The Corner

Politics & Policy

Tax ‘Reform’: Don’t Pinch the SALT deduction

True tax reform should aim to satisfy four main ‘fiscal’ principles: It should aim at a tax system that is flatter (with lower nominal rates), broader (as many people as possible should have skin in the game), simpler and, even allowing—as I would –for some supply side magic, it should be fiscally responsible.  As that final goal is extremely difficult to reconcile with those earlier principles without either truly brutal claw-backs in entitlements (not something I would favor) or (my very clear preference) some sort of federal VAT/GST/Sales tax, both political impossibilities for now, the best that can be hoped for is that any change in the tax regime should not worsen the country’s (unattractive) long term financial condition by too much.

It’s hard to see how (despite proposals such as the cut in corporate tax rates—good, but 20 percent looks like an overreach—and the welcome abolition of the Alternative Minimum Tax) the GOP plans genuinely satisfy any of those conditions.

And there’s something else. Any tax reform must take into account political realities. Structuring tax cuts in a way that makes it more likely that tax increasers will be back in power before long is an exercise in futility. Structuring them in a way that sweeps away the popular tax ‘breaks’ that have acted as some sort of defense against the worst that the tax grabbers can do is more than futile, it is self-destructive.

Looked at this way, the GOP’s plan(s) (as they currently stand) are both futile and self-destructive.

That makes criticisms of the Republican onslaught on individual tax deductions not only valid, but necessary. There are plenty to choose from (the House plan to eliminate the tax deductibility of alimony payments is another to add to a list so politically damaging that I can only assume it was handed to Paul Ryan by Nancy Pelosi), but, prompted by this excellent New York Times article by the Manhattan Institute’s Nicole Gelinas, I thought I’d return to the State and Local Tax  (SALT) Deduction (and, yes, yes,  I live in New York City).

In a post the other day, I argued that removing this deduction was politically unwise (essentially for the reasons I gave above) and  that, contrary to the claims of some who support this change, it will not make any difference to the high tax and spend policies in states such as New York, New Jersey and California. The fact that such a ‘reform’ would make the tax code even more progressive was (to me) no argument in its favor, and, if we’re looking at how it would play politically, would do nothing to change the minds of those who see the GOP plans as a giveaway to the rich.

I also added that, as someone who believes that higher taxes holds back economic growth, an effective tax increase on many of the more economically productive people working in a not insignificant slice of that shrinking part of the country still able to boast growth in new businesses or new jobs is… unwise: Goose, golden eggs and all that.

Now Gelinas (who, unlike me, supports the removal of the mortgage interest rate deduction) throws federalism into the debate over the SALT deduction:

Scholars and judges differ over where state control ends and federal oversight starts. But no scholar argues that states, cities and towns don’t possess the right and obligation to staff schools, pave roads, purify water and put out fires.

For this, local and state governments need money — which they mostly get from their own taxpayers, not from Washington. To assert that the federal government has the primary claim on this tax dollar, as Republicans are doing, is to claim that the federal government bears the primary responsibility for these tasks.

That’s not a conservative argument, but a European one. In France, the national government, not Paris, stands behind a $37 billion “Grand Paris” plan to improve public transportation. In America, by contrast, Washington expects New York and New Jersey to bear half the cost of a new tunnel under the Hudson River, even though Amtrak, the national railroad, depends on this critical piece of infrastructure. Similarly, New York has received only $1.3 billion toward the $4.2 billion cost of the first three stops of the Second Avenue subway. The rest comes from New York taxpayers.

Wealthier taxpayers do disproportionately benefit from these tax deductions, because they pay the most in taxes. In New York City, just 1 percent of tax filers — 37,273 households — pay 49.3 percent of city income taxes.

A number that is a further blow to the claim that politicians in blue states will be scared straight by the proposed Republican changes. Donors’ influence only goes so far.

Then there’s the question of timing:

If Congress were going to diminish America’s local-governance model anyway, now is not the time. Nearly a decade into the economic recovery, state and local governments remain under fiscal stress, particularly when it comes to pension and health care promises to retirees.

Note Gelinas’ comment on timing, This mess exists after nearly a decade of (relative) economic recovery. What happens when—as it always will—the next recession arrives?

This is not a problem, as Gelinas points out, confined to Blue States (my emphasis added):  

Texas owes $39.1 billion for pensions, but has set aside just $25 billion. Gulf states, including Florida and Louisiana, must invest in flood-protection measures. Houston voters approved new borrowing for such infrastructure this month — borrowing enabled by local tax deductions

One reality remains — somebody must pay. Three sources exist: taxpayers; public-sector retirees, via pension and health-benefits cuts; and municipal investors, via Detroit-style debt defaults in severe cases. Congress is making the first more difficult for state and local governments, and in most places, legal protections prevent governments from cutting pension benefits.

That leaves bondholders. As the Standard & Poor’s rating agency said this week, the overall impact of a tax plan that curtails state and local tax deductions “could be costly and detrimental to the credit quality of many public-finance issuers.”

To put it another way, the cost of borrowing for state and local governments is likely to increase, something that ultimately will have to be paid for by local taxpayers.

Gelinas (again, my emphasis added):

Signing a bill into law that creates systemic distress for a financial market that affects the lives of all Americans is hardly the best way to improve the economy. And it may result in eventual tax increases, not tax cuts, at the federal level. Global investors may grow tired of America’s lurching from crisis to crisis and raise the cost of federal borrowing, as well.

As a reminder, the GOP plan is going to increase the size of the federal deficit. That’s not going to reassure bond buyers either.

As another reminder: borrowing costs are at historically low levels.

Finally, let’s scroll back to candidate Trump in May 2016:

“If interest rates go up one percent, that’s devastating,” the presumptive GOP nominee for president told CNBC on Thursday. “What happens if that interest rate goes up 2, 3, 4 points? We don’t have a country.”

Campaign hyperbole, sure, the picture is not as dark as that, but candidate Trump’s worries were far from completely unfounded.

They should not be forgotten.

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