It is a truth universally acknowledged, that a person in possession of a good home, must hate property taxes. Happily, their ability to deduct such local taxes for federal tax purposes likely makes these taxes easier to swallow. By mollifying taxpayers, the deduction enables localities to levy higher taxes and provide more and better public services for all residents. Or so the story goes.
As Gladriel Shobe argues in her latest paper, the distribution of this subsidy to local governments may be skewed to homogeneously wealthy communities, rewarding and perhaps even driving economic segregation. Understanding the first two building blocks of Shobe’s argument is duck soup for a tax-expert audience.
First, the deduction predominantly benefits wealthy taxpayers because the wealthy are more likely to itemize. Second, the local tax deduction subsidizes localities by allowing them to charge higher tax rates than they could in the absence of a deduction. Shobe builds on this elementary logic to make the novel point that only segregated wealthy communities benefit from the subsidy because only segregated communities have the critical mass of itemizing taxpayers to enable them to charge higher taxes. Worse, any subsidy to segregated wealthy communities is not shared with poor communities because local tax revenue typically stays within the jurisdiction that collected it.
Based on this reasoning, Shobe concludes that the local tax part of the state and local tax (SALT) deduction rewards and perhaps even contributes to economic segregation. Although the deduction does not directly motivate wealthy folks to self-segregate, the public services financed by its subsidy to local governments undoubtedly play a major role in such segregation. Shobe offers public schools as the primary example of a public service that reflects and promotes heightened economic segregation. Local taxes provide about half of the public revenue spent on schools. If the local tax deduction allows localities to increase taxes, schools’ budgets (and, presumably, quality) in those areas will increase. Shobe’s reasoning suggests that such an increase will only occur in homogeneously wealthy communities because only those communities have sufficient itemizing taxpayers to drive tax policy choices. Meanwhile, while the wealthy concentrate in these better school districts, the poor will be priced out of such communities. Economic segregation is the result.
Shobe is careful in her claims. She does not (and perhaps cannot) empirically prove that the local tax deduction directly causes economic segregation. However, aside from her intuitive reasoning, she also cites to indirect and anecdotal evidence. For instance, she cites to research suggesting that the SALT deduction may not be capitalized into housing prices in lower-income neighborhoods. In particular, one study found that enactment of the $10,000 SALT cap only reduced housing prices in high-priced areas, which could suggest that lower-priced neighborhoods derive less benefit from the deduction.
In suggesting various reforms, Shobe considers the SALT deduction cap as one way to reduce benefits to segregation. However, she notes that the cap also reduces the deductibility of state taxes, which don’t have the same segregating effect. Shobe suggests that a better policy might prioritize the deduction of state taxes rather than local taxes, for instance, by placing a lower cap on local taxes, limiting deductions for taxes paid in segregated communities, or switching to a credit instead of a deduction.
Tax limits on local governments are important to this analysis, which Shobe briefly notes. The local tax deduction likely provides less subsidy to places that cannot increase local taxes due to various limits on local government taxing power. Thus, Shobe’s analysis is especially important in places with no property tax limits or with weak limits, such as Connecticut or Hawaii. (Although, it is worth noting that property tax limits do not seem to promote equity, and may exacerbate inequality by reducing funding for broad-based public services like education.)
Shobe’s theory is intuitively appealing, and testing it presents an intriguing challenge. Specifically, while the deduction may reward economic segregation, how can we know if it drives such segregation? Among other things, building the causal chain requires establishing that the local tax deduction enables local governments to raise taxes only in segregated wealthy communities. Perhaps the outcomes of local tax-increase referenda, compared before and after the enactment of the SALT cap, could offer some evidence. Of course, such referenda are not required in all states, and their use and success depend on a slew of difficult-to-parse factors.
Shobe’s article is important, both for pulling local taxes out from under the SALT umbrella, and for complicating the analysis surrounding the SALT deduction. Experts and policymakers considering design of the deduction as well as local tax workarounds to the deduction cap would be wise to consider her points.