Ending the state

Will the Republican tax bill devastate America’s bluest states? That’s the impression you’d get from two recent op-eds in the New York Times, the first by a pair of liberal academics, and the second by a conservative policy analyst, both of which castigate Republicans for drastically shrinking the state and local tax deduction, also known as SALT. Ray Dalio, the legendary hedge fund investor, argues that curbing SALT will cause more millionaires and billionaires to flee high-tax states for low-tax states, thus causing a severe revenue crunch in the former. And in a ghoulish interview with Bloomberg, conservative gadfly Stephen Moore describes the House and Senate tax bills as “death to Democrats,” partly on the grounds that “they go after state and local taxes.”

Count me as a skeptic. While conservatives do indeed have reason to cheer SALT’s demise, so do egalitarians on the left and right, whether they’re in blue states or red.

Before I go on, I should note that I’m not a fan of the Tax Cuts and Jobs Act (TCJA), for a number of reasons. Because the federal income tax burden on middle-income households is already quite low, the best way to help them would be to reduce their payroll tax burden. Republicans have chosen to do nothing about this, despite having recently been presented with a golden opportunity to do so. Cutting corporate taxes makes sense, but I worry that Republicans have done it in a way that will encourage U.S. multinationals to offshore more of their production activity, which is exactly the opposite of what they’ve set out to do. Moreover, if we’re going to cut corporate taxes, I believe we ought to make up for at least some of the lost revenue by raising taxes on shareholders, as Utah Sen. Mike Lee has suggested. Again, that hasn’t happened.

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But there is one thing I like about TCJA, and that’s the fact that it has reduced the SALT deduction to a vestigial rump. Specifically, the Senate- and House-passed bills both eliminate the deductibility of state and local income and sales taxes, and they limit the deductibility of property taxes to $10,000. I’ve made the case before that Republicans should get rid of the entire SALT deduction to finance a refundable tax credit for families with children. They haven’t, and I can’t say I’m shocked. What’s also true, however, is that once the SALT deduction is gone, it’s going to be very hard to bring it back.

Essentially, SALT allows high-income households in high-tax states to shield more of their income from federal taxes. Consider Massachusetts, one of the more affluent states in the U.S. Recently, there’s been a big push for a 4 percent surtax on incomes over $1 million, the revenues from which would be plowed into various statewide spending programs. As the fiscal sociologist Josh McCabe has observed, however, there’s a wrinkle, which is that while a Massachusetts millionaires’ tax would raise $2 billion for the commonwealth, it would also reduce federal tax revenue by $600 million under the existing SALT deduction. Get rid of the SALT deduction and the federal government will still get its $600 million — assuming, that is, the millionaires who are paying the tax choose to remain in Massachusetts or they don’t reduce their taxable income via other means, such as simply working less.

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What’s the conservative case against this state of affairs? Thanks to the SALT deduction, high-income households don’t bear the full burden of state and local taxes, which makes it easier for state and local governments to raise taxes. The backlash against tax hikes isn’t quite as severe as it would be in the absence of the SALT deduction. So if you’re a conservative who believes that state and local governments can be extraordinarily wasteful and inefficient, you might see curbing SALT as a good way to make taxpayers at the state and local level more sensitive to whether their tax dollars are being spent wisely.

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Where conservatives go wrong, and where some of SALT’s liberal champions go wrong, too, is in believing that higher taxes will necessarily lead millionaires and billionaires in high-tax states, like New York and California, to move to low-tax states, such as Florida and Oklahoma. Cristobal Young, a sociologist at Stanford, has found that it is extremely rare for high-income households to uproot themselves in the face of tax hikes, in part because most of America’s rich are “embedded elites,” who feel a strong connection to the cities and towns where they made their fortunes. Wall Street hedge funders and Silicon Valley entrepreneurs already pay through the nose to live in high-tax states, and getting rid of SALT isn’t going to have a drastic effect.

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The egalitarian liberal case for ending SALT requires some explaining. The basic argument is that while high state and local taxes can finance redistribution at the state and local level, they by definition can’t finance programs that benefit poor people who live in other regions, including much poorer regions. State governments in poorer states could raise taxes to finance social programs, and they often do. But poorer states have less fiscal capacity than richer states. The same tax rates in both states will generate more revenue in the rich one than the poor one. To offer the same level of services, poor states have to impose highertaxes than rich states, which in turn might drive out affluent taxpayers, or prevent economic development from getting off the ground in the first place. And that’s why there’s a strong case for making redistribution the responsibility of the federalgovernment, which can tax rich people and finance social programs in rich and poor regions alike.

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The logical corollary of ending SALT would be to move toward federalizing social programs aimed at bettering the lives of the poor, such as Medicaid. In a similar vein, Congress could greatly expand the child credit and make it fully refundable, as the Democratic Sens. Michael Bennet and Sherrod Brown have recently proposed. One consequence of their proposal is that the federal government would provide an income floor for poor families with children, regardless of whether they live in rich states or poor states. Poor kids living in states with low levels of fiscal capacity would be the biggest beneficiaries by far. But taxpayers in poor states would benefit, too, as they’d be able to share more of the burden of ensuring that local kids have a healthier start in life with taxpayers in rich states.

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Wouldn’t federalizing these social programs undermine the role of the states as laboratories of democracy? Not in the slightest. If anything, it would make American federalism more coherent, as the federal government would focus on what it does best—cutting checks, as it’s successfully done with Social Security for many decades—while leaving infrastructure and education largely in the hands of state and local governments. We could still see innovation at the state and local level. We’d ensure that poor people don’t get shortchanged just because they have the misfortune of living in a poor state. That’s something Republicans and Democrats should be able to get behind.

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• Tax Reform
• Taxes

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