Blue State Bailout: The Regressive Cost of Lifting the SALT Cap
The SALT deduction does little to help middle-and low-income taxpayers
The House budget reconciliation bill includes a proposal to raise the state and local tax deduction cap from $10,000 to $30,000. The SALT deduction allows taxpayers to deduct state and local income taxes (or, alternatively, sales taxes) and property taxes from their federal income tax liabilities. This benefits Americans who live in high-tax states but places a corresponding burden on federal taxpayers, who must compensate for the lost revenue.
Following the enactment of the 2017 Tax Cuts and Jobs Act (TCJA), the SALT deduction for taxes paid in any taxable year from 2018 to 2025 was limited to $10,000 per household ($5,000 for married individuals filing separately). This $10,000 cap raised an estimated $668 billion over the decade, helping to pay for a large chunk of other TCJA provisions, such as lower individual income tax rates and a doubling of the standard deduction. The cap also represented a shift toward simplifying the tax code and broadening the tax base—a long-time goal of free-market conservatives.
In terms of fiscal impact, the Treasury estimates that under current law, the SALT deduction will result in more than $1.51 trillion in lost federal revenue over the next decade (2025–2034). The SALT deduction is one of the largest tax expenditures in the tax code, so if policymakers don’t limit this deduction, it will significantly worsen the nation’s long-term fiscal imbalances.
In response to changes in the House budget proposal, a handful of fiscally irresponsible lawmakers are demanding that the SALT cap be raised to an eye-watering $124,000 for joint filers. If enacted, this change would amount to a roughly $900 billion tax transfer from ordinary Americans to the highest-income earners. Such a move would be both highly regressive and deeply irresponsible from those who so often claim to be “fiscally responsible.”
Concentrated Benefits, Dispersed Costs
Aside from its monumental fiscal cost, the SALT deduction is also incredibly regressive, furnishing highly concentrated benefits to the wealthy and dispersed costs to poorer individuals and states. The benefits of the SALT deduction are limited to those at the very top of the income scale. In 2022, fewer than 11 million tax returns (out of 160 million) deducted state and local income taxes — that’s less than 7 percent of all income tax returns.
According to 2022 IRS statistics of income data (Table 2.1), 65 percent of the total value of SALT deduction tax benefits goes to a small group of 1.4 million taxpayers earning more than $500,000 per year. By contrast, those making less than $100,000 a year receive just 4 percent of the benefits.
The benefits are concentrated not just among the highest earners, but also among a handful of high-income, high-tax states. These taxpayers tend to be clustered in affluent states such as California, New York, New Jersey, Connecticut, and Illinois.
As the map below shows, the benefits of the SALT deduction are captured by wealthy, high-income households largely concentrated in Democratic strongholds. It seems counterintuitive that a Republican-controlled Congress would want to subsidize the property taxes of wealthy individuals in blue counties at the expense of hard-pressed workers in middle America.
The National Taxpayers Union Foundation calculated that if the SALT cap were raised from $10,000 to $25,000, more than 78 percent of the benefits would flow to blue states, with red states receiving less than 22 percent. California and New York would receive 30 percent and 17 percent of the benefits, respectively.
The proposal by the SALT caucus to raise the deduction to $124,000 (for joint filers) would similarly involve redistributing most of the tax benefits to the most well-off. As the pie chart below shows, more than 90 percent of the tax benefits in this proposal would trickle up to the top 14 percent of earners, while almost two thirds would go to the top 2 percent of earners.
The deeply regressive nature of this tax expenditure has serious economic consequences. For example, the SALT deduction contributes to economic segregation by subsidizing wealthy communities at the expense of poorer ones. A 2020 article found that the SALT deduction “provides a greater subsidy, per capita, for wealthy, economically segregated localities because only those localities have a critical mass of wealthy taxpayers who claim the deduction. This allows wealthy localities, but not poor localities, to provide services at a cost less than face value to their residents.”
The author concludes that the SALT deduction “likely contributes to economic segregation because it provides an incentive for the wealthy to segregate into wealthy, subsidized localities over less segregated and less subsidized localities.”
Distorting State Tax Competition
Not surprisingly, the SALT deduction also distorts the financing decisions made by state and local lawmakers. As Veronique de Rugy pointed out in 2016, for instance, governor of Alaska Bill Walker cited SALT as instrumental in proposing a hike in income taxes over a hike in the sales tax. Walker said, “We selected an income tax over a sales tax for a couple of reasons. ... State income taxes are deductible from your federal taxes.” Translation: “Thanks to SALT, we can increase your taxes without upsetting you as much as we should.”
Therefore, the SALT deduction influences the types of taxes that state and local governments implement, biasing them toward those that are deductible rather than most efficient. It is no surprise, then, that prior research on the SALT deduction has found that it results in a increases of state and local taxes by about 13–14 percent.
In other words, SALT not only shifts the tax burden from high-income individuals to federal taxpayers, but it also enables state governments to raise taxes knowing that a significant portion will be deductible at the federal level. This is a lose-lose.
New York congressman and SALT caucus member Nick LaLota recently stated: “We live in the highest tax state in the entire nation and our constituents [Long Islander’s] want a higher SALT because of those oppressive, onerous policies that come from Albany.”
The SALT deduction allows policymakers to maintain high tax burdens in their respective states while reducing their incentive to lower these “oppressive” and “onerous” policies. Why would policymakers from high-tax states work to reduce these tax burdens, knowing that taxpayers in middle America will simply bail them out through the SALT deduction?
Tax Reform Priorities Should Be Pro-growth
In renewing the expiring provisions of TCJA, policymakers have an opportunity to maximize the benefits of pursuing pro-growth tax reform. As it currently stands, the House budget falls short in achieving this goal. For example, the most growth-inducing provisions (i.e., full expensing) in the current bill are temporary. Rather than making concessions to the SALT lobby, policymakers should prioritize making the pro-growth business provisions permanent.
What’s more, the proposal to raise the SALT deduction to $30,000 is deeply problematic on the growth front. It is a problem not just because it doesn’t boost economic growth, but because it significantly hurts economic growth. According to the Tax Foundation, this provision reduces economic growth by 0.7 percent — wiping out two thirds of the growth impact of lower income taxes and wider thresholds. It also has a severely negative impact on the capital stock, leading to lower worker wages and fewer job opportunities.
The most fiscally prudent course action would be to extend the existing $10,000 SALT deduction cap beyond 2025. But politically, this option may no longer be realistic as policymakers are likely to settle on a higher cap as proposed in the House budget. Refusing to cave to the demands of the SALT caucus would send a strong signal that policymakers are truly committed to addressing the nation's fiscal challenges. It would also free up some extra space to pursue genuine tax reforms that support economic growth, such as making full expensing permanent.