Tax policy should be Fair, Reasonable and Non-Discriminatory (FRAND). Tax policy should be rational and permitted by our Constitution. The current federal cap on State and Local Tax (SALT) deductions for income taxes does not meet those minimum requirements.
In evaluating policies, it is often important to examine their effects at the extremes, thus we should recognize that if SALT and federal marginal tax rates were each at 50%, or otherwise summed to 100%, and there were neither a Federal SALT deduction nor a state deduction for federal taxes (as now allowed by six states), then a taxpayer would be required to pay a marginal tax rate of 100%. In the absence of deductions, a combined top marginal tax of 100% sets a fixed cap on income. Clearly, such a cap would be neither fair nor reasonable. No matter how high taxes may be, at least some after-tax income must remain as receipts grow, even if that residual is small.
A tax that takes all income over some cap could result in a homeless man winning the Megabucks lottery and seeing the bulk of his winnings go to taxes — and taxes on taxes. If the sum of the SALT and federal marginal rates were higher than 100%, then that “lucky” homeless man might even end up with either no disposable income at all or even an unpaid tax balance! (He would have been better off earning a much smaller jackpot!) Those who argue that such a situation is unimaginable, because marginal tax rates could never be “as high as 50%,” should remember that just a few decades ago, the top Federal marginal income tax was 94%, and it remained as high as 91% until well into the 1960’s. Today’s very low federal tax rates should be considered neither normal nor permanent.
Simple math and logic show that in order to avoid marginal income tax rates of 100% or more, we must ensure that income taxes paid to one jurisdiction can be deducted when paying income taxes to another jurisdiction. This is why taxes paid to foreign countries can be either deducted or taken as a tax credit. If we didn’t allow US citizens to deduct the often very high income taxes demanded by other countries, we’d find that few Americans could afford to live or work abroad. We might even see an increase in the number of ex-pats who give up their citizenship. The same principles that support the Foreign Tax Credit should be recognized within our own domestic borders.
Taxes aren’t income.
An income tax should be applied only to receipts that actually benefit a taxpayer. However, that portion of one’s gross receipts which must eventually be paid in taxes, whether or not withheld, is most properly thought of as the government’s money only held temporarily in trust by the taxpayer in order to make its computation and collection more convenient. Tax money may temporarily move through a taxpayer’s accounts, but it should not be considered to be part of the taxpayer’s income, rather, it is revenue of the taxing authority. To illustrate this point, consider a world in which we had only consumption taxes and all taxes were paid by the sources of income, not the recipients of income. In such a world, it would be clear that one’s actual income does not include taxes paid. Nonetheless, tax receipts of the government might be precisely the same as with the system of income taxation that we use today. (Of course, such a system of consumption taxes would only work with a flat tax, unless everyone knew everyone else’s income, but that is a detail we can ignore.)
If we accept that income taxes aren’t part of an individual’s income, then it should be clear that charging an income tax on that which is not income is inherently unfair and inequitable.
The SALT cap is discriminatory.
The SALT cap, while facially neutral, is actually quite discriminatory. Even though the U.S. Court of Appeals for the 2nd Circuit rejected “Blue States” objections to the SALT cap, its effect is to inequitably raise the tax burden on those who live in states with higher state and local taxes. Those states tend to be wealthier, with dense urban areas, and with Democratic majorities; they are the Blue States. Thus, it isn’t surprising that many have suggested that the real reason that Republicans have championed the SALT cap was their desire to shift more of the nation’s tax burden onto Democratic states in the hope that doing so would lead to a weakening of incumbent Democratic leadership and a strengthening of Republican support in the Red and Purple states. It was also the often stated goal of SALT cap advocates to coerce the Blue States into reducing their taxes and spending by making higher state and local taxes more burdensome; their goal was coerce Blue States into becoming more like Red States…
The eagerness with which Republicans increased the tax burden on the Blue State wealthy belied their often repeated vow to fight tax increases of any kind. What we learned was that they were insistent on holding the line on taxes that might be paid by Republicans, but they were quite happy to raise taxes if the burden fell more on Democrats. As we have come to expect, the Republicans demonstrated their willingness to put “Party before Country.”
The SALT cap may be unconstitutional.
Our Constitution states:
The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States; . . .Article I, Section 8, Clause 1
However, as shown above, the imposition of SALT caps means that the effective federal tax on what is actually income varies based on one’s home state. This is precisely the lack of uniformity that our Constitution wisely prohibits.
While the 16th Amendment allows the levying of taxes “without apportionment among the several States, and without regard to any census or enumeration,” it does not remove the requirement that taxes should be “uniform” and should not vary based only the state of residence.
The SALT deduction need not be a “gift” to the rich
There is no question that the more income you have, the more likely you are to benefit from deductions for taxes paid (as long as you pay your taxes. (Many of the very wealthy don’t.). Those with less income often find that the SALT deduction isn’t sufficient to justify itemization. Additionally, their tax burden often includes a higher portion of non-deductible taxes, such as sales and fuel consumption taxes. While the majority of those taking the SALT deduction are middle-class, it is undisputed that the very wealthy receive the largest SALT deductions and thus benefit the most from them. Thus, it is the very wealthy who would, if nothing else changes, benefit the most from removing the recently created cap on SALT deductions.
However, if the SALT deduction’s reduction of the effective top marginal tax rate is thought to reduce tax rates for the very wealthy below what is fair and reasonable (as I think it would), the obvious solution is to simply increase the top marginal tax rates.
The SALT cap is an attack on government
We shouldn’t be surprised that ex-President Trump supported the SALT tax, saying it would “create an incentive” for state politicians to “do a good job of running [their] state.” By this he meant lowering both taxes and spending and, in doing so, he stayed true to the Republican slogan that “Government is the problem, not a solution.” However, we are better advised to look to Lincoln for guidance on the proper role of a government “of, by, and for the people,” and not in opposition to the people. Lincoln said:
The legitimate object of government, is to do for a community of people, whatever they need to have done, but can not do, at all, or can not, so well do, for themselves in their separate, and individual capacities.Abraham Lincoln, Fragment on Government (July 1, 1854)
The reality is that those who live in Blue States, in large part because those states are more dense and urban than Red States, inevitably see more of their needs addressed through broadly shared resources which, of necessity, are provided by or managed by government. In a city like New York, no matter how independent and self-sufficient you may wish to be, you simply can’t escape the reality that a city like ours can not function well unless everyone in it works together and unless we have an effective, broadly-capable government to coordinate the provision of common infrastructural needs. While rural Republicans may dream of a supposed utopia populated by independent, self-sufficient, high-testosterone frontiersmen, for them to impose their fantasy on the rest of us is an attack on the very idea of the kind of government that makes possible our modern life in cities. They seek to increase the tax burden on Blue States as yet another means to Starve the Beast of effective government and force its enfeeblement. In this effort, they must be stopped.
Tax burden is not impacted by which jurisdiction provides the deduction
Whether it is the state or the federal government that allows the deduction doesn’t impact the total amount of tax paid, although it does impact the share of tax revenues enjoyed by each jurisdiction. In general, whichever jurisdiction offers the deduction ends up getting less tax revenue even though total tax revenue remains the same. (See box below.)
Tax burden is not impacted by which jurisdiction provides the deduction:
If you lived in New York City today and had $100 million in income taxed at the top marginal rate, you would be taxed 37% by the federal government and 14.8% by NYC and NYS. Without a deduction for either SALT or federal taxes, your combined top marginal tax rate would be 51.8%. (Of course, if you lived in one of the seven states with no income tax, it would only be 37%.)
However, if the Federal government allowed a 100% deduction for SALT, you’d pay $14.8 million in SALT ($100 * 14.8% = $14.8) and $31.524 million in federal taxes (($100- $14.8) * 37% = $31.524). Your combined tax bill on your top marginal income would be $46.324 million ($31.524 + $14 .8 = $46.324), giving you an effective top marginal tax rate of 46.324%. If, on the other hand, the federal government allowed no deduction for SALT, but New York allowed deducting federal taxes, you would pay $37 million in Federal taxes ($100 * 37% = $37) on your top income and only $9.324 million in SALT (($100 – $37) * 14.8% = $9.324). You would still pay a total of $46.324 million in taxes (($37 + $9.324 = $46.324) and still have an effective top rate of 46.324%.
While you pay the same total tax no matter which jurisdiction provides the deduction, if you get a federal deduction for SALT, you pay more SALT and less federal tax, and if you get a state deduction for federal taxes, you pay less SALT and more federal tax. Which jurisdiction provides the deduction only impacts the distribution of tax revenues, not their total.
Taxes should be Fair, Reasonable, and Non-Discriminatory.
Much of the debate concerning the SALT caps is focused on how much revenue will be gained or lost by their continuance, reduction, or elimination. However, our primary focus should be on designing a system of taxation which is fair, reasonable, non-discriminatory (FRAND), and constitutional. An income tax system with SALT caps cannot meet the minimum requirements for a system of taxation and should not be imposed.