Alex Zhang (J.D. 2021, Yale), The State and Local Tax Deduction and Fiscal Federalism, 168 Tax Notes Fed. 2175 (Sept. 21, 2020) (Winner, 2020 Christopher E. Bergin Award for Excellence in Tax Writing):
In this article, Zhang argues that the Tax Cuts and Jobs Act’s limit on the state and local tax deduction undermined the deduction’s effectiveness, thus underscoring the inherent defects and obstacles in advancing federalism with a tax measure.
In addition to impairing the SALT deduction’s effectiveness in mitigating the balance of federal payments, the TCJA limit illustrates at least two inherent shortcomings in using the SALT deduction to effectuate federalism.
First, the SALT deduction simply is highly regressive: Before the TCJA limit, only 19 percent of SALT deduction tax expenditures were distributed to households with an AGI of lower than $100,000, even though this AGI group constitutes the vast majority of American households. Eighty-one percent of SALT deduction tax expenditures therefore benefited households with more than $100,000 of AGI — a small minority of American households. The TCJA’s SALT limit, while it was probably intended to punish high-tax jurisdictions, will likely mitigate this regressivity. In general, households with AGIs of lower than $100,000 are not substantially affected by the TCJA’s limit, while the SALT deduction tax expenditure for households with AGIs of higher than $100,000 will plummet by at least 35 to 40 percent. This means that after the TCJA limit, households with AGIs of lower than $100,000 are likely to see their share of SALT deduction tax expenditures rise from 19 percent to 37 percent.
Second, because federal expenditures are so unevenly distributed, it is unrealistic to expect SALT deductions to close the gap between deficit and surplus states. Even before the TCJA limit, SALT deduction tax expenditures still leave high tax states such as Connecticut, Massachusetts, New Jersey, and New York running large deficits in federal payments in the billions of dollars. The TCJA limit has exacerbated this shortcoming.
Therefore, a much better way of preserving federalism in taxation is for the federal government to adopt a more balanced approach to appropriations and expenditures. Given regional differences, it is not necessary that each state receives the exact same amount of federal spending — but the current state of highly uneven distribution of federal spending is not sustainable. Given polarized politics, it is unlikely that Congress or the executive branch can reform federal expenditures in such an effective way. Before that happens, then, SALT deductions still have some role to play in our system of federalism.