Please Pass the (Smarter, Free Market) SALT Deduction – The American Spectator | USA News and PoliticsThe American Spectator

Senate and Congressional versions of the “big, beautiful bill” that extends the 2017 Tax Cuts & Jobs Act (TCJA) diverge sharply on key provisions. The $10,000 SALT cap — limiting state and local tax deductions — draws the most heated rhetoric. Congressional Republicans from high-tax blue states vow to raise the cap to at least $40,000, and would like to eliminate the cap entirely, returning to the pre-2017 status quo. But the new Senate bill keeps it at $10,000, prompting SALT Caucus member, Rep. Mike Lawler, R-NY, to immediately declare the Senate bill “dead on arrival.”

Both sides make a range of arguments, including, intriguingly, a few competing pro-free-market economic and political arguments. Given the shared interest in free markets, growth, and fairness, can we find a possible pro-free-market compromise on SALT?

Competing Free Market Arguments

The SALT Caucus Republicans argue that the elimination of the SALT deduction in 2017 undercut the GOP politically in high tax states, shifting those states even further to the left. Constituents came to doubt that Republicans could protect them from SALT cap tax hikes, which advocates say hurt local growth just like any tax hike would.

Since 2017, Republican and high-income voters have fled in droves to low-tax states, thereby increasing the national political polarization. A failure to raise the SALT cap now, they say, would further damage the tax-cutting brand of blue state Congressional Republicans and trigger the loss of the GOP majority. Lifting the cap now would win blue state Republicans the gratitude of their constituents as a bulwark against high taxes, and secure future GOP majorities for freer markets.

They may have a point. In 2018, after the elimination of the unlimited SALT deduction in 2017, Republicans lost between 33 percent to 83 percent of congressional seats they held in New York, California and New Jersey, partly because they failed to protect those constituents from a tax hike, when the rest of the country received a tax cut. Those losses contributed to the overall loss of the GOP majority in 2018.

Meanwhile, Senate Republicans — none from blue states — see SALT deductions as unfair to low-tax states. They say it promotes higher state and local taxes and spending to pay off Democrat cronies, adding unfair tax cost to the federal tab — a tax expense better spent on pro-growth tax cuts. Delivering growth, they say, is the real key to future GOP majorities.

SALT Caucus Republicans respond that their red state colleagues hypocritically use SALT tax savings, not just for pro-growth tax changes, but to extend counterproductive IRA energy subsidies disproportionately flowing to red states. These would be eliminated by any serious advocate for free market-led growth or more effective climate and energy policy. (Sadly, that category does not include many blue state Republicans, who want Federal subsidies to continue to their districts as well. They make the non-free market “fairness” argument that the SALT deduction equalizes benefits for high tax blue states, offsetting the red state Federal subsidy advantage.)

The above conflicting free market arguments both contain a degree of truth. SALT caps probably could imperil the GOP majority. But SALT deductions have also unfairly subsidized high tax agendas in blue states. How do we bridge the gap and gain all the free market, political, and economic benefits both sides seek?

Can we overcome Senate objections by redesigning the SALT deduction as an incentive that drives state and local taxes lower, not higher, in blue states? That change, if possible, would give tax-cutting politicians an edge, reduce Federal tax expense, and make the SALT deduction more fair and pro-growth than it is now, by making it an incentive to lower the highest state income tax rates, not raise them.

That turns the SALT issue upside down.

Introducing: The SALT Desalinator

We could effectively “desalinate” the SALT deduction if we specify that a more generous SALT deduction is only available for states that steadily reduce their top income tax rates to gradually bring them in line with the present mean top state income tax rate (6.65 percent) over a period of, say, five years. So for instance, California, with the highest marginal tax rate of 13.3 percent, would have to reduce that to 11.97 percent for 2026, 10.64 percent for 2027, and so on down to a 6.65 percent maximum qualifying state income tax rate in 2030, for any of its taxpayers to receive the more generous deduction. Similar limits would apply to local income and property tax rates.

This moves the power to maintain the SALT deduction from Congress and puts it in the hands of local legislatures in high-tax states. Voters in these states could then maintain their SALT deduction simply by electing representatives who reduce excessively high state income taxes.

Either way, the Federal SALT deduction tax expense from high-tax states would go down over time. Either blue states reduce state and local tax rates and maintain a generous, but less expensive SALT deduction. Or they keep taxes high, and lose the more generous SALT deduction for all their residents. Over time, this lowers the tax expense of the SALT deduction and makes it more even and fair to all states. Progressive state and local tax codes with ultra-high rates would no longer be subsidized by the SALT deduction.

This SALT desalinator compromise would empower future tax-cutting political candidates and support blue state tax revolts. It spurs growth by encouraging state-level tax cuts, which would likely drive corresponding spending restraint.

If the Senate and Congress can agree on this SALT desalinator compromise, they should consider eliminating the SALT cap entirely for states with qualifying tax rates. By eliminating the cap, the extra incentive to keep state income tax rates low spreads to the higher-income taxpayers, who then become more engaged in the political struggle to keep taxes reasonable. It gives them a better chance to fight back against unfair taxes and a feasible alternative to tax exile.

Don’t cap the SALT deduction. Instead, cap progressive tax codes that qualify for it, to ultimately lower and flatten state and local taxes, and empower politicians willing to lead on fiscal restraint.

READ MORE:

Time to Put Our Fiscal House in Order

Clean Capitalism Without Borders