The drama over the attempts to raise the state and local tax deduction above the $10,000 limit included in the Tax Cuts and Jobs Act has become more of a soap opera recently. The rehashed story line has gotten stale, but the furor over the limit has an irresistible political attraction that ensures its longevity.
Congress’s current “will they or won’t they?” saga is the result of the line drawn by Democrats in states and districts where the $10,000 limit fell most heavily.
Some congressional Democrats have insisted on a SALT deduction change as a requirement for a reconciliation bill deal. The limit affected taxpayers in Republican-held areas, too, but not in such a concentrated way.
Full repeal is expensive, and the benefits of even partial repeal go largely to higher-income taxpayers, which makes it hard to square with the messaging around raising their taxes. The House’s compromise in the Build Back Better Act (H.R. 5376) was to increase the cap from $10,000 to $72,500 until 2031.
On November 3 Senate Budget Committee Chair Bernie Sanders, I-Vt., and Senate Finance Committee member Robert Menendez, D-N.J., introduced a scaled-back proposal. They suggested repealing the cap for families making $400,000 or less, but leaving the $10,000 limit in place for everyone above that income threshold.
The TCJA used the $400,000 level in other code sections as a line above which taxpayers are deemed too rich for some benefits. It has never been a great threshold for tax policy purposes.
The top quintile of household incomes starts north of $230,000; $400,000 is the average of the top 5% of household incomes. Here is a good place for a reminder that the median household income in America is under $70,000 (and unsurprisingly, it dropped in 2020). Sanders said his proposal would be deficit neutral over 10 years.
New York v. Yellen
New York and three other states tried and failed to convince the Second Circuit that the SALT deduction limit in the TCJA was unconstitutional in New York v. Yellen, No. 19-3962 (2d Cir. 2021).
That’s as it should be — deductions are unequivocally matters of legislative grace. If taxpayers think Congress is too restrictive on tax deductions, the appropriate place to seek recourse is not the courts, but the ballot box.
Federal court also isn’t the place to make arguments in the court of public opinion, but that’s effectively what the attorneys general of New York, Connecticut, New Jersey, and Maryland attempted. Litigation isn’t free. The states’ taxpayers paid to litigate a case that the states almost certainly wouldn’t win.
The states asserted that Congress can’t limit the SALT deduction because to do so violates the 16th Amendment. The Second Circuit appropriately told the states that this argument didn’t hold water, because the taxing power is extremely broad.
The mere longevity of a deduction in the tax code doesn’t mean it’s constitutionally sacrosanct. It would have been highly problematic if the states had prevailed on the line of reasoning that Congress can’t limit or take away a tax benefit such as the SALT deduction once it’s in place.
The argument that the TCJA’s limit unconstitutionally coerces the states to abandon their preferred fiscal policies was likewise found to be fallacious.
The states claimed that the cap violated the 10th Amendment because Congress was attempting to coerce them into lowering their tax rates, and that it violated the constitutional principle of equal sovereignty among the states because it disproportionately affected high-tax states.
The sovereignty claim was based on faulty reasoning that conflated the interests of politicians, for whom it’s beneficial to have the federal government continue to subsidize state spending at the same level as before the TCJA, with the actual sovereign interests of the states.
The interests of a state’s high-income taxpayers are also not the same as those of the state in every respect. Regardless of the SALT deduction amount, the states were always going to collect exactly the same amount of tax revenue as they did before the TCJA because their tax rates would be wherever state lawmakers set them; the only difference the limit makes is that individual taxpayers receive less of a federal tax benefit than they would without it.
The steady drumbeat to repeal the TCJA’s limit on the SALT deduction and give a year-end gift to mostly high-income taxpayers may finally come to an end if Congress passes the reconciliation bill with some sort of repeal included.
The lesson of the past four years, and especially the past few months, is that if building back better doesn’t involve some more generous version of the SALT deduction, the story will go on and on and on.