On the politics of SALT in tax proposal
Never before has Congress politicized the Internal Revenue Code. … Such politicization is a bad precedent.
This column is not about reducing your sodium intake. Rather, it is about the deduction for state and local taxes, which tax practitioners affectionately refer to as “SALT.”
One of the most controversial provisions in the Trump/GOP tax proposals has been the elimination of the SALT deduction. This is needed to fund corporate tax rate cuts. (See Part 1 in this series, “We all pay for corporate tax cuts,” published Oct. 7 https://signalscv.com/2017/10/ jim-de-bree-pay-corporate-taxcuts/.)
It is not clear at this point what the individual rate cuts will cost, but without repealing the SALT deduction, those cuts are likely to be deficit-accelerators as well.
The GOP argues that the deduction claimed by millions of taxpayers subsidizes high state tax rates and encourages state and local governments to spend more money. Paradoxically, the federalist principles the GOP espouses (i.e., shifting federal spending to the states), mandate that the states spend more money.
It turns out that blue states tend to have higher taxes, so by eliminating the SALT deduction, the GOP believes it is enacting a tax increase to be borne principally by people who would not vote for them anyway.
Never before has Congress politicized the Internal Revenue Code in this manner. Frankly, irrespective of one’s political views, such politicization is a bad precedent.
There are three ways that state and local governments can fund their expenditures. The first is through taxes. The second is by incurring debt. The third is the receipt of direct federal subsidies. Much state spending is subsidized by the federal government, and to be fair, all three ways to fund expenditures have to be viewed in an overall context.
State borrowing is subsidized because the interest paid by state and local governments on debt instruments is generally not taxable to the recipient. Consequently, state and local governments can borrow at a lower cost. Most people who invest in state and municipal bonds are people in the highest tax brackets.
Eliminating the tax exemption for interest on municipal bonds would increase the tax burden of the wealthy. The tax increase resulting from eliminating the SALT deduction is borne largely by the middle class.
When you borrow money, the lender looks to your ability to repay the loan. Usually that means you need to have sufficient income to repay the loan.
The same is true for state and municipal governments. The best indicator of a state’s ability to repay its obligations is its gross domestic product — the sum of all of the goods and services produced in the state.
If you rank the states with the highest ratio of debt to GDP, you would expect to see a number of blue states with irresponsible borrowing. You would also expect California to be at the top of the list.
The average debt ratio for all states is 15.88 percent of GDP. California ranks 20th at 15.08 percent. New York is the highest at 22.28 percent, followed by Kansas and South Carolina, both over 20 percent. Both Kansas and South Carolina have implemented state tax cuts and have incurred significant debt to fund those cuts.
Illinois and Connecticut have ratios of about 18 percent; both states are experiencing fiscal difficulties. Texas, the largest red state, has a ratio exceeding 17 percent.
At some point these states will have to raise taxes to repay their debt obligations.
Another rationale for repealing the SALT deduction is it ostensibly causes poorer states with lower taxes to subsidize high-tax wealthier states. However, the states with the highest tax rates generally have higher income levels and they pay a higher percentage of the overall federal tax burden.
This rationale fails to consider the amount of federal assistance provided to each state. The Tax Foundation analyzed the percent of each state’s budget that was funded through assistance from the federal government in the form of federal grants-in-aid.
According to the Tax Foundation, “The top recipient of federal aid in FY 2014 was Mississippi, which relied on federal assistance for 40.9 percent of its revenue. Other states heavily reliant on federal assistance include Louisiana (40.1 percent),
Tennessee (39.9 percent), Montana (39.1 percent), and Kentucky (38.5 percent).”
By comparison, California gets only 25 percent of its budget from federal sources and ranks 43rd.
Let’s also look at this from the perspective of federal per capita spending for each state compared with every dollar paid by that state in federal income taxes. South Carolina tops the list by receiving nearly $8 of federal spending for every dollar of federal taxes paid by residents.
In comparison, California receives about ninety cents for every dollar spent by taxpayers. The top five states and eight of the top 10 are red states.
As you can see, taxpayers in blue states already pay for a disproportionately high amount of state expenditures, including those of states in which they do not reside.
The Republicans appear concerned with states funding expenditures through taxes, but not through debt. Their plan will likely encourage more state and municipal debt.
Repealing SALT deductions is a major component of the GOP’s plan that effectively increases the tax burden of many families making over $50,000 and households with a six-figure income. The beneficiaries are those with more income and corporations.
While my cardiologist wants me to reduce my salt intake to improve my health, I am not certain that the Republicans’ desire to eliminate SALT deductions has similar beneficial results.