The limit on the SALT deduction is a major game changer for local government and will lead taxpayers to demand lower taxes or at best to reject any additional funding requests for state pensions, schools, public safety and health services.
The SALT deduction allows households to deduct state and local taxes on their federal returns. A plan to remove the deductibility would disproportionately harm individuals who live in states with a high overall state tax burden, such as Illinois. This is because removing deductibility raises the federal income tax burden by the value of the tax bill due to the state.
In some of Illinois’ counties, the average SALT deduction per tax return is over $5,000 per year in some Illinois counties according to the Tax Foundation. But that benefit could vanish if Trump’s tax reform plan comes to pass, costing Illinois households thousands.
An increase in the overall tax burden faced by Illinoisans would have a disastrous impact on Illinois’ economy. This is because an increase in the tax burden further constrains households and businesses, thus discouraging economic activity. In addition, a higher tax burden raises the benefits to be gained from moving toward states with lower tax rates.
Illinois is already experiencing capital flight. According to Internal Revenue Service data, Illinois is already losing higher-earning residents to out-migration. A consequence of these outflows of labor and capital is state tax revenues suffer as the tax base shrinks. This exodus has had disastrous effects on the state’s budget. Eliminating the SALT deduction would only make this trend worse – as the full effect of Illinois’ high state and local taxes is truly felt.
But if state lawmakers pre-empt the possible elimination of the SALT deduction with tax cuts that improve Illinois’ competitiveness relative to other states, the president’s plan can trigger large inflows of capital to Illinois that would grow the state’s economy.
Competitive tax cuts grow the tax base, raising additional public funds without further harm to the average household. As a result, government programs that help the less fortunate can be better funded in a more competitive low-tax regime.
Fiscal solvency is a symptom of tax competitiveness while insolvency – as in Illinois’ current fiscal state – indicates a lack thereof. The bulk of evidence suggests tax hikes shrink the tax base while tax cuts grow the tax base and improve economic conditions for everyone.
It’s a tax provision that could prove costly for schools, police departments, drug treatment centers, and other state and local public services.
The sweeping tax overhaul imposes a $10,000 limit on the combined sum of property and state and local income taxes that a household could deduct. And that’s even if taxpayers would have an incentive to itemize anymore. The $10,000 cap will help pay for corporate and personal tax cuts totaling $1.5 trillion over the next decade.
Conservatives have argued that unlimited state and local deductions amount to a federal subsidy for the wealthy in high-tax states like New York, New Jersey, California and Illinois with their prosperous suburbs. But many middle-class families in those states face disproportionately high housing costs and depend on deducting their state and local taxes. These households could soon pressure states and localities to ease their burden by cutting taxes –which would likely force cuts to social programs and public services.
What’s more, pursuant to a separate provision in the tax bill now the federal tax law will no longer subsidize employers that help their employees pay their commuter costs. This change will likely increase the cost of public transit for riders.
Some Republicans in high-tax states resisted their party’s cap on local and state deductions. Two of them — Reps. Darrell Issa of California and Lee Zeldin of New York — opposed the overall tax measure because of the likelihood that it would hurt their constituents. And despite Republican arguments to the contrary, high-tax states already tend to send more money to Washington than they receive back in federal spending.
“On balance, this bill remains a geographic redistribution of wealth — taking extra money from a place like New York to pay for deeper tax cuts elsewhere,” Zeldin said. “This bill chooses winners and losers in a way that could have and should have been avoided.”
More than 73 percent of homeowners in Westchester County just north of New York City face property taxes alone that exceed $10,000. This means they couldn’t deduct any state or local income taxes. The same is true of half of Manhattan homeowners, a quarter of those in San Francisco, 17 percent of suburban Chicago homeowners, and 10 percent of those in Arlington, Virginia, just outside Washington, D.C., according to figures tracked by Attom Data Solutions.
The limit on the deduction could lead taxpayers there to demand lower taxes or to reject any additional funding requests for state pensions, schools, public safety and health services.
The overall tax bill would impose new costs on many taxpayers that would outweigh any savings on federal taxes, argues Matthew Chase, executive director of the National Association of Counties.
“We don’t see it as a net gain for taxpayers,” Chase said. “They want to strangle our revenue sources.”
The National Education Association, a teachers union, estimated that the cap on state and local deductions could put at risk $15.2 billion in annual public school spending, or $304 per pupil. Marc Egan, the association’s director of government relations, said the change could discourage local governments from investing in education and might eventually depress economic growth.
“We’re always making the case that investing in education is a common-sense way to grow the economy,” Egan said. “Why Congress continues to resist that on a number of fronts is a mystery.”
Even as Republicans in Congress decided to cap the state and local tax deduction for households at $10,000, their tax bill will continue to allow corporations to deduct their state and local taxes as a business cost.
Since the federal income tax code was introduced in 1913, Americans have been allowed to exclude the taxes they pay to state and local governments. Roughly a third of taxpayers have enough expenses to itemize their deductions. And nearly all who do so deduct their state, local and property taxes. These deductions have helped make it affordable for cities and states to fund school systems, health care services and police forces, while making it more acceptable for a community’s richest households to pay taxes that can help the poorest.
The tax bill nearly doubles — to $24,000 — a family’s standard deduction, which goes to taxpayers who don’t itemize their deductions. So there would automatically be fewer people who would deduct their state and local taxes.
But in addition, many households in high-tax states can no longer itemize their deductions because of the new cap on state and local taxes. This could reduce the perceived value of these taxes and incentivize voters to push for lower state and local taxes — a stated goal of some conservatives.
Gov. Bill Haslam has said he thinks the tax overhaul could encourage more people to move from high-tax states to his state of Tennessee, which charges no state income tax.
“We think it actually will encourage both investment growth and population growth in Tennessee,” Haslam said.
High-tax states are already considering adjustments to their policies. Steve Sweeney, president of the New Jersey Senate, has warned that the bill could derail his state’s planned tax increase on millionaires. That idea, estimated to generate about $600 million in revenue, is a central pledge of Democratic Gov.-elect Phil Murphy’s agenda to help raise pension payments and school funding. Murphy has said he is still committed to the tax hike on wealthy earners. But if lawmakers now balk, its prospects become more problematic.
California lawmakers are considering ways to restructure the state’s tax code to limit the impact on its taxpayers, said Assemblyman Phil Ting, a San Francisco Democrat. Speculation has centered on reducing income taxes and raising payroll taxes — in effect, shifting some of the state tax burden from workers to employers.
“We’re looking at a variety of alternatives,” Ting said.
Allowing up to $10,000 of state and local taxes to continue to be deducted, he said, “takes it from horrible to slightly less horrible.”
Illinois lawmakers concerned about fiscal solvency are at a crossroads. They can adopt competitive tax policies that will curb capital flight, eventually reversing a negative trend at the expense of other high-tax states, or they can do nothing.
If lawmakers do nothing, the elimination of the SALT deduction, if implemented, will result in further erosion of Illinois’ tax base.
I think the best way for Illinois to respond is to enact a graduated income tax.
Also known as a progressive tax, it’s a principal embraced by 33 states that charge wealthier individuals a higher income tax rate.
Illinois is one of just eight states that has a flat income tax. Nine other states do not levy a state income tax.
Politically speaking, Illinois is about as blue as it gets, with dominant Democratic majorities in both houses of the state legislature. There’s a good chance a Democrat will be elected governor in 2018.
Now is the time for Illinois Democrats to flex their political muscle and push for a graduated income tax. It’s a perfect response to the nastiness of the tax plan being pushed by the GOP-controlled Congress and a way for the state to help middle- and low-income families by making wealthier individuals pay more.
As recently as 2016 with House Bill 689, the legislature considered a measure to amend the state Constitution to allow for a graduated income tax. The proposal would have cut taxes for 99 percent of state residents, raised them on the top 1 percent and generated nearly $2 billion annually in additional revenue.
Amid the turmoil of the state’s budget impasse it wasn’t politically feasible to pass the legislation then, but the GOP tax plan is a game-changer. It’s time for Illinois to seriously pursue a graduated income tax structure.
The limit on the deduction is a major game changer for local government and will lead taxpayers to demand lower taxes or to reject any additional funding requests for state pensions, schools, public safety and health services.