(Bloomberg Opinion) -- In the latest version of the White House’s Build Back Better plan, House Democrats have managed to offer big refunds to wealthier taxpayers in blue states while keeping the official cost of the plan under $1.75 trillion. While one can’t help but admire their legislative ingenuity, the move is a costly gimmick — and bad policy.
First, some background: As part of 2017’s Tax Cuts and Jobs Act, Republicans capped the amount of state and local taxes individual filers could deduct on their federal tax returns at $10,000. The complete elimination of the SALT deduction has long been a goal of tax reformers, and many viewed the cap as a step in the right direction. But the move was also seen — and even touted by some Republican operatives — as an attack on blue states that have a combination of high tax rates and wealthy residents.
The cap on SALT deductions is set to expire, however, in 2026. Members of the House from New Jersey, one of the blue states most hurt by the cap, have made it their mission to get it repealed sooner — this year, as a part of Build Back Better.
They face two major obstacles. First, a complete repeal of the cap would be so regressive that including it in Build Back Better would mean that some billionaires would likely receive a net tax cut. Second, the change would cost nearly $500 billion in lost revenue.
House Democrats have a plan to mitigate these two issues. First, instead of repealing the cap altogether, they would simply raise it from $10,000 to $72,500. Doing so would benefit those making $250,000 to $1 million a year rather than those making $100 million or more. Second, they propose to extend this new cap until 2031.
Since the old cap was set to expire in 2026, along with the rest of the 2017 tax law, this extension would theoretically raise revenue. To repeat: By giving wealthy taxpayers a bigger deduction, and leaving it in effect for longer, the Democrats’ bill would raise more revenue than just leaving the status quo in place. In a nice touch, the bill would also make the new $72,500 cap retroactive to the 2021 tax year, ensuring that its beneficiaries get a big refund check next April.
The net effect that is that House bill would deliver a huge retroactive tax cut to high-income families, which the Congressional Budget Office would likely score as adding virtually nothing to the deficit. That’s an impressive display of budgetary wizardry.
In reality, however, raising the cap would reduce revenue by $300 billion over the next five years, and by at least as much over the five years after that, relative to the baseline of keeping the lower cap in place. Only a tiny sliver of that tax savings, 2.5%, would go to households making less than $100,000 a year. And because the benefits to higher-income households come in the form of a deduction rather than a rate cut, they provide little incentive to work or invest.
Proponents of the SALT deduction argue that without it, wealthy residents would flee to lower-tax jurisdictions, reducing the ability of states to fund social services for their lower-income residents. But the evidence of that happening after the passage of the 2017 tax law is minimal at best.
What the SALT deduction may do best is encourage the formation of small, exclusionary municipalities with high property taxes — taxes that their residents know they will be able to deduct on their federal return. In the 246 square miles of New Jersey’s Bergen County, for example, there are some 70 municipalities. One of the smallest and wealthiest, Rockleigh, has a median household income of more than $190,000, an average property tax bill of more than $15,000 and a population of about 400.
The House’s proposal would devote $600 billion over the next 10 years to subsidizing places like Rockleigh — while funding the expansion of the child tax credit only through 2022. This is an inversion of the principles progressive Democrats profess to hold. One can only hope the Senate has the wisdom to reject this bill.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Karl W. Smith is a Bloomberg Opinion columnist. He was formerly vice president for federal policy at the Tax Foundation and assistant professor of economics at the University of North Carolina. He is also co-founder of the economics blog Modeled Behavior.
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