Just before Christmas, President Trump signed into law the highly controversial tax bill touted by Republicans as a win for the middle class and criticized by Democrats as an overzealous gift to large corporations and the very wealthy. Of the various provisions, perhaps the most contentious is one limiting the state and local tax (SALT) deduction to a maximum of $10,000. As reported by Politico, this could amount to losses as high as $24,900 for residents in New York City and $17,000 for people living in Marin County, California. In general, the tightening of the SALT deduction could be a blow to urban areas throughout the country, namely those in the Northeast and California.
Prior to the law’s passing, the SALT deduction – which was first introduced in the early 20th century – has proven to be an unofficial subsidy for states and localities, who rely on the deduction to maintain funding levels for schools, streets and other public necessities. Additionally, the deduction prevents US residents from being taxed twice on income. Here’s how it works: a taxpayer who decides to itemize their taxes (that’s about a third of the tax-paying population) can deduct income taxes or sales taxes in addition to property taxes. Most residents deduct income taxes (as opposed to sales taxes), as this amounts to a higher deduction.
Without the deduction, public schools throughout the country stand to lose funding that is barely existent to begin with. Urban public schools already suffer, having very little funding to provide a quality education to students from mostly low-income households. Losing the deduction could put pressure on states and localities to reduce the funding going toward these schools.
This is partially due to the regressive tax structure used in the US to fund schools. While areas with higher property taxes tend to have better-funded schools, low-income districts (with equally low property taxes) have poorer funding. This is the case despite efforts to offset this disparity with local, state and federal subsidies. With the SALT deduction, this disparity can only worsen.
Moreover, the tax bill promises to substantially reduce the amount of resources available to schools in low-income areas. So-called qualified zone academy bonds (QZABs) have been stricken from the tax code, meaning schools no longer have access to low interest bonds, often used to finance rebuilding projects and renovations.
And because property tax deductions are now severely limited, there is less incentive for people to buy homes. According to a report circulated by Trulia and reported on by Business Insider, homeowners living in major cities throughout the country would lose out on substantial tax deductions. For instance, one in five homeowners in the New York City region – that includes Long Island – have property taxes exceeding the $10,000 limit. Tax liabilities would increase significantly all along the California coastline. In San Francisco, for example, 96.2 percent of homes could face major tax liabilities thanks to the SALT deduction. And since, according to the Government Finance Officers Association, over 60 percent of the deductions from taxpayers making less than $50,000 annually are property taxes, this is a problem for the middle class.
It should be noted that the SALT deduction is, by virtue of being a deduction, a regressive tax policy. According to a report by the Joint Committee on Taxation, in 2014, the benefits from the SALT deduction went primarily toward those making above $100,000. That being said, the Republican decision to cap the deduction could do more harm than good. As mentioned above, states and cities depend on the cushion provided by the SALT deduction to set funding levels for certain public programs, namely schools. Without this indirect subsidy, cities may have to reduce funding for infrastructure, as they can hardly ask wealthy individuals for even more money.
What’s more, as pointed out by the Center on Budget and Policy Priorities, even though the SALT deduction is in and of itself a regressive policy, cutting it amounts to an even more regressive policy because the revenue produced by the repeal will ultimately go toward marginal income tax-rate reductions. And marginal income tax-rate reductions, under the new plan, will benefit wealthy citizens even more than the SALT deduction.
A Way Out?
As it turns out, there may be a way forward. According to Daniel Hemel, of the University of Chicago, under the SALT repeal, business owners can still deduct state and local payroll taxes. This means states can shift income taxes to employers. Employers, meanwhile, can lower their employees’ pay accordingly. So instead of paying an employee $100 and taxing them $5, employers can pay $5 worth of payroll taxes and pay the employee $95 in wages (without the income tax). In this scenario, according to Hemel, “Everyone is just as happy as before — except that partial repeal of SALT has raised zero for the federal government.”
We’ll see if Hemel’s proposal takes hold. For now, we have one more year before we have to pay taxes under the new regime. Until then, there’s much to think about.