interests of the wealthy—symphonies, orchestras, and art galleries—state and local spending tends to benefit people more broadly, in support of public education, health care, state roads and bridges, and so on.
A History of Attempts to Undermine
Conservatives understand perfectly the ways in which the SALT deduction supports government social services. In 1985, Ronald Reagan proposed completely eliminating the deductibility of state and local taxes. At the time, progressives like American Federation of Teachers (AFT) president Albert Shanker cried foul. The AFT estimated that the state and local tax deduction provided a $16.5 billion subsidy to public education—bigger than the entire $15 billion U.S. Department of Education budget at the time. ”This proposal would constitute the largest slash in Federal aid to education in our history,” Shanker said.
Shanker knew if you take away the federal incentive for state and local spending, then the politics of state and local spending changes: high end taxpayers, who have disproportionate political clout, would be less likely to support a new school bond or a state tax increase if they could no longer deduct costs from their federal taxes. Fortunately, Reagan lost that fight.
High end taxpayers, who have disproportionate political clout, would be less likely to support a new school bond or a state tax increase if they could no longer deduct costs from their federal taxes.
Fast forward to the 2017 debate over Trump’s tax bill for tax cuts to the wealthy. The same logic applied. In a 2017 analysis, Michael Dannenberg, a former staffer to Ted Kennedy who works with Education Reform Now, outlined the reality: “The federal deduction for state and local property taxes alone totaled over two times the size of direct grant aid provided through the Title I and IDEA programs for disadvantaged students. In 2016, the federal subsidy for all state and local taxes was valued at $97 billion and helped finance over four times that much in state and local public elementary and secondary education spending for all students.”
The 2017 tax cut didn’t completely eliminate SALT deductibility—but it capped it at $10,000 for a married couple filing jointly. The cap, taken together with a broad expansion of the standard deduction to $24,000 for that couple, significantly reduced the federal subsidy for state and local spending on important investments. To give a sense of the magnitude of the change, the Joint Committee on Taxation estimates that full repeal of the SALT cap would cost an estimated $77 billion compared with the current $10,000 limitation on deductibility.
At a time when state and local governments need support from the federal government, policymakers should prioritize direct aid—in the form of stabilizing funds—but also boost indirect aid in the form of the SALT deduction. For generations, that was the bargain the federal government struck with state and localities to support education and other priorities. Both direct and indirect federal aid are necessary to the long-term survival of the social safety net and the agenda of opportunity in America.
Header photos: U.S. Speaker of the House Rep. Nancy Pelosi (D-CA) delivers a statement at the hallway of the Speaker’s Balcony at the U.S. Capitol in Washington, DC. Source: Alex Wong/Getty Images