As the 116th Congress gets settled in, Nancy Pelosi and fellow House Democrats are adjusting to their new reality of being back in the majority. With that comes an assessment of their policy priorities for the next two years. Among other initiatives, one of their targets appears to be the reinstatement of the state and local tax (SALT) deductions that were eliminated in the tax cuts package from 2017. A bill has already been introduced by Rep. Eliot Engel (D-N.Y.).
The SALT deductions are very simple. Taxpayers are given the option to deduct the amount of taxes they pay to state and local governments from their federal taxable income. This option was erased in the 2017 tax bill, and replaced with a doubling of the standard deduction.
Democrats aren’t the only ones getting on board with this effort. There is also a handful of Republican lawmakers who have been advocating for the SALT deduction, and Rep. Peter King (R-N.Y.) has introduced his own bill to reinstate it. Perhaps this makes sense. After all, Republicans and conservatives purport to stand for lower taxes and smaller government. More deductions would seem to allow taxpayers to keep more of their income while keeping it out of the federal government’s hands.
However, this is not what the SALT deduction means in reality. In fact, reinstating the SALT deduction would strike at the very heart of the Tenth Amendment, and the spirit of the free market. Conservatives have been saying for years that states need to be “laboratories of democracy.” If an individual or organization does not like the policies of one state, they can simply move to another to find the best fit, and states would alter their policies to meet demand. It is the free market at work in a governmental sense.
The SALT deduction undercuts this market. It gives tax and spend legislators at the state level a backstop. If they engage in wasteful spending that requires high taxation, the SALT deduction ensures they don’t have to worry about a blow back or exodus. Those extra taxes can merely be deducted from their federal taxes, consequences will be minimized, and lawmakers won’t be inspired to enact any reforms.
One could say the SALT deduction is essentially a bailout of tax and spend politics at the state level. Despite it being a way to allow more taxpayers to funnel fewer dollars to the federal government, it will have a diametrically opposite effect at the state and local level.
According to the San Francisco Business Times, 32 companies moved their headquarters out of the Bay Area to other cities such as Austin, Salt Lake City, and Atlanta. This is the Bay Area alone. California is ranked 29th by Forbes in its ranking of best states for businesses. This is despite California being ranked number one in terms of “economic climate.” Its statewide policies have dragged it down and, with the SALT backstop removed, it should expect to see more companies relocate to more fiscally responsible localities.
This is the very essence of the free market. If a product is not working well for a consumer, they will inevitably move on to a different brand, and the company will have to adjust to avoid losing more customers. If a product is too expensive, a consumer will simply buy a cheaper alternative. Any third entity coming in and saying they will offset the costs incurred on expensive or faulty products would be destroying any incentive to lower prices, or to create a more efficient product. It is the same with state governments. If state legislators want people and businesses to stay in their state, they need to create a better economic environment, instead of relying on the federal government.
Free market conservatives need to reject the arguments of faux purists who say that any tax deduction is a good one. Starving the federal government of excess money is, no doubt, a most noble goal. However, that is accomplished by doubling the standard deduction, which applies to all Americans, not just those in high tax states. American policymakers can limit federal revenue while also ensuring that states face the consequences of poor decisions at the state level. These are not mutually exclusive goals.
This particular tax deduction stands in the way of incentivizing lower taxes, smaller government, and deregulation in each of the fifty states. All fifty states may not choose to go that route, but, without the SALT deduction, they will have to pay dearly for that decision.
This is why numerous governors in high tax states have tried to implement workarounds to allow people in their states to continue receiving the SALT deduction, in spite of the change in federal law. Ironically, it would be far easier for these governors to ease the tax burden on their constituents by cutting spending in wasteful projects, and using those savings to lower their own taxes. Advocates of fiscal restraint and free marketeers should be the last people trying to help them in their efforts.