(Bloomberg Opinion) -- It wasn’t too long ago that New York’s governor was sounding the alarm about the revenue the state was losing because of the 2017 federal tax-reform law. Like his colleagues in other blue states, Andrew Cuomo was worried about the effect of the law’s cap on state and local tax deductions. “This is worse than we had anticipated,” he said in February.
Three months later, the news is the opposite: These states are seeing revenue increases. What changed? Both sides of this story — the politics and the economics — were entirely predictable. Tax policy is often cast in terms of winners and losers, and that type of thinking can easily lead politicians astray.
Conservative commentators kicked off the frenzy when they described the cap as a “tax on blue state progressives.” Liberals then vowed to resist any tax increases imposed on their states by the President Donald Trump. Both camps accepted as a given that states like California and New York would see an exodus of high-income residents looking to avoid the increased taxes.
Maybe that will still happen. But most economic models — even ones favored by conservatives — always indicated that the effect would be small and gradual.
For one, the change affects relatively few taxpayers. The burden of the SALT cap falls heaviest on the top 1%. Yet analysis by the Tax Foundation suggests that removing the cap would only raise their after-tax incomes by 2.79%.
Economic conservatives have long argued that it’s not the overall tax burden that matters so much as the effective marginal tax rate: what people pay on their next dollar earned. But the complexity of the interlocking federal, state and local tax systems makes it all but impossible to do more than speculate about what the effect of the SALT cap on marginal tax rates would be.
It’s likely that, when taxes at all levels are considered, a small fraction of taxpayers could see an effective marginal tax rate increase of 4% to 5%. But the effect of marginal tax rates on the economy could take a decade or more to play out. As a result, the SALT cap was always unlikely to prompt an immediate reaction. Instead, those increases in marginal tax rates will tip those who were already considering major changes — a job offer, say, or the birth of a new child — to take more time off or that job in another state.
Meanwhile, those taxpayers will for the most part be paying higher state income taxes because of other changes made to federal tax law by the 2017 reform. The net effect, as blue states are discovering, is an increase in revenue.
So it was always highly unlikely that the SALT cap was going to lead to a dramatic fall in state revenues. The worries were mostly the product of partisan gamesmanship. That’s unfortunate, because it obscured the bigger picture: The optimal policy, from an economic standpoint, is not just capping but eliminating the SALT deduction, which is both regressive and inefficient. In fact, it’s a reform that should have political appeal as well — to both conservatives and liberals.
To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Karl W. Smith is a former assistant professor of economics at the University of North Carolina's school of government and founder of the blog Modeled Behavior.
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