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For Democrats, SALT Deduction Makes for Tricky Politics

Posted on Nov. 8, 2021

Once again, the state and local tax deduction seems poised to embarrass Democrats, exposing a familiar conflict between the party’s principles and its politics.

Having promised for years to unravel the Trump tax cuts and raise taxes on the rich, Democrats have been hamstrung by their narrow majorities in both houses of Congress. Under pressure from moderates, party leaders have been forced to abandon most of the marquee items on their ambitious tax agenda, including long-sought progressive reforms to individual and corporate tax rates, capital gains, and the tax treatment of inherited wealth.

In place of these progressive reforms, Democrats have lately floated the possibility of a huge, regressive tax cut: a temporary repeal of the cap on SALT deductions.

As unveiled early last week, the SALT plan included a five-year suspension of the limit originally imposed by the Tax Cuts and Jobs Act. The suspension would be retroactive to 2021 and would run through 2025, after which the cap would return for the next five years. The net effect would score as a revenue increase over the 10-year budget window — assuming that the cap’s suspension wasn’t extended or made permanent at some point.

According to various estimates, the Democratic proposal would deliver a windfall to wealthy taxpayers in high-tax states. The Committee for a Responsible Federal Budget estimates that a five-year suspension of the cap would cost $475 billion, with $400 billion going to the top 5 percent of households. Or framed slightly differently: “Over two years, SALT cap repeal would distribute over $300,000 to a household in the top 0.1 percent of earners compared to only $40 for a family in the middle of the income spectrum.”

That is not a good look for the party of progressive tax reform. But it’s certainly a familiar one. Democrats have been defending the SALT deduction since the 1980s, when the Treasury Department made a strong case for dismantling it. As the department’s tax experts explained in their famous 1985 study on tax reform:

The current deduction for State and local taxes disproportionately benefits high-income taxpayers residing in high-tax States. The two-thirds of taxpayers who do not itemize deductions are not entitled to deduct State and local taxes, and even itemizing taxpayers receive relatively little benefit from the deduction unless they reside in high-tax States. Although the deduction for State and local taxes thus benefits a small minority of U.S. taxpayers, the cost of the deduction is borne by all taxpayers in the form of significantly higher marginal tax rates.

Predictably, such arguments failed to persuade lawmakers from high-tax states. And in the Reagan era, those lawmakers hailed from both parties, making the argument over SALT deductions less partisan and more sectional. Ultimately, the bipartisan coalition successfully shielded the SALT deduction from its high-minded antagonists at Treasury. (Prior analysis: Tax Notes, Oct. 9, 2017, p. 176.)

If you’re a Democrat looking to protect a rich person’s tax deduction, it’s helpful to have some Republicans on your side. But it gets tricky when the burden of defending a regressive tax break falls entirely on the shoulders of progressive tax champions. And that’s what started to happen after the Reagan episode.

Gradually, the SALT deduction has become a more exclusively Democratic priority. With the rise of political sorting, partisan diversity in state delegations has declined. You have to look a lot harder to find Republicans representing high-tax states these days. (Especially since the SALT cap was enacted!)

Progressivity’s Problems

Which brings us back to 2021 and the Democrats’ struggle to make good on their many promises to raise taxes on the rich. It’s proven to be a heavy lift, thanks chiefly to the intransigence of party moderates like Sens. Joe Manchin III of West Virginia and Kyrsten Sinema of Arizona. The task hasn’t been made any easier by the iffy politics of soaking the rich.

Polls are clear that Americans support higher taxes on wealthy individuals and corporations. But politicians know that this policy preference doesn’t translate reliably into ballot box success.

In a recent article for Politico magazine, sociologist Monica Prasad — one of the best analysts of American tax politics working today — makes an important point. Bill Clinton and Barack Obama both managed to engineer significant progressive tax reforms during their presidencies. But both suffered major midterm election defeats shortly afterward. “The midterm defeats were not caused by the tax increases, but increasing taxes on the rich didn’t help either Clinton or Obama,” Prasad writes. “Although polls always show majorities favorable to taxing the rich, people don’t seem to vote based on that issue.”

Occasionally, Americans have endorsed sweeping, progressive tax reform. But those moments have been rare, confined almost exclusively to wartime. “Other than global catastrophes with mass casualties, nothing seems to produce the desperation that leads to broad, bipartisan consensus on raising taxes on the rich,” Prasad writes. “Indeed, even a global catastrophe with mass casualties can’t always do it, as the pandemic has shown, because low interest rates have made it easier for the government to borrow instead.”

Prasad’s capsule history of American taxation helps explain why some Democrats might be wary of targeting the rich: Even when polls suggest that such tax hikes might prove popular, history suggests they might not.

History also explains why some of these Democrats might even go a step further, not simply resisting new taxes on the rich, but supporting a major tax cut for some of the nation’s most fortunate filers. In the 1980s, that bipartisan coalition of lawmakers from high-tax states saved the SALT deduction from hostile tax experts. In 2021 that coalition is now almost exclusively Democratic, but its members are no less determined to protect their constituents’ pocketbooks.

Arrayed against these pro-SALT deduction lawmakers are the same experts (or, more likely, their students and protégés), as well as almost all Republicans. The GOP seems to be taking special delight in watching the Democrats squirm. As Prasad points out, the issue is tailor-made for Republicans: “As political maneuvering it’s brilliant, because it forces Democrats into a position of deciding between their principles of taxing the rich and their political wishes to protect their constituents.”

Indeed, it does. The drive to restore the SALT deduction to its former glory (or infamy, take your pick) derives from the same political calculus that yielded President Biden’s pledge to avoid tax increases on anyone making less than $400,000 a year. Or, for that matter, similar pledges (at lower thresholds) offered by Hillary Clinton and Obama in years past.

Today, as always, Democrats are determined to insulate their own voters from the pain of prospective tax hikes. To be clear, Republicans do the same thing. All the time. And the effort, in both cases, is reasonable; politicians try to take care of the people who vote for them.

And history shows that — quite frequently — these politicians have also used taxes to punish people (or areas of the country) who don’t vote for them. The tariff was a sectional revenue device. It gave way to the income tax — another sectional levy. (Prior analysis: Tax Notes, Jan. 15, 2018, p. 293.)

Still, when protections for a party’s voters are drawn broadly, they can be hard to sustain — especially when they conflict so obviously with a party’s broader ideological stance and policy agenda. For the SALT deduction, it’s hard to defend someone making $400,000 a year as anything less than “rich.” For a party committed to raising taxes on the rich, how can such taxpayers be targeted for a major tax reduction?

More than a few elected Democrats are asking the same question.

“Beyond unacceptable” were the words that Sen. Bernie Sanders, I-Vt., chose to describe the SALT deduction plan when it first appeared in the media. “At a time of massive income and wealth inequality, the last thing we should be doing is giving more tax breaks to the very rich,” he declared. “Democrats campaigned and won on an agenda that demands that the very wealthy finally pay their fair share, not one that gives them more tax breaks.”

That’s certainly true. But it’s also true that (1) Democrats have been campaigning on that sort of agenda for a long time, and (2) they have been defending the SALT deduction for just as long.

The inconsistency is nothing if not consistent.

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