Tuesday , September 22 2020

SALT

Summary:
Chris Pullman and Richard Reeves at Brookings write opposing a reinstatement of the deduction for state and local taxes on the federal income tax. Jonathan Parker, a great economics tweeter, tweets approvingly, I offer a little more guarded approval. Yes, it's praiseworthy when any organization in our politicized times criticizes the favored narrative of the party ...

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Chris Pullman and Richard Reeves at Brookings write opposing a reinstatement of the deduction for state and local taxes on the federal income tax. Jonathan Parker, a great economics tweeter, tweets approvingly

SALT
I offer a little more guarded approval. Yes, it's praiseworthy when any organization in our politicized times criticizes the favored narrative of the party they are perceived to be associated with. And the SALT deduction should, in my view, not be reinstated. 

But though they are right, but they are not right for the central reasons. And the reasons they give are a lot less non-partisan than Jonathan makes it sound. 

Their arguments against SALT are entirely based on redistribution -- tax the rich more. 

1. Lifting the SALT cap would be massive tax cut for rich 

2. Lifting the SALT cap much more pro-rich than Trump’s tax bill  

3. Even with the cap, the SALT deduction is most valuable to affluent  

OK, it's fun to point out the hypocrisy of Nancy Pelosi, Chuck Schumer, and Joe Biden savaging the Trump "tax cuts for the rich" and promising more such, yet so heartily backing a proposal that is very narrowly targeted at lowering taxes for their (largely Democratic, Blue-state) wealthy supporters.  

But this argument is Democrat v Democrat. By this analysis, the tax system should always be more progressive. The only answer to "how much should we tax the rich?" is always "more." That's not really "non-partisan!" 

When is enough enough? What is the  right overall (federal, state, local, payroll, sales taxes, property taxes, estate taxes, etc. all considered) average and marginal tax rate for high income households? How close are we to that? The answer is not always "more," and every single element of the tax code should not be evaluated by its contribution to greater progressively alone. The progressively of the entire tax and transfer system matters, not each provision in isolation.  

Most of all, economic analysis should focus on incentives. There really is nothing a-political to say about redistribution, but there is plenty a-political to say about incentives. 

My main objection to the state and local tax deduction is that it gives a distorting incentive to state governments. With a 40% top federal marginal tax rate and a deduction, when a state like California raises taxes on "the rich," by $100, that rich person pays $40 less in federal taxes. People who live in other states, in the end, pay $40, without the chance to complain. Rich people in the California have less incentive to complain. (Or to move to Nevada. In droves.)  

I'm of the opinion that marginal tax rates are too high, when you put all the taxes together, so I might favor the deduction for that reason. Again, that's an incentive argument, and I have less of an opinion about average tax rates. But in my judgement, I'd rather see marginal rates decline because state governments face the full cost of their decisions and face the economic effects of high marginal rates. Deductibility is also useful to make sure that the total tax rate does not exceed 100%. Even the most left-wing person must admit that disincentive effects kick in somewhere!    

John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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