There’s currently some discussion in Washington DC about repealing the limitation on the deductibility of state and local taxes (from one’s federal taxes.) Back in 2018, the US government began limiting SALT deductions on federal income taxes to no more than $10,000/taxpayer. Repeal of this provision would have effects on both economic efficiency and economic equity:
Efficiency:
Repeal would cause many more people to itemize their taxes, which would increase the time and money costs of preparing taxes. It would also drive a wedge between the local cost of state and local spending and the total cost. Thus 70% of the cost of a $1 billion government project in New York or California might be paid for by local taxpayers, while the other 30% would be paid for by taxpayers in all 50 states. This would push states toward projects that don’t pass cost/benefit analysis, but that might seem desirable if one ignores the external costs imposed on out-of-state residents. An example might be high-speed rail in California.
Equity:
Repeal of the SALT limitation would reduce taxes on upper income taxpayers. Because there is no free lunch, other taxpayers would have to pick up the slack. If we run large budget deficits, then future taxpayers would absorb the bill.
PS. Because I live in California, I would pay less in taxes if SALT limits were repealed. However, my taxes would become much more complicated in terms of required record keeping, so I doubt I’d be any happier. Don’t just think in terms of “who pays”; a successful country is one that avoids lots of needless deadweight losses.
READER COMMENTS
robc
Jan 29 2021 at 4:39pm
One thing about the efficiency argument. State standard deductions dont always align with the Federal.
For 2019 I had to do KY and SC taxes. SC uses the Federal deduction. KY has a very low standard deduction. So I had to itemize for KY (I actually did for Fed and SC too, as I just squeaked over the limit) even if I wouldn’t have had to for Federal taxes.
I have two problems with the SALT limitation is it is now. I would prefer they just eliminate that deduction altogether, but ignoring that here are the problems:
1. It creates a marriage penalty. The limit is the same for singles and married filing jointly.
2. They made the same mistake they have made a bajillion times in the past and have had to correct, they didn’t index the SALT limit to inflation.
I am kind of okay with #2 as that would lower the SALT limit in real dollars over time. But its just bad form. If you want to eliminate the deduction, eliminate it. Doing it like this just creates gamesmanship down the line.
Scott Sumner
Jan 29 2021 at 7:54pm
Good points.
TMC
Feb 1 2021 at 2:09pm
I’m not sure there’s a marriage penalty there. Look at it as $10k per house.
robc
Feb 2 2021 at 6:25am
Unmarried couple can deduct $20k. Clear marriage penalty.
robc
Jan 29 2021 at 4:41pm
This is why I favor the Single Land Tax.
Jose Pablo
Jan 29 2021 at 6:45pm
Or a VAT (plus some property and Pigouvian taxes but no income taxes whatsoever) that would make tax advisors’ and accountants’ many abilities useful in other parts of the economy …
Add an UBI scheme in place of the infinite number of actual ways of subsidizing whatever real or imaginary need (no more “paternalistic distortions of voters behavior”) and you could also dream of rendering the politicians obsolete …
What a dream!
robc
Jan 29 2021 at 7:37pm
Vat has deadweight loss, so no.
Jose Pablo
Jan 30 2021 at 8:41am
Sometimes suppression strategies are just unfeasible (we kind of learn that this year). Mitigations strategies make sense then.
The “deadweight” of having an army of brilliant (and awfully expensive) people dedicated to optimizing your tax expenses (by expending time reading the details of an extremely boring, sadistically large a utterly nonsensical tax code), instead of developing new batteries technology or curing cancer, is just huge.
A ‘universal-single-rate-VAT” would put all these experts to do “honest”, useful work (plus a “realistic” SALT, plus a carbon tax, plus collecting tolls on the use of public infrastructure … the “acid test” of the taxes being “no tax consultant can significantly mitigate your tax burden” and/or “no more than 2 pages of tax code is required to fully explain each tax”, which are, basically, the same thing after all).
Jose Pablo
Jan 30 2021 at 12:47pm
It should said “… (plus a realistic “Property Tax”, …. ” and not ” … plus a realistic SALT, …”
robc
Jan 31 2021 at 9:17am
All of the benefits you mention of the vat apply to the slt as well. In addition, the slt has zero deadweight loss.
Jose Pablo
Jan 31 2021 at 5:02pm
Robc,
how can slt provide revenue equivalent to around 40% of GDP? Particularly in an economic system in which the ratio of land value to GDP keeps decreasing.
robc
Feb 1 2021 at 8:48am
It cant. That is another benefit of the SLT. Its the perfect tax system for a night watchman state.
I have mentioned it before, but the Land Tax is the only tax I can support morally. As a deontological libertarian, that is more important to me than amount of revenue. And as a happy accident, puts a nice limit on the size of the state too.
Jose Pablo
Feb 2 2021 at 11:11am
You will never be elected President, Robc! … that I can tell.
robc
Feb 2 2021 at 3:12pm
If elected I will not serve.
Brandon Berg
Jan 30 2021 at 3:40am
The Single Land Tax kind of made sense in George’s day, when land ownership was mostly hereditary and total government spending was low. It makes much less sense now.
First, a single land tax can’t support a modern welfare state. The total market value of all the land in the US is on the order of 100% of GDP. At a 15:1 price-to-rent ratio, you could expect to raise about 7% of GDP with a 100% tax on the rental value, whereas total government spending is about 35% of GDP. If you want to cut government spending by 80%, a) that’s a political non-starter, and b) it doesn’t matter that much how you raise that money, because it’s only 7% of GDP.
It’s also horribly unfair, because the entire incidence of the tax, for all eternity, falls on the poor schmuck who happens to hold the title to the land when the tax is passed. If you have $100k in the bank when the tax is passed, you pay nothing. If you use that as a down payment on a $600k house ($400k land, $200k structure) and then the tax is passed, you now have a net worth of negative $300k, because the land is worth nothing. And now you have to pay the tax and the mortgage.
“Single land tax” is a misnomer. It’s less a tax than the government seizing your land and giving you first dibs on renting it. And it can’t be a single tax, unless we cut government spending to a fraction of current levels.
john hare
Jan 30 2021 at 5:21am
And what’s the likelihood that many of those poor schmucks default on the tax and lose it to the state? After which a state holding title to the vast majority of taxable land collects nothing.
Michael S.
Jan 30 2021 at 1:22pm
if all land owners defaulted and the state held all land, it would earn the rent
john hare
Jan 30 2021 at 2:32pm
Do you really think the state could manage that any better than anything else?
robc
Feb 1 2021 at 9:54am
Every tax change has the problem of changing who the incidence falls upon.
My Father, for example, opposed a change to consumption tax because he was retired and had paid income tax all his life, so why should he get taxed at a high rate on consumption in retirement. It reeked of double taxation to him.
And he was right. But also wrong. Any change has that issue. What matters is to choose a tax system that is morally justifiable.
Kevin Dick
Jan 29 2021 at 5:44pm
For a second I thought you were arguing that a repeal on the cap of strategic nuclear weapons was efficient.
Alan Goldhammer
Jan 29 2021 at 5:56pm
Hi Scott, your comment about repeal of SALT making tax filing more complicated doesn’t fly with me. Yes, my tax filing is a bit simpler these days but anyone using one of the popular tax preparation software packages only has to change a couple of numbers and that’s it. I don’t know why you think record keeping is difficult as you already receive the required forms. This is not difficult matter.
Personally, I’m in favor of doing away with all tax preferences, eliminating the carried interest loophole, cleaning up all the real estate loopholes (there are many of them which is why you see organizations setting up multiple LLCs even though the money eventual goes to one person(s)). I would also eliminate the corporate tax which collects a smaller percentage of total revenue every year and put in a VAT which is far easier to administer and cannot be gamed. I would also like to see unrealized capital gains capture in some way in estate transfers but that’s probably a bridge to far.
robc
Jan 29 2021 at 7:40pm
The complication is having to buy turbotax.
If it was easy, they would be out of business.
And while I agree with some of your suggestions, replacing it all with an SLT is much better.
Scott Sumner
Jan 29 2021 at 7:54pm
I hire someone to do my taxes, and this will make it more expensive. As far as paperwork, now I have to save all receipts on charitable donations, property taxes, car taxes, etc.
Alan Goldhammer
Jan 30 2021 at 8:50am
Unless your tax filing is incredibly complicated, one of the tax filing programs is just fine. I don’t use the questionnaire feature but fill the forms in. The change in the tax law makes charitable donations worthless for most filers since the thresholds are way too high. If one has a lot of real estate holdings things might get a bit complex but not insurmountable. You might want to try one of the programs and compare the the time input and cost versus what you are paying an accountant.
For our family income and home office investment trusts it takes me about two hours to do all the taxes. I would probably pay an accountant $2K to do the same work.
Scott Sumner
Jan 30 2021 at 10:49am
I used to use Turbotax but gave up on it. Too frustrating. I pay a few thousand, but my accountant saves me more than that in taxes.
Jose Pablo
Jan 30 2021 at 12:44pm
I am afraid your savings on this matter are other people’s cost … no “value” (social or economic) added by your accountant’s hard work.
Mike W
Jan 30 2021 at 6:09pm
“I pay a few thousand, but my accountant saves me more than that in taxes.”
You don’t seriously believe that?
Scott Sumner
Feb 1 2021 at 12:35pm
I do, as when I filled out my taxes I didn’t take some of the deductions that he uses.
derek
Feb 3 2021 at 2:29pm
Like what? I kind of wonder what I am possibly missing with TurboTax.
Zeke5123
Jan 30 2021 at 12:15pm
While tax can be a reason to set up multiple entities it is far from the single one. These other reasons include limiting liability from one property to another, financing (banks want multiple ways to enforce security) etc.
Thomas DiMaio
Jan 30 2021 at 5:20am
With respect to efficiency, I think one has to look at what is being subsidized by what is in large part a deduction for residential real estate taxes. We had a time around 15 years ago where a disproportionate (and then growing) portion of the workforce was employed building, selling, and financing each others houses while other sectors of the economy were stagnant. Personally, I think the economy is better off (i.e. more efficient) in the long run with somewhat less capital flowing into housing and more flowing into other investments.
What is left out of the equity argument is that, at least in theory, someone paying $15,000 in SALT in a high tax state is getting $15,000 of services and someone paying $2,000 in a low tax state is getting $2,000 worth of services. That few people in high tax states see it that way is their own problem that should be addressed at the ballot box.
In the hierarchy of complicated and today burdensome rules that exist, I would put incorporating SALT into a tax return very low on the list.
Thomas Hutcheson
Jan 30 2021 at 6:31am
Efficiency: States do not pay income tax, people do. What is the consumption/leisure or some other decision that is distorted by deductability? S&L taxes are one of the few things for which deductability makes sense. Taxpayers have no control over them so they are like income never received. More people will itemize? So what even if we had partial tax credits as a fairer way of subsidizing certain kinds of consumption instead of deductions, people would still have to keep records.
Equity. Sure, you’d need higher rates on high-income people. Why isn’t collecting the revenue from a broader swath than the narrower swathe of people living in high nominal income states more equitable?
Decentralized decision making. What happened to 50 laboratories of democracy?
Mike W
Jan 31 2021 at 9:03am
Is it a valid argument that the SALT deduction partially equalizes federal tax rates for cost of living differences?
A grocery store manager in Kentucky can have the same standard of living as a grocery store manager in California but, the California manager’s compensation will be significantly more due, in part, to the higher cost of living. Should the California manager pay higher federal taxes?
robc
Feb 1 2021 at 9:57am
The CA manager can move if he wants lower taxes. Although as a former KYian, it isn’t a low tax state.
Mike W
Feb 1 2021 at 1:26pm
Actually, I was referring to federal taxes. The California manager pays more in federal taxes because the cost of living in California makes her federal taxable income higher.
The federal SALT deduction makes up for some of that.
robc
Feb 1 2021 at 3:39pm
Yes, I know what you meant. And he could move, have a lower cost of living, and still work the same type job for less money and get the federal tax break. And despite KY not being great, probably a state tax break too (vs CA, but not everywhere).
It is like if we got rid of the mortgage interest deduction, we lose it offsetting people living in higher cost neighborhoods. But they can move too if its that important.
I am not sure yet, but I think 2020 is going to be my first year of not taking the mortgage interest deduction due to the higher standard deduction. Best part of the tax law change was that, it makes it easier to one day get rid of the mortgage interest deduction.
Pigbitin Mad
Feb 19 2021 at 3:25pm
I am not rich and I got socked with paying an extra $5,000 that I was not expecting. I have some mutual funds which cause me grief every year, but I have now had to arrange to have $500 per month taken out of our paychecks (combined) to offset this fiasco.
Combined income is something like $125K Mutual fund income, who knows?
Extra tax payments, $6000 per year and it still is never enough. It seems I have to take out more and more each year.
I own a coop apartment worth $140K and the mortgage interest on that does not exceed my standard deduction.
I wish people would stop characterizing this as something only rich people are affected by. In NY, a couple making $125K is probably lower-middle class.
And they ran on repealing it, and now they say it “cannot” be undone. I say scrap the entire thing and go back to the tax code of 2017. WHILE WE ARE AT IT, I PROPOSE A CHILD TAX PENALTY. We do not need more people gobbling up the finite resources of the earth. Population control is something that needs to happen yesterday.
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