The SALT fight is coming to a head

In April, this column reported on the great SALT controversy and how it impacts California taxpayers. SALT stands for “state and local taxes,” and for many years prior to President Trump’s term in office, taxpayers could deduct those taxes from their federal tax returns without limitation. But in 2017, Congress enacted Trump’s tax reform, which limited the amount of state and local taxes that taxpayers could deduct up to $10,000. Whether limiting the SALT deduction is good or bad tax policy is not nearly as interesting as the politics behind it.

The adoption of the limitation by the Republican-led Congress was broadly perceived as a big middle finger to high-tax states such as California. Whether a pretext or not, states with modest income tax rates, or no income tax at all, complained that their residents were essentially subsidizing residents of profligate, big-spending states.

But moderate- to high-income taxpayers in California and other high tax states lost a valuable deduction on their federal returns. Suddenly they felt the full pain of high state income tax rates and property taxes. Frantic state politicians began plans to lessen that pain. For example, immediately after passage of the tax reform law, California floated the idea of a semi-voluntary “charitable deduction” scheme to give high-wealth Californians some relief. It would have created a “charitable” fund within the general fund so high-earning taxpayers could claim a deduction for “donating” the equivalent of what they owed in state taxes. But the IRS, in an opinion letter, quickly shot down that idea.

More successful was a method adopted by many states to provide relief for certain “qualified entities,” consisting mostly of small businesses organized as partnerships, LLCs or S corporations. While Gov. Gavin Newsom signed California’s workaround embodied in Assembly Bill 150, it provided little relief for citizen taxpayers.

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The last remaining hope for opponents of the SALT limitation was a lawsuit brought by four states seeking to invalidate the SALT limitation on constitutional grounds. But just last month, this challenge was unanimously rejected by the Second Circuit of the U.S. Court of Appeals in New York v. Yellin.

The Republican-majority Congress may have been pleased with the pain inflicted on high tax states, but in a clear case of schadenfreude, the loss of the SALT deduction may have cost Republicans their control of Congress. Several members from California who voted for the 2017 tax reform measure were blamed for raising taxes on their over-taxed constituents and that cost them their reelection bids. But now, Republicans watch Democrats fight among themselves over SALT.

There are many progressive Democrats in Congress who don’t want to bring back the unlimited SALT deduction even if they’re from high-tax states that would benefit, because the SALT deduction favors the rich far more than the middle class and working poor. The progressive wing of the Democratic Party has made no secret of their dislike of the policy. In short, don’t expect AOC, other members of “The Squad,” or Bernie Sanders to support increasing the cap.

As we’ve noted before, the split within the Democratic Party over the SALT deduction reveals no small degree of hypocrisy. For all their complaining about “income inequality,” Democrats from high tax states who want to help their rich constituents are on the verge of expanding SALT deductibility as part of the Build Back Better package. The SALT fight may be just one of the many roadblocks to the Democrats’ bill but it is certainly the most entertaining and one with ramifications for high-tax California.

Jon Coupal is president of the Howard Jarvis Taxpayers Association.