Recently, the U.S. House of Representatives passed a bipartisan tax deal, followed by the introduction of the SALT Marriage Penalty Elimination Act by Rep. Mike Lawler (R-NY). This bill, which passed the House Rules Committee 8-5 on February 1st, may be considered on the House floor as soon as next week. However, it raises several concerns regarding its impact on the budget deficit, the tax code, and its benefits to higher earners.
The bill proposes to increase the $10,000 cap on state and local tax (SALT) deductions to $20,000 for joint tax filers who earn under $500,000 in adjusted gross income for the 2023 tax year. For those earning over $500,000, the current law $10,000 cap would remain in place. The rationale behind this proposal is to eliminate the SALT deduction cap’s marriage penalty. However, reducing the SALT cap to $5,000 for single filers could be another way to address this issue.
While the bill represents a serious effort by policymakers to address the concerns of members in SALT-sensitive districts, its design creates several problems that violate the principles of sound tax policy. First, the proposed change to the SALT deduction cap would cost about $11.7 billion, according to the Tax Foundation’s Taxes and Growth model. If the proposed change was extended to 2024 and 2025, it would cost another $25.5 billion over those two years. The bill contains no offsets, so the revenue loss would increase the budget deficit and accrue additional interest costs.
Second, the proposed income limit of $500,000 creates a new and massive marginal tax rate cliff in the tax code. Joint filers earning $499,999 would be able to deduct up to $20,000 in SALT from their return. Joint filers earning one additional dollar would see up to $10,000 in SALT deductions immediately disallowed. This tax cliff would create distortions in taxpayer behavior by incentivizing filers to stay just under the income limit and introduce new taxpayer frustration.
Third, the adjustment to the SALT cap only benefits taxpayers who elect to itemize their deductions and pay more than $10,000 in state and local income or sales and property taxes. Taxpayers who do so tend to be higher earners, which means SALT relief usually makes the tax code less progressive.
Finally, the bill would not increase long-term economic growth or encourage additional economic activity because it changes SALT rules temporarily and retroactively in 2023 only. For an adjustment to encourage growth, it must be done on a permanent basis. The negative economic effects of the SALT cap could be considered when planning the design of a SALT cap post-2025, but the temporary and retroactive change considered in this bill does not alter long-run economic growth.
In conclusion, while the SALT Marriage Penalty Elimination Act is a well-intentioned effort to address the SALT deduction cap, it presents several issues that could have significant implications for the tax code and the economy. Policymakers should consider these factors carefully when planning the future of the cap.