How the SALT Deduction Subsidizes Opportunity Hoarding
As part of last year’s tax reform, Congress introduced a $10,000 cap on the state and local tax (SALT) deduction. The change has been controversial, splitting members of Congress across regional and party lines. Now, the controversy has been rekindled by the push to make the tax reform’s changes to individual income taxes permanent (they are currently set to expire after a decade) and by a recent report from the Tax Policy Center showing that the benefits of repealing the SALT cap would accrue overwhelmingly to high-income taxpayers.
Among policy experts, there is a consensus that the cap disproportionately affects upper-income taxpayers in blue states. Stakeholders have used these basic facts to frame repeal proposals as either a valid response to a partisan attack on blue states or a hypocritical rationalization of tax cuts for the rich. Although the distributional effects of the SALT deduction cap are important, advocates of its repeal argue that what we really want to consider are its political effects. This is where we find more disagreement. Experts typically focus on two behavioral responses to higher real-estate taxes — migration and support for financing increased spending — but have ignored a third: support for housing regulations.
Missing Political Feedback Effects
The debate surrounding the merits of the SALT deduction is linked with debates about the appropriate size of government spending and structure of the tax system. On the spending side, demand for government services is constrained by the willingness of taxpayers to finance them. Because the SALT deduction lowers the cost of financing state/local government spending, residents will demand more spending with the deduction than they would in its absence. In other words, the SALT deduction incentivizes (depending on your perspective) big government or a generous social safety net.
On the tax side, the argument is that the SALT deduction incentivizes a heavier reliance on progressive taxation. Because it is only available to taxpayers who itemize, and it typically only makes sense for high-income taxpayers to itemize, the SALT deduction has the effect of reducing the cost of levying taxes on high-income earners relative to everyone else. In both cases, it potentially changes people’s incentive to vote in the ballot box or with their feet.
Many conservatives believe that in the absence of the SALT deduction, residents of high-tax states would quickly see the merits of moving to low-tax states after finding themselves forced to pay the full costs of higher government spending. There have been countless studies on the migration patterns of select groups of wealthy taxpayers (e.g., superstar athletes) in reaction to state tax changes, but the most comprehensive comes from sociologist Cristobal Young. He finds that tax rates have a negligible effect on the rich when it comes to decisions about state residency. For all the talk of capital being highly mobile, the owners of capital are just like everyone else. They set down roots in a certain region and are unlikely to move cross-country just to save a few dollars on their taxes. As the Brookings Institution’s Vanessa Williamson reasons, “blue-state Democrats may have reasons to alter their tax systems to avoid the new SALT cap, but the threat of losing revenue to millionaire flight should not be one of them.”
Many liberals believe that the SALT deduction reduces political resistance to higher taxes among the rich. As such, the new cap will make it harder to raise revenue through progressive taxes, forcing policymakers to look elsewhere for revenue or reduce spending. Because the SALT deduction was introduced as part of the original 1913 federal income tax, it is impossible to study its impact by seeking variation over time or across states. Some economists have tried to measure its impact by studying small changes that have been made to the deduction and come away with mixed results. Those that do find some evidence the SALT deduction induces states to rely more on progressive taxes often fail to account for basic alternative explanations, such as partisan control of state governments.
Moreover, this debate neglects one of the basic facts in the literature on fiscal federalism: The United States is the only country in the world that allows taxpayers to deduct the cost of state and local taxes. Despite this, it spends less than most rich democracies. For example, the absence of a SALT deduction has not stopped Canadian provinces from raising three times as much revenue from progressive income taxes as American states.
The problem with these claims about the SALT deduction is that they focus almost exclusively on the state level — whether people move from one state to another or whether they support more progressive state taxes. Few are discussing the SALT deduction’s potential effect on local communities. We do see feedback effects on peoples’ decisions about where to live and how to vote, but not in the way most people think.
SALT Deduction and NIMBYism
An emerging literature in sociology and political science is shifting our attention to local politics. Many of these studies focus on the problem of “not in my backyard” (NIMBY) politics. We know that self-interested homeowners take their property values into consideration when voting and even do so at the expense of their ideological preferences. We know homeowner self-interest propels them into action at greater rates than other stakeholders. The result is the growth of exclusionary, NIMBY housing policies that exacerbate racial inequality and reduce social mobility.
In contrast to other tax breaks like the mortgage interest deduction, the potential role of the SALT deduction in reinforcing or undermining exclusionary housing policies has drawn little attention from opponents of NIMBYism. It is worth unpacking its political effects, however, because the evidence suggests capping the SALT deduction dealt a substantial blow to NIMBYism.
From the perspective of pure self-interest, affluent homeowners have two major reasons to promote exclusionary housing policies. First, because such policies push up the value of existing housing, current homeowners see their property values skyrocket. This is important in the United States, where credit is cheap for those with the requisite collateral to take out loans. As the values of their homes rise steadily over time, homeowners build more equity that they can use for big-ticket items such as home improvement projects, their children’s college educations, and even medical emergencies.
Second, high prices make exclusionary communities unaffordable for most families. In keeping them that way, wealthy homeowners engage in a form of opportunity hoarding whereby they ensure their property taxes go exclusively toward the safest neighborhoods, best schools, and most amenities for themselves, to the exclusion of lower-income families.
The affluent town of Wellesley, Massachusetts, is a perfect example of these political dynamics. It is consistently ranked as one of the best places to live in Massachusetts, in large part because it excludes nonaffluent families by regulating housing so tightly that it is nearly impossible to build multifamily housing there. In theory, exclusion can be expensive though. As the value of your home rises, so does your property tax burden.
Imagine owning a house in Wellesley with today’s median value of $1,267,000. The property tax rate of 1.18 percent, while below the state average, means you will be end up paying $14,938 in total property taxes each year. It turns out that exclusion is very expensive. As exclusionary policies continue to drive up the value of your home, your taxes will get more expensive. In this scenario, a self-interested homeowner is forced to weigh the benefits of home equity and municipal services against the cost of property taxes. In other words, the homeowner must bear the cost of their NIMBYism.
Pouring SALT on the Wound
This is where the SALT deduction is important. Rather than subsidize property tax rate increases with the noble end of providing services, it looks like the SALT deduction incentivizes increases in the assessed value of the underlying property, bought through exclusionary policies. Prior to the introduction of the $10,000 cap, that homeowner was able to deduct the entire cost of their property taxes from their federal liability. For simplicity, let us assume they are in the 24 percent income-tax bracket. Of the $14,938 they paid in local property taxes, the federal government will refund them $3,585, effectively reducing their property tax burden by 24 percent. This amounts to a $3,585 incentive for residents to support exclusionary policies because they gain all the benefits while the full cost is subsidized by taxpayers outside of the community.
With the new SALT deduction cap, that same homeowner can only deduct $10,000 worth of property taxes, reducing the NIMBY subsidy from $3,585 to $2,400. They must now pay more of the cost of their NIMBYism. As their home value increases and the real value of the unindexed cap decreases, they will be forced to pay even more of that cost over time.
It is no coincidence, as many blue-state politicians have complained, that the cost of the SALT deduction cap falls disproportionately on residents of states like California, Massachusetts, New Jersey, and New York. It is a downright lie to say that it falls predominantly on the middle class in these states, though. The reality is that the SALT deduction cap reduces subsidies for affluent people in affluent exclusionary communities who have been collecting a NIMBY premium for far too long. We should be celebrating it as a victory for inclusion and affordable housing.
As members of Congress begin to think more seriously about what kinds of federal policy changes can help tackle the scourge of local NIMBYism, dropping efforts to repeal the SALT deduction cap are a great start. But ultimately, they need to move toward the goal of eliminating the SALT deduction altogether.
Joshua McCabe is an assistant professor of sociology and the assistant dean for social sciences at Endicott College. He is an expert on tax and social policy; author of The Fiscalization of Social Policy: How Taxpayers Trumped Children in the Fight Against Child Poverty (Oxford University Press); and a Niskanen Center Senior Fellow.