A pinch of compromise to appease the critics of the SALT ceiling
Recently, the Democratic governors of California, Connecticut, Hawaii, Illinois, New Jersey, New York and Oregon called on the White House to push to remove the cap on deductions from the IRS for local and state taxes – known to tax fools as SALT. Several Congressional Democrats are also making this pitch. Their lobbying has come under attack from both ends of the political spectrum. Some of the more progressive Democrats rightly point out that removing the cap would unduly benefit the wealthy, and Republicans argue that a higher cap would reward residents of blue states who tax and spend excessively.
As part of Trump-era tax cuts in 2017, a limit of $ 10,000 per tax return was imposed to help fund cuts elsewhere, such as with the alternative minimum tax which often further penalized the middle class than the investor class. However, the SALT cap was only one part of this tax reduction bill. The 2017 law also cut rates for the top bracket far more than the value of those taxpayers’ SALT deductions, and the Trump team also found a way to give huge tax relief to crony real estate investors and partnerships. private individuals with a 20% deduction from their income in what is called the QBID – the qualifying business income deduction.
I wrote previously that the QBID giveaway never made mathematical sense in the first place, since owners of private companies and partnerships already enjoy lower tax rates than investors in public companies whose income from corporations are taxed while their dividends and capital gains are also taxed. at the individual level. So putting a comparable limit on the QBID at the same time as the SALT limit is increased – say to $ 20,000 per joint declaration – would provide tax relief for upper-middle-class taxpayers, entrepreneurs and investors with no one percent windfall. . For Democrats, this is fair trade and provides some, but perhaps not all, of the revenue needed to raise the SALT cap.
But raising the SALT deduction cap to a level that appeases upper-middle-class voters is only half the issue raised by these seven Blue State governors in their call for President Biden. All of these states have high tax brackets for the wealthy and now suffer from the threat of actual emigration from their wealthier residents, those who shop at tax establishments with a view to moving their primary residence to a remote location. low tax or no income. Tax state.
This political dilemma is what public finance experts call “tax competition,” a race between state and state to deliver tax breaks to the wealthy. The federal system must create a level playing field, based on which each state can make rational decisions without this weapon of federal tax policy in its head, and then live with the consequences if they do lead the rich to other places in the future. exaggerating. them.
The derogatory complaint of wealthy taxpayers is that any move to increase federal and state income tax brackets for millionaires is “confiscatory.” They show the highest federal marginal tax rate of 37% (which is expected to revert to pre-Trumpian levels of 39.6%), more the 3.8% surtax on investment income financed by Medicare, more their respective state and sometimes the city’s income tax rates, which can be double digits – pushing the combined marginal rate above 50 percent for higher levels. In New York and throughout California, for example, the state-local combination can total top marginal rates above 13%. Hawaii and New Jersey both peak above 10 percent, with Oregon and Washington, DC, just behind at 9.9 percent. When you factor in the federal tax bite and about half of its earned income is taken away by tax collectors, a state’s proverbial geese don’t just hiss or bite, they flee.
The level of truly confiscatory taxation is questionable, but many fair people would agree that working for less than half of your after-tax income is a logical reason to migrate to a low-tax place if the combined rates are not capped. While accepting the responsibility of paying his fair share, billionaire Leon Cooperman has made televised arguments to draw the 50% line. Aware of this serious but self-serving point of view, there are two important political nuances that require further examination and reflection:
● The SALT deduction is not limited to income taxes. This includes property taxes and (sometimes) sales taxes, and no one can argue that “income forfeiture” includes active taxes on McMansions, especially in tax havens like South Florida, where private wealth is protected from creditors by family property protection laws. If wealthy people choose to buy trophy houses, rare works of art, and lavish yachts, it is their elective decision, not a reason for federal tax benefit.
● Most millionaires are not wage slaves working for wages and bonuses, but are instead allowed to wallow in lower capital gains tax rates. This privilege applies in particular to hedge fund tycoons, oil tycoons, real estate developers and the idle wealthy who have inherited or built large portfolios now taxed at a maximum federal rate of 20%. Again, the question is whether a marginal federal rate of 20% and a high-end state and local income tax rate of 10-14% are really “confiscatory.” Most salaried professionals would disagree, and gag on providing tax relief to these One Percenters while they pay higher rates on the earned income shown on their W-2 forms.
To craft a fair compromise that resolves all of these problems, a SALT deduction cap raised to $ 20,000 could be supplemented with an income tax “circuit breaker” – a provision of the federal tax code allowing a direct tax credit. (not just a deduction). ) for top taxpayers whose combined federal, state and local income and social charges exceed 40% of their total adjusted gross income (not just their last marginal dollar). Property and sales taxes should be excluded from this calculation, making it specific to income tax. Income taxed at lower rates, such as capital gains, would not qualify.
This breaker design eliminates forfeiture tax rates, while denying benefits to preferred investors and fund managers who already treat the federal tax code for lower rates. Looking ahead to the next budget bill, if Democrats in Washington end up raising tax rates for wealthy investors and setting a higher cap on payroll taxes, or if Blue states set even higher rates for wealthy investors? millionaires, then this meticulous tax compensation would provide a reasonable safety valve to counter the recurring chants of “confiscation” by the One Percenters and their congressional sycophants.
Robin Hood’s tax policies must have their limits. But millionaire Blue State investors shouldn’t always have their cake and eat it, too, as they would if Congress repealed the SALT deduction cap entirely.
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