The most optimistic, Aaron Sorkin-esque view of American politics would hope that politicians would be willing to set aside petty ideological squabbles in a time of crisis. Fresh off temporarily derailing crucial, time-sensitive coronavirus response legislation in order to push a divisive progressive wish list, Nancy Pelosi continues to do her best to destroy that optimistic view of politics once and for all. Her current legislative priority in the midst of a national health and economic crisis?Expanding a tax deduction that primarily benefits the wealthiest Americans.
The Speaker’s call to retroactively lift the cap on the state and local tax (SALT) deduction going back two years is just the latest example of Pelosi starting an ideological food fight in the middle of a crisis, throwing progressive spaghetti at the wall in the hopes that her opponents are too busy responding to the crisis to see what sticks. The legislation that Pelosi introduced to disrupt the passage of the last coronavirus relief legislation included such progressive goodies unrelated to the crisis as controversial postal service and multiemployer pension bailouts, bans on corporate lobbying, and carbon emissions restrictions.
Prior to the tax reform law of 2017, the SALT deduction allowed taxpayers who itemize their deductions to deduct all of their state and local income or sales taxes plus all of their property taxes. Those taxpayers who elected to take the standard deduction — roughly 70 percent of taxpayers at the time — were unable to claim the SALT deduction.
And even before the deduction was capped as part of tax reform, the benefits from the deduction flowed primarily towards the wealthiest taxpayers. In tax year 2015, 84 percent of the benefits of the deduction flowed towards those taxpayers with adjusted gross incomes (AGIs) above $100,000. Just 3.5 percent went to taxpayers with AGIs below $50,000.
The 2017 tax law capped the maximum benefit a taxpayer could receive from the SALT deduction at $10,000, while at the same time doubling the standard deduction. These changes, taken together, reduced the number of taxpayers claiming the deduction significantly. Just under 10 percent of taxpayers claimed the deduction. The SALT deduction still exists in the tax code as a deduction that primarily benefits the wealthy, but the tax reform law scaled back the scope of it.
But the biggest problem with the SALT deduction was the incentives it created. In effect, the deduction allowed high-tax states to have their high-tax habits subsidized by low-tax states.
The SALT deduction enabled high-tax areas to levy relatively higher tax rates on their wealthier taxpayers by reminding them that they could deduct those taxes paid at the federal level. Wealthier taxpayers in high-tax regions still paid higher taxes, but the effect was “discounted” by the SALT deduction.
The fact that the SALT deduction cap has made taxpayers in high-tax jurisdictions feel the full brunt of excessive tax harvesting has made the deduction a particular source of angst for progressives who would usually be opposed to tax breaks for the wealthiest Americans. A coalition of northeastern blue-state governors were so riled up by this change that they even launched a quixotic legal battle to ask the courts to declare that taxpayers had a right to deduct their state and local taxes from their federal return (they do not).
But just as these governors bemoaned the new accountability, states quickly began rethinking tax hikes. The most prominent example of this came when New Jersey Senate President Steve Sweeney flipped from supporting a proposed millionaires’ tax to opposing it because of the SALT deduction cap.
If the Speaker is serious about responding to the specific challenges the coronavirus presents, then she should stop treating it like a legislative opportunity and start treating it like a crisis.