How will Democrats use their razor-thin hold on the Senate to reform taxes? There are many positive proposals that may now be on the table, including expanding child tax credits, tightening capital gains taxes, and truncating the value of tax deductions.
But one thing they should emphatically not do is lift the cap on the SALT (state and local tax) deduction. Lifting the $10,000 cap, introduced in the 2017 Tax Cuts and Jobs Act, would give huge benefits to the rich and affluent — but almost nothing to everyone else. The top 0.1 percent would receive an average tax cut of almost $145,000 while the average middle-class family would get less than $27. Lifting the SALT cap would in fact favor the rich and affluent more than the Republican tax law that Democrats denounced.
Unfortunately, both Senate Majority Leader Chuck Schumer and Speaker Nancy Pelosi say that lifting the cap is high on their fiscal to-do list. Last July, Sen. Schumer said: “I want to tell you this: If I become majority leader, one of the first things I will do is we will eliminate it forever….It will be dead, gone, and buried.”
Hopefully, Sen Schumer and Rep. Pelosi will change their mind on this. Lifting the SALT cap is bad economic policy; it is hard to find a single sensible economist who supports it. But of course, this is at least as much about politics as economics. Democrats representing affluent areas of expensive cities — including both Leaders — will feel under pressure to bring home some bacon to their most outspoken constituents. In fact, the residents of California and New York received a full third of the total benefits from the deduction before the new cap — more than the 40 states getting the least.
But at a national level, it is much less clear that the SALT deduction makes for good politics. Most of the key swing states, including Georgia, Pennsylvania, North Carolina, New Hampshire, and Arizona were below the national average in the value of the SALT deduction as a percent of adjusted gross income before the new cap. Florida and Nevada were in the bottom seven states.
Of course, states and local governments do need help from the Federal government. In fact, more help is need now than ever. The pandemic is hurting state and local government revenues, to the tune of around $350 billion over the next three years. Now is the time to enact a better federal support system for states and localities, and to replace the SALT deduction, rather than revert to the previous system.
The good news is that there are a number of good policy options available to legislators, many of which were outlined at a recent Brookings event on this subject, and any of which would be much fairer and more effective than lifting the SALT deduction cap. The key point is that Congress should help states directly, rather than through the long, roundabout route of a regressive tax break to individuals.
For example, Congress could redirect SALT money to establish the State Macroeconomic Insurance Fund (SMIF), as proposed by Tracy Gordon, Len Burman, and Nikhita Airi, our colleagues at the Tax Policy Center. The SMIF would essentially act as an automatic stabilizer, offering states payments tied to their economic conditions, according to a clear set of rules. This function is necessary because states are often constrained by balanced-budget requirements, hampering their response to economic downturns. The SMIF could also be constructed more like insurance with requirements for states to maintain rainy day funds or to contribute a certain percentage. A new federal policy to smooth state spending over economic downturns is desperately needed; and the SMIF is an innovative idea for achieving this goal.
Second, Congress could restructure the block grant funding of Temporary Assistance for Needy Families (TANF). Part of welfare reform in the 1990s, these block grants give states a set amount of money. However, over time, the real value of these funds has declined precipitously, as the funding formula does not include inflation adjustments. Further, there are massive inequities between states where richer states often end up with more funding on a per child basis.
As Josh McCabe has argued, the United States should here look to Canada as an example. Canada also block-grants social assistance, but in a way that is much more equitable. The formula is on a per capita basis and includes an automatic 3 percent increase every year. While the specifics can be debated, if the United States adopted a similar system, we would see a far more equitable and generous distribution of social assistance across states.
These two reforms: automatic stabilizers and restructuring TANF would support state spending on a cyclical and structural basis, resulting in more help during recessions and more transfers to the neediest families.
By adopting these types of reforms, we can help states without giving a tax cut to the rich and affluent. As McCabe points out, other federal systems around the world, including Canada, Germany, and Australia do not have an equivalent to the SALT deduction.
Rather than return to a, flawed, regressive tax policy, Democrat leaders should take the opportunity of their new-found Congressional power to renew federal support for state and local financing of public services.
President Biden has said he wants to heal the divides in our nation. He has said he wants to tackle the scourge of inequality. And he has echoed the Obama claim that there are not “red states” and “blue states”, but only the United States. It would not be good, then, to pass a $137 billion tax cut for the rich, which provides the most benefit to the states which voted Democrat.
Repealing the SALT cap is bad policy; it may also be bad politics. Importantly, there are much better alternatives available for supporting states and cities. Let’s hope the Dems look forward, not back.
Richard V. Reeves is a Senior Fellow and Christopher Pulliam a Research Analyst at The Brookings Institution.
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