Throwing SALT in the Wounds

One of the most insidious provisions of the Tax Cuts and Jobs Act of 2017 (“TCJA”) was the repeal of the deduction for state and local taxes (known as “SALT”).

It was a cornerstone of the legislation and was touted by Republicans as a measure that would ostensibly discourage state and local governments from irresponsibly imposing future taxes.

Now suddenly, Rep. Mike Garcia introduced legislation that opposes Republican orthodoxy by reinstating the SALT deduction. Not only that, but many local Republicans are citing this as one of his major accomplishments.

With apologies to the late Paul Harvey, perhaps we should examine the rest of the story.

Let’s start with the earliest iterations of the TCJA, which were intended to be revenue-neutral tax reform (changing the way taxes are imposed) rather than a tax cut. That proposed legislation had bipartisan support and was similar to prior incarnations of the Republican-sponsored bill, which were even supported by the Obama Administration to some degree.

The bill was originally designed to close many large corporate loopholes and reduce the corporate tax rate from 35% to 28% in a revenue-neutral manner.

However, as the summer of 2017 turned to fall, the Republicans wanted to enact tax cuts in the name of tax reform. In order to pass, the bill needed 60 votes in the Senate. Unfortunately for the Republicans, the only way they could accomplish overcoming the 60-vote threshold was by invoking the budget reconciliation process.

However, in order to do so, the tax cuts could not increase the federal budget deficit by more than $1.5 trillion over 10 years.

The centerpiece of the TCJA was President Donald Trump’s insistence that America have the lowest corporate tax rates of any major nation. The problem was that, after reducing the corporate tax rate, the 10-year federal budget deficit ballooned to $2.3 trillion. In order to preserve the reconciliation process, $800 billion of additional taxes had to be raised.

It just so happened that repealing the SALT deduction for eight years generated $793 billion of tax revenue (after 2025 the SALT deduction is reinstated). Furthermore, those increased taxes would be paid primarily by taxpayers in blue states.

It was the best of all worlds for Republicans because they could pay for their tax cuts by increasing taxes primarily on people who would not vote for them anyway. In a previous 2017 Signal column, I wrote that Congress had never before politicized the Internal Revenue Code in this manner, and irrespective of one’s political views, such politicization is a bad precedent.

Taxpayers who are hit hard by the SALT deduction repeal include those who live in the suburbs. The removal of the SALT deduction has been cited as one of the reasons why the Republicans did so poorly in the suburbs in the 2018 mid-term elections.

Given the demographics of his congressional district, I guess I shouldn’t be surprised that Congressman Garcia proposed legislation to reinstate the deduction. But one has to wonder whether he is serious, or whether this is merely a political stunt to divert attention away from his Jan. 6 vote to not accept the electors from two states.

Why would Mr. Garcia and local Republicans support a bill that is diametrically opposed to the reasoning endorsed by the Republican Party? Perhaps because they know the bill he proposed is dead on arrival.

Generally, if proposed tax legislation reduces the federal government’s revenue, the sponsor must also come up with another proposal that offsets the revenue decline. Over the years, a large number of proposed tax reduction bills died because they reduced revenue.

When lobbyists suggest tax law changes that benefit their special interest groups, Congress always asks how the provision will be paid for. Mr. Garcia’s bill doesn’t provide a mechanism for funding the revenue loss, so like so many other proposed bills, it will go nowhere.

The Democrats have talked about restoring the SALT deduction, but doing so will cost about $400 billion. They simply do not have the revenue source to fund the deduction’s reinstatement.

Furthermore, we are going to have to pay for the cost of dealing with the pandemic. Ultimately, the government has three choices — print money and bring back inflation, raise taxes or some combination of the two.

In the current environment, reinstating the SALT deduction is just too expensive.

In fact, SALT deductions may have to be permanently repealed to help pay for the pandemic. This is not unexpected because history has shown that once deductions disappear, they rarely return.

For these reasons, suburban taxpayers will probably continue to pay higher taxes (at some of the highest effective tax rates) and legislation proposing illusory tax cuts merely throws salt into the wounds of those taxpayers.