Baker Institute expert explores tussle over tax reform and deduction limits

David Ruth
713-348-6327
david@rice.edu

Jeff Falk
713-348-6775
jfalk@rice.edu

Baker Institute expert explores tussle over tax reform and deduction limits

HOUSTON – (Feb. 15, 2019) – The Tax Cuts and Jobs Act of 2017 placed a $10,000 limit on the amount of state and local taxes people may deduct on their federal income tax returns. One year after the law’s passage, this so-called SALT deduction limit remains one of its most contested provisions, according to an expert in the Center for Public Finance at Rice University’s Baker Institute for Public Policy.

Credit: 123RF.com/Rice University

Joyce Beebe, a fellow in public finance, examined the pros and cons of the limit and state-level efforts to circumvent the caps in a new report, “Fiscal Federalism and the State and Local Tax Deduction Limit.”

Prior to the tax reform, there was no cap on the amount taxpayers could claim for the deduction. Several states have since proposed or passed legislation to circumvent the limit. In response, the IRS issued a warning against state charitable contribution workarounds in May, followed in August by proposed U.S. Department of Treasury regulations intended to block those state actions.

Four states (New York, Connecticut, Maryland and New Jersey) filed a lawsuit against the federal government, claiming the cap unfairly targeted them and represented federal interference with states’ constitutionally protected rights. In November, the federal government sought to dismiss the case, arguing that the states do not have legal standing to file the lawsuit.

“Beyond the pointed statements between the federal and state government officials, these arguments bring up an important issue: What are the existing fiscal interactions between the federal and state governments, and how would the SALT deduction cap change these dynamics?” Beebe wrote.

Her report reviews the connections between the governments and summarizes the viewpoints for and against a SALT deduction limit. It also discusses recent state actions to mitigate the effects of the cap, as well as federal government reactions and individual-level workarounds.

“Fiscal federalism, which describes the financial relations between different levels of government based on their respective responsibilities, is a unique and indispensable feature of a federal government system,” Beebe wrote.

The federal government provides substantial financial assistance to state and local governments. Beebe’s report focuses on two of the largest federal support mechanisms — federal grants and the SALT deduction.

“Although removing the SALT deduction cap would cost the federal government more than $600 billion over the next decade, newly elected Democrats from high-tax states have begun discussions on either increasing or removing the cap,” Beebe wrote. “The partisan nature of the tax reform and the high level of fiscal deficits mean the limited SALT deductibility would have profound revenue implications, and the adversarial relationship between state and federal governments would intensify. Although the SALT deduction cap has been interpreted as a political move to harm blue states, or a maneuver simply to finance the TCJA, there is no doubt the federal government provides substantial financial assistance to state and local governments.”

Because the SALT deduction is administrated through federal tax policy, the key economic issue centers on the magnitude of the spillover effects of state and local government spending, Beebe said.

“Some of the workarounds may prevail on legal grounds, but whether they make good state tax policies is a separate matter,” she wrote. “Key state-level issues on both revenue and expenditures need to be addressed. The growing spending on entitlements and the looming budget shortfalls require not only efficient administration but also a reconsideration of spending priorities.”

For more information or to schedule an interview with Beebe, contact Jeff Falk, associate director of national media relations at Rice, at jfalk@rice.edu or 713-348-6775.

-30-

Follow the Baker Institute via Twitter @BakerInstitute.

Follow the Baker Institute’s Center for Public Finance via Twitter @Baker_CPF.

Follow Rice News and Media Relations via Twitter @RiceUNews.

Related materials:

Report: www.bakerinstitute.org/media/files/files/401eb013/bi-report-021219-cpf-salt.pdf

Beebe biography: www.bakerinstitute.org/experts/joyce-beebe

Baker Institute Center for Public Finance: www.bakerinstitute.org/center-for-public-finance

Founded in 1993, Rice University’s Baker Institute ranks among the top five university-affiliated think tanks in the world. As a premier nonpartisan think tank, the institute conducts research on domestic and foreign policy issues with the goal of bridging the gap between the theory and practice of public policy. The institute’s strong track record of achievement reflects the work of its endowed fellows, Rice University faculty scholars and staff, coupled with its outreach to the Rice student body through fellow-taught classes — including a public policy course — and student leadership and internship programs. Learn more about the institute at www.bakerinstitute.org or on the institute’s blog, http://blogs.chron.com/bakerblog.