The tax deduction for state taxes is an assault on a great advantage of America’s federal system.
The tax deduction for state taxes is an assault on a great advantage of America’s federal system.
A merica’s Constitution was a work of genius in many ways. One of those was a federal structure that left most government decisions to the states, with only limited and enumerated powers for the federal government. That allowed people to live according to local choice in the ways that suited them and their communities best. And it also allowed people who were dissatisfied with local government to move elsewhere.
In this structure of “competitive federalism,” one key area was state taxation: A state that wanted to attract more people and more capital need only lower their tax burden and provide a more efficient mix of services. Because the introduction of a national income tax only increased the competitive pressure on states that were already taxing too much, those states demanded a deduction from federal income taxes for state tax payments.
It was always a terrible idea, designed precisely to favor rich states over poor ones. Capping the deduction at $10,000 was one of the best ideas in President Trump’s 2017 tax reform, particularly for poor communities. Brad Polumbo, writing at National Review, highlighted this aspect of Democrats’ push to remove the cap:
According to the Committee for a Responsible Federal Budget, nearly half of the benefits of repealing the SALT cap would go to households earning more than $1 million annually. Just 0.5 percent of the tax relief would go to households making less than $100,000. The liberal-leaning Brookings Institution estimates that eliminating the SALT cap would give members of the top 0.1 percent an average tax cut of nearly $145,000. Meanwhile, members of the middle class would, on average, see a $27 tax cut. Ironically, Brookings also notes that “Lifting the [SALT] cap would in fact give almost three times as much, as a share of the cut, to the top one percent as the [GOP tax] cuts did as a whole.”
A clear problem of the federal deduction for state tax payments is that it unfairly benefits rich people — the richest most of all. That is a problem that Trump’s cap helped solve by concentrating the benefit lower down the income ladder among those who could use the tax deduction.
That is not the only reason that removing the cap is a terrible idea, however. The whole concept of deducting state tax payments from analogous federal taxes is poisonous to the very structure of the Constitution and to the competitive pressure that structure was designed to exert on excessive state taxation.
In fact, the federal deduction for state taxes represents a core commitment of progressive government going back to its inception, namely the drive to negate the vital competition between state governments. Rich progressive states banded together in Congress to impose their uncompetitive levels of regulation and taxation on everybody, so we could all be uncompetitive together. It was a device that uncompetitive progressive states deployed to eliminate the competitive advantage of poorer states, and had the purpose and effect of keeping those states poorer for longer than they would have been otherwise.
That, in a nutshell, was Franklin D. Roosevelt’s New Deal, the whole point of which was to cover state cartels and monopolies, in agriculture and labor, with a blanket of protection. It was also the driving force behind the deduction for state tax payments.
The deduction for state estate-tax payments (the “death tax”) occurred because the accumulation of wealth in northern states led southern states with better climates to reduce their state estate taxes. Rich elderly people started moving south for retirement, and northern states reacted by demanding both a high federal estate tax and a deduction from it for state estate-tax payments.
The punishing result was to deprive Americans in northern states of the ability to choose among state estate taxes. If you moved south, your choice was no longer between paying a lot of estate tax and a little, but rather between paying it to the state government or to the federal government. In other words, if you moved south seeking a less confiscatory death tax, the federal government would step in to rob you of your tax savings.
Keep in mind, this was done by northern states full of rich people exercising their control of Congress to rob poor states of one of the few advantages of being poor — which is that you can compete on price.
A recent letter from the governors of seven states to President Biden lamented, “For the first time since Abraham Lincoln created the federal income tax, [Trump’s] cap on SALT deductions established a system of double taxation. . . .”
The charge of double taxation is particularly clever coming from the nation’s most unsightly examples of bloated bureaucracy: among them California, New York, New Jersey, and Illinois.
Think of it this way: Some states conclude that they want to keep taxes as low as possible at all levels. Tax-heavy states then demand the creation of a federal tax to cover the state tax, with a deduction for the state tax, and of course it’s okay if the federal government gets a cut on top of the state taxes. The whole idea is double taxation.
The governors complain that Trump’s cap of $10,000 on the deduction for state tax payments “disproportionately targeted Democratic-run states, increasing taxes on hardworking families.” As Brad Polumbo showed, the deduction is a tax cut for the rich, pure and simple. And the Trump cap did not “target” Democratic states. It targeted uncompetitive states.
If that shoe fits, you can wear it — or you can move south.