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The Tax Cuts and Jobs Act (P.L. 115-97) (TCJA) represents the most significant overhaul of the tax system in decades. One of the most contested provisions during the bill’s drafting was the proposed repeal of the itemized deduction for state and local income, sales, and property taxes (SALT deduction). The authors report the latest status of the SALT deduction, present the common arguments for and against repeal, and provide a brief overview of the SALT deduction’s impact during the last major tax reform debate in 1986.

When Congress released its framework for tax reform in the fall of 2017, it only allowed itemized deductions for interest paid on home mortgages and charitable contributions, suggesting a repeal of the SALT deduction. A repeal of the SALT deduction would increase federal revenue by an estimated $1.3 trillion over a 10-year period, affecting approximately 24% of taxpayers nationwide (Frank Sammartino and Kim Rueben, Revisiting the State and Local Tax Deduction, Tax Policy Center: Urban Institute and Brookings Institution, Mar. 31, 2016, http://tpc.io/2kj1zKq). On December 15, 2017, Congress released its conference agreement bill, the Tax Cut and Jobs Act (H.R. 1) (TCJA), which did not repeal the SALT deduction entirely, but instead limited the deduction to $10,000 for state and local income, sales, and property taxes paid, applying to tax years beginning after December 31, 2017, and scheduled to sunset after December 31, 2025 (Wilson Andrews and Alicia Parlapiano, “How the Final Tax Bill Will Affect Families, Homeowners, Businesses and More,” New York Times, Dec. 14, 2017, http://nyti.ms/2yYXAXY). In addition, the bill increases the standard deduction to $12,000 for unmarried tax filers and $24,000 for joint filers, meaning taxpayers will require itemized deductions exceeding these levels in order to realize any benefits from the SALT deduction. Filers who reside in states that have an income tax and do not own a home will most likely not be able to take the SALT deduction under the bill due to the increase in the standard deduction. The TCJA was signed by President Trump on December 22, 2017, and will take effect for tax years after December 31, 2017 and before January 1, 2026.

The states impacted most severely by the $10,000 cap on the SALT deduction are California, New York, New Jersey, Illinois, Massachusetts, Connecticut, and the District of Columbia (Greg David, “As Trump Talks Taxes, It’s Time To Zero in on Deductibility,” Crain’s New York Business, Feb. 28, 2017, http://bit.ly/2CEVEpX). These states have taxpayers with significant amounts of taxes beyond the $10,000 cap, which cannot be deducted. States with no income taxes, such as Texas and Florida, will be less affected, since taxpayers can elect to deduct the sales tax they paid during the year in lieu of state and local income taxes. The conference bill also does not repeal the individual alternative minimum tax (AMT), instead moving the phaseout threshold up to $500,000 for single filers and $1,000,000 for joint filers (http://nyti.ms/2oNdh4v).

The tax code was last overhauled more than 30 years ago, when President Ronald Reagan signed the Tax Reform Act of 1986 (P.L. 99-514) (TRA ’86). One of the more controversial issues debated in that process was the possible repeal of the SALT deduction. This article examines the practical implications and limitations of the SALT deduction, briefly explores the previous attempt to repeal the deduction as context to the existing debate, and examines the potential impact the $10,000 limitation in the TCJA could have on taxpayers that utilize the SALT deduction.

Prior Law

Prior to the TCJA, the Internal Revenue Code (IRC) section 164 provided taxpayers with an itemized SALT deduction [IRC section 164 (a)(1), (2), and (3)], subject to the AMT. In addition, taxpayers may elect to deduct state and local general salestaxes in lieu of deducting state and local income taxes [IRC section 164(b)(5)(A)]. The sales tax deduction, which had been repealed in the TRA ’86, was temporarily reinstated in 2004 with varying expiration dates; Congress made sales tax deductibility permanent beginning after December 31, 2014, in the Protecting Americans from Tax Hikes Act of 2015 (P.L. 114-113).

Exhibit 1, taken from the most recent data from the IRS, details the number of taxpayers that claimed the SALT deduction and the cost of the benefit of the deduction in the 2015 tax year. The states with the largest SALT deductions claimed are listed.

Exhibit 1

State and Local Tax Deduction 2015, States with Major Impact

[State; Number of Returns (millions); Percent of Returns with Deduction; Amount of Deduction (dollars in billions); Average Dollar Amount Claimed; Percent of Amount Claimed; United States; 44.3; 100.0; $552.7; $12,471; 100.0% California; 6.1; 13.8; $112.6; $18,438; 20.4% New York; 3.3; 7.5; $73.6; $22,169; 13.3% New Jersey; 1.8; 4.1; $32.2; $17,850; 5.8% Illinois; 1.9; 4.3; $24.1; $12,524; 4.4% Massachusetts; 1.3; 2.8; $19.5; $15,572; 3.5% Connecticut; 0.7; 1.6; $14.3; $19,665; 2.6% District of Columbia; 0.1; 0.3; $2.3; $16,443; 0.4% Source: IRS, Statistics of Income Division, Historical Table 2, September 2017]

California, New York, New Jersey, and Illinois were the largest beneficiaries of the SALT deduction, with California residents representing more than one-fifth of the total SALT deductions claimed.




















































The aggregate cost of the SALT deduction in the United States was approximately $553 billion in 2015, benefiting approximately 44 million tax filers. It should be noted, however, that a significant number of filers who claim a SALT deduction were also impacted by the AMT, which requires that certain deductions, including the SALT deduction, be added back when calculating a taxpayer’s alternative minimum taxable income. There is no way to determine exactly how many of the 44 million filers who claimed a SALT deduction were affected by the AMT, or the extent of the dollar impact. Moreover, many of these taxpayers may have also been affected by the itemized deduction limitation (IRC section 68), which reduces or even eliminates the overall benefit of the SALT deduction. Note that the TCJA repeals the itemized deduction limitation.

Exhibit 2 breaks down the SALT deduction by type of tax for the same states for 2015, showing the dollar amount as well as the number of claimants. California claimed approximately $80 billion in income tax deductions in 2015, affecting nearly 5 million tax filers, while New York claimed approximately $20.2 billion in real estate tax deductions by 2.4 million filers.

Exhibit 2

SALT Deduction 2015 (Dollars in Billions)

[U.S.; CA; NY; NJ; IL; MA; CT; DC S&L Income Taxes (number); 32.9; 5.0; 2.8; 1.5; 1.6; 1.2; 0.7; 0.0013 S&L Income Taxes (dollar); $334.3; $79.9; $47.3; $16.8; $11.6; $12.0; $8.8; $1.8000 S&L General Sales Taxes (number); 9.5; 1.0; 0.4; 0.3; 0.3; 0.1; 0.1; 0.0004 S&L General Sales Taxes (dollar); $16.7; $1.5; $0.5; $0.2; $0.4; $0.0; $0.0; $0.0004 Real Estate Taxes (number); 37.5; 4.8; 2.4; 1.6; 1.7; 1.1; 0.7; 0.1370 Source: IRS, SOI Tax Stats, Historic Table 2 (2015)]

In examining the number of taxpayers claiming the SALT deduction in 2015, approximately $334 billion, or nearly 60% of the SALT deduction claimed, was for state and local income taxes by 33 million tax filers. The SALT deduction for real estate taxes was the next largest at $187 billion, benefiting approximately 37 million tax filers, the largest number of SALT beneficiaries. General sales taxes totaled approximately $16 billion, affecting over 9 million tax filers. California, New York, New Jersey, and Illinois were the largest beneficiaries of the SALT deduction, with California residents representing more than one-fifth of the total SALT deductions claimed.

Arguments for Retaining the SALT Deduction

James A. Maxwell, in Tax Credits & Intergovernmental Fiscal Relations (Brookings Institution, 1962), provides a historical rationale for a federal deduction for state and local income taxes, based on two grounds. First, deductibility of state and local income taxes may be regarded as a refinement of gross income in order to reach taxable income. Maxwell argued that the economic status of a person for purposes of the federal income tax should be measured after a deduction of state and local taxes, referring to such taxes as “unavoidable” personal expenses. Second, deductibility may be regarded as a means of assisting “in the financing of activities in the public interest”; it is an indirect way of subsidizing state and local governments in raising revenue for governmental purposes for those local expenditures that the federal government does not pay for (e.g., police, fire, sanitation). The Urban-Brookings Tax Policy Center, in the state and local taxes section of its online Briefing Book, argues that the portion of a taxpayer’s income offset by the SALT deduction is “not really disposable income, and that taxing it at the federal level is double taxation” (http://tpc.io/2knskxx).

Another argument for retaining the SALT deduction is the “sub-government” payment concept, whereby taxpayers receiving state government services paid for with taxes that are deductible are in effect receiving such services at a discount. By repealing the SALT deduction, taxpayers would have to pay for such services at an “after-tax cost,” which could constrain state governments’ ability to raise revenues (David Brunori, State Tax Policy: A Primer, Rowman and Littlefield, 2016). Sammartino and Rueben argue that funds expended by states that have “spillover” benefits and affect residents of other jurisdictions can be a rationale for maintaining the SALT deduction; however, they also contend that if the spending benefits solely the residents of such states, the SALT should not be deductible.

The SALT deduction is not a pure deduction. As discussed above, prior to the TCJA, many taxpayers lost a portion of the deduction through the application of the AMT, as well as the itemized deduction limitation, but many taxpayers still realized a net benefit afterward. This should be factored into any serious discussion about the real net cost of the SALT deduction.

The most compelling argument for retaining the deduction is that the majority of the states that benefit from the SALT deduction contribute significantly more tax revenue to the federal treasury than they receive back (directly and indirectly) from the federal government. Exhibit 3 compares the revenues received by the largest states affected by a SALT limitation to the federal spending for such states for fiscal year 2014. California, for example, contributed approximately $13 billion more in federal taxes than it received in appropriations; New York had excess contributions of approximately $48 billion, while New Jersey provided $51 billion in excess contributions. The only area without excess contributions is the District of Columbia, whose major industry is the federal government. With the $10,000 annual limit on the SALT deduction, these excess contributions will be significantly greater. Thus, maintaining the SALT deduction without the cap allowed for some fiscal parity within the United States.

Exhibit 3

Federal Revenue per State vs. Federal Spending, Fiscal Year 2014

[Revenue Ranking; 2014 Federal Revenue per State (in thousands); Percent of Revenue; Spending Ranking; 2014 Federal Spending per State (in thousands); Percent of Spending; Excess Contributions; U.S.; $3,064,301,358; 100%; N/A; $3,252,754,000; 100%; N/A CA; 1; $369,193,162; 12.0%; 1; 355,810,000; 10.9%; $13,383,162 NY; 2; $250,618,177; 8.2%; 4; 201,978,000; 6.2%; $48,640,177 NJ; 6; $134,869,876; 4.4%; 13; 83,281,000; 2.6%; $51,588,876 IL; 5; $148,332,148; 4.8%; 7; 110,386,000; 3.4%; $37,946,148 MA; 9; $100,160,858; 3.3%; 15; 74,994,000; 2.3%; $25,166,858 CT; 19; $57,697,380; 1.9%; 28; 43,947,000; 1.4%; $13,750,380 DC; 30; $26,432,733; 0.9%; 24; 48,916,000; 1.5%; ($22,483,267) Sources: Federal Revenues, IRS Data Book, Table 5 Federal Spending, Pew Research Charitable Trust Analysis from U.S. Department of Commerce's Bureau of Economic Analysis]

Deductibility may be regarded as a means of assisting “in the financing of activities in the public interest”; it is an indirect way of subsidizing state and local governments in raising revenue for governmental purposes for those local expenditures that the federal government does not pay for (e.g., police, fire, sanitation).

Arguments for Repeal of the SALT Deduction

A major argument for repeal of the SALT deduction is that it forces “lowtax” states to subsidize “high-tax” states (Rachel Greszler and Kevin Dayaratna, “Time to End the Federal Subsidy for High-Tax States,” Heritage Foundation, Mar. 26, 2015, http://bit.ly/2kLSI3e). Jared Walczak, Scott Drenkard, and Joseph Henchman, in the Tax Foundation’s 2017 State Business Tax Climate Index (http://bit.ly/2Bz5Z7y), classify the “worst” and “best” states to reside in with respect to the cost of taxes. The index examines income, sales, property, excise, and business taxes, as well as state unemployment insurance. The “best” states listed in the study are those with lower taxes, including Wyoming, South Dakota, Alaska, Florida, Nevada, and others (note that the first four states listed do not have an income tax). The “worst” states are notably high-tax states, including New Jersey, New York, California, Vermont, Minnesota, Ohio, and others (each of these states has a high income tax). Greszler and Dayaratna argue that states with no income tax, such as Wyoming and South Dakota, indirectly subsidize other states, including New Jersey and New York. Exhibit 3 above demonstrates, however, that New Jersey and New York, for example, contribute significantly more in tax revenues than they receive in appropriations, challenging this argument.

The second argument is that the SALT deduction, prior to the TCJA, benefits higher-income tax filers who itemize deductions rather than lower-income filers who do not. In that regard, Greszler and Dayaratna also argue that “more than 70% of all taxpayers receive no benefit from the state and local tax deduction.” Specifically, only 16% of taxpayers earning less than $30,000 are eligible to itemize deductions, while more than 95% of tax filers earning $200,000 or more itemize. It must be noted, however, that the Greszler and Dayaratna study makes no mention of how the benefits of the SALT deduction were often limited by the application of the AMT or the itemized deduction limitation (pre-TCJA). The New York Times did an analysis of those most affected by the repeal of the SALT deduction, highlighting average amounts in specific counties: San Francisco County, Calif., $88,925; New York County, N.Y., $159,395; Westchester County, N.Y., $88,152 (Alicia Parlapiano and K.K. Rebecca Lai, “Among the Tax Bill’s Biggest Losers: High-Income, Blue State Taxpayers,” Dec. 5, 2017, http://nyti.ms/2klaxqC). In addition, taxpayers earning more than $200,000 realize a disproportionate amount of the SALT deduction nationwide, 94% of the share of the deduction in the tax bracket; these results are consistent with the Greszler and Dayaratna study.

The most compelling argument for retaining the deduction is that the majority of the states that benefit from the SALT deduction contribute significantly more tax revenue to the federal treasury than they receive back (directly and indirectly) from the federal government.

TRA ’86 and the SALT Deduction

The last major overhaul of the U.S. tax code was TRA ’86, which was formally drafted and extensively debated during 1984–1986. It was considered one of the most difficult pieces of legislation ever enacted and serves as a case study for the recent tax reform debate. In 1986, the SALT deduction was one of the largest tax expenditures that many lawmakers sought to repeal; many of the arguments for and against repeal are relevant today. The genesis of the idea to reform the Tax Code originated in the 1981 Economic Recovery Tax Act (ERTA) (P.L. 97-34) debate when Office of Management and Budget (OMB) Director David Stockman suggested to President Ronald Reagan that trimming deductions, which he famously called “equity ornaments” (“The Education of David Stockman,” Atlantic Monthly, December 1981, http://www.theatlantic.com/politics/budget/stockman.htm), would produce savings that could be offset against rising budget deficits at that time.

During 1984, a group of tax experts and economists within the U.S. Treasury Department studied the existing tax system and began formulating a blueprint to reform the tax code. Sheldon Pollack writes in The Failure of U.S. Tax Policy: Revenue and Politics (The Pennsylvania State University Press, 1996) that the Treasury’s undertaking was to critically examine the feasibility of tax reform and provide proposals to simplify existing tax rules. The proposals, known as “Treasury I,” intended to simplify the tax code and provided a revenue-neutral set of proposals that included some drastic measures for individual tax filers, among them the elimination of the SALT deduction (W. Elliot Brownlee, Federal Taxation in America: A Short History, Woodrow Wilson Center Press and Cambridge University Press, 1996). The “most extreme” part of Treasury I was the elimination of the SALT deduction, which was deemed collectively as “the most generous tax break for millions of Americans” (Timothy J. Conlan, Margaret T. Wrightson, and David R. Beam, Taxing Choices: The Politics of Tax Reform, Congressional Quarterly Press, 1990). The rationale for the repeal, per Conlan et al., was that “the state and local deduction was simply too big to ignore,” costing the federal treasury nearly $31 billion in revenue in 1985, and that it was “‘inefficient’ and ‘unfair,’ disproportionately benefiting wealthy individuals and communities.”

In May 1985, President Reagan was presented a revised tax reform report (Treasury II), which also included the elimination of the SALT deduction. Treasury Secretary James A. Baker understood repealing the SALT deduction would “cause a tremendous uproar,” but strongly believed that the repeal would provide the lion’s share of tax expenditure offsets necessary to significantly lower income tax rates overall (Jeffrey Birnbaum and Alan Murray, Showdown at the Gucci Gulch: Lawmakers, Lobbyists, and the Unlikely Triumph of Tax Reform, Vintage Books, 1987). In addition, “a political calculation also lurked behind the repeal of the state and local deduction. The deduction mostly benefited residents of high-tax states like New York and did far less for residents of states with lower taxes.”

New York Governor Mario Cuomo (D-NY) and New York City Mayor Edward Koch (D-NY) argued in the press that New Yorkers would suffer from the elimination of the SALT deduction. Cuomo claimed that repeal would cause New Yorkers’ federal taxes to unfairly rise and that repealing the SALT deduction would cause “great demand to cut those local taxes” for a state that had some of the largest number of poor and vulnerable citizens, including the elderly (Maurice Carroll, “Big Service Cuts Feared in Albany,” New York Times, May 30, 1985, http://nyti.ms/2CDsUO0).

The legislation began in the Democratic-controlled House of Representatives during the summer of 1985, where the bill was crafted behind closed doors to avoid pressure from the press and lobbyists. The Ways and Means Committee Chairman, Dan Rostenkowski (D-IL), used his political power throughout the process to prevent the repeal of the SALT deduction. In November 1985, prior to moving the bill to a floor vote, Rostenkowski secured an agreement with House Speaker Tip O’Neill (D-MA) that there would be no vote on the draft bill if the SALT deduction was repealed. The bill also contained provisions that favored low- and middle-income Americans, closed many controversial tax loopholes, but also created new ones. The tax reform bill was approved by the Ways and Means Committee on December 3, 1985 by 28 votes to 8; two weeks later, the House passed the bill by a margin of 256 to 171.

While the House bill had survived a difficult political calculus, the Senate bill nearly went down in defeat. Senator Bob Packwood (R-OR), Chairman of the Senate Finance Committee, was reluctant to take up the bill partly due to his (and other members of the Finance Committee’s) receipt of political contributions prior to the 1986 midterm election.

Ultimately, a compromise was reached to repeal the SALT deduction for sales taxes while retaining it for income and property taxes. Birnbaum and Murray reported that Senator Daniel Patrick Moynihan (D-NY) was willing to let the SALT deduction for sales tax go in order to preserve the deduction for income and property taxes, which provided a greater benefit to New York residents. In addition, the sales tax deduction was perceived as providing a tax benefit for the consumption of consumer goods (Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, JCS-10-87, May 4, 1987, http://bit.ly/2kn1g15).

After the Finance Committee and the full Senate passed the measure, the conference committee brought Chairmen Rostenkowski and Packwood together to negotiate the final bill behind closed doors, reporting the final bill in August 1986. President Reagan strongly pushed Senators for their support on the bill, and the House passed it in a wide bipartisan effort (292 to 136), followed by the Senate vote in September, which passed by 74 to 23. President Reagan signed TRA ’86 into law on October 22, 1986.

Will the Past Be Prologue?

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