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Tax bill: SALT deduction repeal is another blow for blue-state wealth

New York, California are the most affected

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Tax reform is a particularly thorny political undertaking because the process of eliminating deductions and changing tax rates inevitably creates winner and losers. The winners may or may not provide political support to help shepherd reform to passage, but the losers—particularly if it’s a special interest with a powerful lobby—will fight to the bitter end to kill the bill.

By eliminating or capping a number of deductions related to housing, Republicans in Congress have shifted losses to wealthy people in states and districts that traditionally vote for Democrats, with state and local property tax (SALT) deductions being the clearest example.

Currently, taxpayers who itemize can deduct the amount they pay in state and local taxes—such as property taxes and income taxes—from their federal tax return. For income taxes, the deduction keeps income from being taxed twice, once at the state level and again at the federal level. Both the House and Senate tax reform bills eliminate all SALT deductions, with the exception of a state and local property tax deduction capped at $10,000.

On Tuesday, The New York Times published a breakdown of how this would hit blue states harder than red states. The obvious is that a number of red states—like Texas, Alaska, Tennessee—don’t even have state income taxes, while reliably blue states with dense urban areas—like New York and California—have high state and local taxes.

For low- to moderate-income people, the elimination of SALT deductions likely won’t matter because both the House and Senate bills double the standard deduction, from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for couples. The Tax Policy Center estimates that this would lead to a drop in the number of taxpayers who itemize, from 45 million to 18 million. Many low- to moderate-income people will simply take the standard deduction as opposed to itemizing, rendering special interest deductions moot.

But for high-income individuals and couples in high-tax areas, the elimination of SALT deductions would likely lead to a higher tax bill; it would also likely lead to losses in revenue for state and local governments. But of the top 10 states that claim the highest SALT deductions for households that make more than $200,000, all 10 are states Hillary Clinton carried in 2016.

A similar dynamic would play out in the House’s proposal to lower the cap for mortgage-interest deduction. Currently, homeowners can deduct interest on loans up to $1 million in property value. The House bill proposes lowering it to interest on loans up to $500,000 in property value. Because originations on mortgages between $500,000 and $1 million are mostly in dense urban areas that tend to vote Democratic, the change would affect mostly wealthy people in blue states.

In this highly charged partisan political environment, Republicans have been accused of weaponizing the tax code in a number of ways, including by shifting the losses to people who wouldn’t support their efforts anyway. But it’s worth noting that in passing the Tax Reform Act of 1986—which was a bipartisan effort led by Democrats Dan Rostenkowski of Illinois and Bill Bradley of New Jersey in conjunction with President Ronald Reagan—similar thinking was behind an attempt to repeal SALT deductions, and the political environment wasn’t half as toxic as it is now.

“The deduction mostly benefited residents of high-tax states like New York and did far less for residents of states with lower taxes,” wrote Jeffrey Brinbaum and Alan Murray in their book about tax reform in 1986, Showdown at Gucci Gulch. “[Treasury Secretary Jim] Baker and [Deputy Treasury Secretary Dick] Darman calculated that pitting New York against the rest of the nation might be good politics and help win the tax plan’s approval.”

Ultimately the repeal of SALT deductions never made it out of the Committee on Ways and Means because it was too politically fraught; there were howls from politicians on both sides of the aisle, and even from representatives from states where taxes are low, as alliances were formed to preserve certain special interest deductions.

In the current tax reform effort, the opposition just hasn’t been as fierce. The bills have moved through Congress at breakneck speed, leaving little time for lobbies to mobilize. Republicans have made no attempt to make it a bipartisan effort, so complaints from Democrats in blue states fall on deaf ears. Because of political polarization, there are few Republicans in high-tax states that would be affected by SALT deduction repeal, although of the 13 Republican House members who voted against the bill, 12 were from either New York, New Jersey, or California, and they cited the SALT deduction repeal as the reason.

Republican leadership will have to walk a fine line in reconciling the two bills, so it’s possible SALT deductions could be used as a bargaining chip to get those 12 House members on board. Signs of wiggle room have already surfaced. To get Maine Senator Susan Collins on board, the Senate included a state and local property tax deduction of up to $10,000, which is also in the House bill.