State and local tax (SALT) deduction

The state and local tax (SALT) deduction is a deduction some taxpayers in the United States use to reduce their federal tax liability. The SALT deduction is an itemized deduction, which means it is available only to taxpayers who take itemized deductions rather than the standard deduction. The SALT deduction has been controversial since the late twentieth century, though it had been part of the tax law since the early part of the century. Opponents of the SALT deduction say most people who use the deduction are wealthy high-income earners. Opponents assert that the deduction is unfair because it favors the wealthiest individuals. Supporters of the deduction claim that allowing taxpayers to deduct state and local taxes prevents a “race to the bottom” in state tax rates. The United States government passed several laws affecting the SALT deduction in the late 2010s and early 2020s.

Background

The history of taxation in the United States began before its formation when it consisted of thirteen British colonies. Great Britain did not levy income tax, but it did institute taxes on items such as real estate and tea. When the colonies won their independence and formed the United States, the Founders gave the federal government the ability to impose taxes on people living in the country. The government instituted several initial taxes, but many of those taxes were excise taxes on specific goods, such as tobacco. In the mid-nineteenth century, President Abraham Lincoln helped to impose what would become the nation’s first income tax. The government used the revenue to pay for the Union’s costs during the Civil War. The government also created the Office of the Commissioner of Internal Revenue, which would later become the Internal Revenue Service (IRS). In 1913, the government created the federal income tax code, which allowed for deductions for higher-income earners. As time passed, the federal government became more reliant on revenue from income taxes until, by 1950, individual income taxes became the primary source of revenue for the government. In 2018, payroll taxes and incomes taxes accounted for about 80 percent of all federal revenue in the country.

Overview

Taxpayers in the United States use deductions to pay less taxes. Federal law lays out specific rules about what costs, purchases, and penalties taxpayers can deduct. Taxpayers can choose to itemize their deductions or take a standard rate of deduction determined by the IRS. In the United States, taxpayers itemize their deductions only when they can deduct an amount that is higher than the standard deduction. Taxpayers can deduct many different costs, such as certain healthcare costs, real estate costs, and business costs. The deductions may include the amount of money they pay on state and local taxes. In general, people who itemize their deductions (rather than take the standard deduction) are high-income earners. Taxpayers in the United States have had the ability to deduct state and local taxes and numerous other costs since the early twentieth century.

As of 2021, taxpayers in the United States can deduct up a set amount of their aggregated state and local taxes each year. In 2020, single taxpayers and married taxpayers filing jointly could deduct $10,000. Married individuals filing separately can deduct up to $5,000 per year. The taxes that people can deduct include state and local income taxes and state and local real estate and property taxes. The federal government also allows taxpayers to deduct state and local sales tax instead of deducting state and local income tax. The sales taxes that taxpayers deduct can include taxes on retail sales, motor vehicle sales, consumption taxes, and more. Most taxpayers using the SALT deduction choose to deduct income taxes rather than sales taxes. Some taxpayers also use the SALT deduction to deduct taxes paid on certain transfers made by trusts and estates.

Like many other types of deductions, SALT deductions are often used by high-income earners. People who use itemized deductions tend to have higher incomes and spend more money, which gives them more opportunities to write off itemized costs. As of 2020, about 88 percent of SALT deductions in the United States were paid by taxpayers with incomes in excess of $100,000. Furthermore, SALT deductions are more common in states with high state taxes, such as New York and California.

SALT deductions reduce the tax revenue available to the federal government. Without SALT deductions, many taxpayers would have significantly higher federal tax liabilities, generating billions of dollars in revenue. According to the United States Congressional Joint Committee on Taxation—a congressional committee made up of members of the House and Senate—SALT deductions cost the federal government about $24 billion in 2020.

SALT deductions have been controversial since the late twentieth century. Opponents of the deductions point to the loss of federal revenue from the system. Furthermore, opponents claim that SALT deductions cause lower-income states to subsidize higher-income states, where federal tax liabilities are reduced by SALT deductions. Opponents of the tax say that it is a regressive tax that helps only the wealthiest of taxpayers. Although some government officials supported cutting SALT deductions for years, the SALT deduction system remained mostly unchanged from the 1910s to the 2010s. Opponents also point out that these deductions can influence tax policy in states and regions where individuals are likely to use SALT deductions. Supporters claim that eliminating SALT deductions would cause a “race to the bottom” in which states attempt to reduce their tax rates so much that they become ineffective.

In 2017, the federal government, led by President Donald Trump, passed the Tax Cuts and Jobs Act. The law made numerous changes to the tax code, including a limit on the deductions taxpayers could take for paying state and local taxes. The so-called SALT cap allowed single taxpayers and married couples filing jointly to deduct only $10,000 and married taxpayers filing separately to deduct only $5,000 per year. Before the 2017 law, taxpayers had no limit on the amount of state and local taxes they could deduct, giving some taxpayers tens of thousands of dollars in tax relief. The SALT cap set in the 2017 law was set to last from 2020 to 2025.

Many state governments objected to the SALT cap. Numerous states, including Maryland and New York, filed a lawsuit against the federal law, claiming that the SALT cap was unconstitutional. However, a federal judge dismissed the lawsuit. Other states took action to reduce the cost of federal taxes for their citizens. One such way was that some states planned to allow their taxpayers to contribute to a state charitable fund instead of paying traditional taxes. Taxpayers can deduct charitable contributions, and the states wanted to use that system to give taxpayers an indirect SALT deduction. However, regulations imposed by the US Department of Treasury prevented these plans from happening.

The 2017 tax law that included the SALT cap was opposed by most Democrats and supported by most Republicans. Democrats asserted that the SALT cap was used to penalize states with high percentages of Democrats, which often had higher state taxes. Because the SALT cap was seen by many Democrats as a partisan punishment on Democratic states, many Democratic lawmakers wanted to lift or change the cap imposed by the 2017 law. In 2020, the House of Representatives, which was then led by Democrats, attempted to pass a law that would raise the cap to $20,000 rather than $10,000. In 2021, Democrats controlled both houses of Congress and the White House, and they passed several large spending bills and enacted new laws. At that time, numerous Democrats in Congress proposed eliminating the SALT or greatly increasing the cap to $80,000 per year through 2025. The proposed SALT cap changes were part of a wide-ranging bill that would also provide numerous social programs, including paid family leave and paid childcare. The reduction or elimination of the SALT in the Democratic bill would have been one of the most expensive elements of the bill. Opponents to removing the SALT cap claimed that the Democrats’ bill, which was meant to support American workers and families, should not provide the biggest benefits to the wealthiest Americans.

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