Congress revisits SALT deduction

As President Joe Biden and Congress push the next round of big tax hikes and spending bills, Californians will be hearing a great deal about the so-called “SALT” deduction. SALT stands for state and local taxes and, for many years prior to President Trump’s term in office, taxpayers could deduct those taxes from their federal tax returns without limitation.

Then in 2017, Congress passed and the president signed the

Tax Cuts and Jobs Act. It limited the amount of state and local taxes that taxpayers could deduct to $10,000. In states with high state income tax rates and/or high property taxes, this meant there were many taxpayers who lost a valuable deduction and felt the full pain of the taxes imposed by their state and local governments.

For Californians, ouch. Because California has the highest income tax rates in America, one of the few saving graces for high-income taxpayers has been the ability to deduct state taxes on one’s federal return.

The fight over the ability to fully deduct state and local taxes has splintered the country. States with modest income tax rates, or no income tax at all, complained that their residents were essentially subsidizing residents of profligate, big-spending states.

Republican members of Congress from high-tax states found themselves in a dilemma. Many supported the Trump tax reform even though it had the effect of raising taxes on their upper-income constituents. For some, that support may have cost them reelection, notwithstanding the fact that the tax reform bill led to record setting economic growth as well as record low unemployment. Even California’s economy exploded under the Trump presidency until the COVID-19 virus arrived on America’s soil.

California’s political class, for the most part, chafed at Trump’s slap against high-tax blue states and has attempted to find a clever workaround to neuter the loss of the SALT deduction. For example, immediately after passage of the tax reform law, California floated the idea of a semivoluntary “charitable deduction” scheme to give high-wealth Californians some relief. It would have created a “charitable” fund within the general fund so highearning taxpayers could claim a deduction for “donating” the equivalent of what they owed in state taxes. But the IRS quickly shot down that idea.

Whether individual states can find ways to negate the loss of the SALT deduction may be moot if Biden and Congress agree to restore the full SALT deduction as part of another reconciliation bill. (Reconciliation bills, to the extent they address only tax and spending issues, can bypass the 60-vote threshold generally required to advance legislation in the U.S. Senate). Such a bill could pass even without Republican support, as the $1.9 trillion COVID “rescue” bill just did.

In late February, eleven Democrat members of Congress, including several from California, sent a letter to President Biden urging that he eliminate the cap on the SALT deduction. However, there are many Democrats who don’t want to bring back the unlimited SALT deduction even if they’re from hightax states that would benefit.

The reason is that the SALT deduction favors the rich far more than the middle class and working poor.

The fissure within the Democratic party over the SALT deduction reveals no small degree of hypocrisy. For all their complaining about “income inequality” and the need to look out for the little guy, California Democrats who want to help the rich are pushing the Biden administration to make full SALT deductibility a plank of his tax package. So grab some popcorn. For tax geeks, this is going to be interesting to watch.