The new Republican-sponsored tax law results in a higher tax burden in Democratic-leaning states. Does the law punish Democrats or fulfill their long-time goal of a progressive tax system?
Introduction
The Tax Cuts and Jobs Act (TCJA) was signed by President Trump on December 22, 2017. The law was touted as a “once-in-a-generation” tax reform program – more substantive than any plan since the Tax Reform Act of 1986. Like that piece of legislation, the TCJA not only changed marginal tax rates, but also limited certain deductions for individual income taxes. One of the major deductions altered by the bill was the state and local tax (SALT) deduction, which allows individuals to reduce their federal tax bill by accounting for state property, income, or sales taxes paid.
The TCJA was able to pass despite pushback from lawmakers of both parties from states whose residents benefit the most from this deduction. Some of those states have resorted to legal challenges to the bill and policy workarounds to reduce its impact on their residents. The biggest beneficiaries of the SALT deduction are individuals who itemize their tax deductions and pay a significant amount of state and local taxes– that is, higher-income individuals in states with relatively high tax burdens.
Background of SALT Deductions
SALT deductions allow individuals to deduct property taxes, as well as sales or income taxes (whichever is higher), levied at the state and local level from their federal tax bill. The TCJA does not eliminate SALT deductions but caps their total value at $10,000 – additional deductions do not apply above that level. This would effectively increase the tax burden on those who were previously able to deduct taxes beyond that amount.
Despite this increase in the tax burden for some Americans, Republicans have touted this provision as a way to simplify the tax code. By eliminating deductions that only apply to certain groups of Americans, more taxpayers will opt to take the standard deduction rather than itemizing their deductions. The Tax Policy Center estimates that roughly 27 million taxpayers will no longer itemize their tax deductions as a result of the TCJA. Of that number, 3.5 million will do so because of the cap on SALT deductions. Supporters of the TCJA argue that this outcome improves horizontal equity in the tax code – that is, it means taxpayers in similar economic situations will pay a similar amount in taxes.
Besides being a method to simplify the tax code, proponents of the cap on SALT deductions have also argued that it effectively acts as a subsidy for high-tax states. States that impose more taxes on their residents are able to raise more revenue without increasing the overall tax burden for those who can simply deduct those taxes from their federal returns. This effectively incentivizes states to raise taxes and collect revenue at the expense of the federal government, the argument goes.
Opponents of this provision – including Democrats and some Republicans from high-tax states like New York, New Jersey, and California – say this provision unfairly burdens their residents. Some even argue that the provision is a cynical form of punishment for states that tend not to vote for Republicans. On that basis, states like New York, New Jersey, and Connecticut have challenged the new law in federal court, saying it prevents states from exercising their legitimate power to tax their citizens. The lawsuit may be a longshot strategy, however.
Distribution of Tax Burdens and SALT Deductions
Looking at the data for which states’ residents tend to rely on SALT deductions, it is not surprising that high-tax states like New York would try to fight the tax law – even if the effort turns out to be purely symbolic. The graph below displays the states by their “tax burden” (that is, the percentage of the average gross income of residents that is paid in state and local taxes) using cell color, as well as the amount in SALT deductions they claim on average (also as a percentage of average gross income) using cell size.
SALT deductions by state
When it comes to the assertions that the tax bill is really meant to punish the GOP’s political opponents, Democrats may have some basis for being suspicious. The states that have the highest tax burden (and thus benefit from the SALT deduction more) are also more likely to vote Democratic at the state and national level. Below, the states are sorted by their tax burden and their political preferences.
US states by overall tax burden
The correlation between political affiliation and tax burden is somewhat intuitive – Democrats are more likely to be progressive, which means they would be expected to prefer more government services. That often necessitates higher taxes. The opposite would be expected from Republicans, who tend to be conservative.
Yet one key tenet of progressive thinking on taxes is that the tax code should also be, well, progressive. That is, progressives prefer that wealthier individuals pay a greater proportion of taxes. The TCJA seems to have achieved that goal with regards to capping the SALT deduction. That’s because wealthier taxpayers tend to be the ones to itemize their tax returns, and wealthier residents tend to pay more in state taxes. That means they are more likely to benefit from the SALT deduction – and capping it impacts them the most.
SALT deductions by income
Conclusion
The conflicting pressures between advocating for a more progressive tax code and enabling states to raise tax dollars more easily – or even insulating one’s own political supporters from higher taxes – present somewhat of a political dilemma for Democrats. One could imagine a similar dilemma for advocates for a simpler tax code. Such advocates often face political pressure to carve out certain deductions or exemptions that benefit one group or advance a particular social outcome. Oftentimes, this tension enables concentrated interests to exploit the opacity of the tax code for their own benefit.
Of course, overhauling the tax code also has implications for spending, especially given that state governments are typically required by statute to maintain balanced budgets. The loss of a de facto federal subsidy for state and local taxes could mean that states will be forced to cut their tax rates to spare their citizens from an increased tax burden, and spending cuts could follow from that. These second-order effects of the TCJA will raise additional concerns for critics of the law.
Regardless of the exact motivation for eliminating the SALT deduction, the final result is that more Americans will file their taxes in a simplified way and higher income individuals will face a larger tax burden. In the recent history of tax legislation, which often strives to lower burdens across the board without addressing the complexity of the tax code, this is a relatively rare outcome.
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Header photo by Jeff Djevdet of speedpropertybuyers.co.uk
Joe Albanese is a second year MPP student at McCourt. He is originally from the Boston area and graduated from Georgetown University in 2014, where he majored in international political economy.