It’s a Write-Off, Jerry!

Alexandra F. Baldwin

There are people who will tell you there is a Seinfeld reference for virtually everything, and I have a hard time arguing with those people. As someone with an unhealthy recall for movie and TV quotes who has seen every episode more than once (don’t ever try and tell me that my stoner phase was unproductive…) I rarely go a day without hearing or seeing something that reminds me of Seinfeld.

Which is why, earlier this week, when a couple of well-meaning Tweeters responded to a tweet about limits on the deductibility of State and Local Taxes (“SALT” - but not the “SALT” that I sometimes refer to on Friday mornings…), I couldn’t help but think of Kramer and his “write-off theory.” The tax bill, I was told, was simply closing a “loophole” in the tax code that made low-tax red states subsidize high-tax blue states.

“You don’t even know what a write-off is.”
“No, but they do! And they’re the ones writing it off!!!”

“Loophole,” of course, has become shorthand for “any tax deduction that benefits another person  but not me.” In a broader sense (like the famed “Gun Show Loophole”) it has become shorthand for “any circumstance that doesn’t currently exist in the way I would like it to,” but I am going to limit this to tax code issues.

The deductibility of State and Local Taxes is no more a loophole than the mortgage interest, 401K contribution or education expense deductions. In fact, since it is based in the sound Federalist principle that one level of government should not tax another and represents a direct hike in marginal rates (as opposed to removing a distortion), you could argue that it is even less of a loophole than those other, behavior-driving tax incentives. {I wouldn’t, because none of them are actually loopholes at all, and because I have already detailed my wish that we eliminate all of them en masse}. Pretty soon you get to a point where every single deduction is a loophole, which is fine, except for not matching up with the meaning of words.

Yes, in the literal sense, the services provided by high-tax states (which, before you call me biased, does not include my current home state of Massachusetts nearly as much as you think) come with reduced revenues to the Treasury. As long as we are being literal, though, we can note that the net impact to the Treasury of all State and Local Tax deductions is less than each of the Earned Income Tax Credit, mortgage interest deduction and either pension or 401K contributions. It’s a fraction of the “cost” of treating capital gains as separate from income, deferring taxes on foreign-controlled corporations or excluding imputed rental income. It is about 25 percent as large of the employer-provided medical insurance “loophole.” The actual “subsidy” flowing from low-tax states to high-tax states (which would be probably 35 percent of the total SALT deduction), in other words, is not a needle-moving figure.

I’d also be remiss in noting that two can play this game, my friends. Not only if this a line of thinking that cuts both ways, it in fact cuts the other way even sharper. The disproportionate share of Federal aid received by low-tax states allows them to keep their taxes artificially low. And those payments are full-value cash payments, unlike a SALT deduction, which is worth only a portion equal to the taxpayer’s marginal Federal tax rate.

There are some other inconvenient facts for low-tax states that are suddenly convinced they are subsidizing high-tax states to some grossly inequitable degree. While the correlation is far from perfect (Hawaii, Kansas and Nebraska are very obvious outliers), those same low-tax states are beneficiaries of Federal spending disproportionate to the Federal tax they pay. Other than the aforementioned Hawaii (methinks there is a naval base that drives this), the 10 states that receive at least double in Federal spending what they pay in Federal taxes are all low-tax states. How, for example, might Mississippi’s state tax rates look different if more than one in five residents wasn’t receiving Federal SNAP assistance? Who, really, is subsidizing whom?

Another imperfect correlation that nevertheless lines up neatly with this debate is that the Federal tax code, which doesn’t adjust for cost of living, is already patently unfair to residents of many of the states that will be hurt by limiting the SALT deduction. A dollar in Seattle is not the same as a dollar in Little Rock, but a person earning the same amount of them in those two places is treated by the tax code as if they are. With a progressive tax code and numerous deductions limited to specific dollar amounts, states with a higher cost of living and proportionately higher wage environments will always pay disproportionately higher Federal taxes.

In a more conceptual sense, the glee taken by some low tax states in formulating a tax code change that impacts other people much more than them is a break from a philosophy that many would claim to believe in. Asking that tax collection and spending be moved from the State to the Federal level is an anti-Federalist position from states that generally espouse more state autonomy. Intellectual consistency would call for those states to want their taxes collected locally more than Federally, but I suppose that intellectual consistency has never been a prerequisite for any American tax policy discussion.

It is almost as if this is really about Republican senators trying to find as many ways as possible to shift the tax burden from their constituents to those of states with Democratic Senators…

The tax code, as I have written before, is a mess. There is no magic to the current rates or deductions, and we should give no deference to the current regime when discussing changes to it. Politically, the biggest problem with the tax code is that it is too complex to even allow for an intellectually honest and rational debate. It is too easy to cherry pick data points and exclude relevant mitigating factors, to speak in half-truths and hide behind the obfuscation of contextualized facts.

This includes the ease with which we often dismiss anything we don’t like as a “loophole.” Before we go throwing out intentional, rational and logical portions of the tax code, though, we should try to be honest with ourselves about what we are doing and why we are doing it. Under that lens, SALT is an economically curious but politically very obvious place to start, and we should be naturally dubious of anything that makes more sense politically than economically.

Besides, you wouldn’t believe what those people are writing off these days.