US tax: reinstating deductions would hamper infrastructure plans

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For high tax rate American city and state governments, deductibility of state and local levies has long been a bedrock of federal income taxation. President Donald Trump’s 2017 tax reform law mostly repealed this state and local tax, or “Salt”, deduction. Lower federal marginal rates were implemented at the same time. Now the deduction may receive an unnecessary reprise.

Blue America howled when the deduction was lost, guessing that this change targeted Democrat states including New York and California. With the Democratic party holding power across Congress and the White House it makes sense to expect a reversal. Yet the deduction, which favours highest-earning Americans, should not be a priority.

Today, up to $10,000 of Salt deductions are permitted. Meanwhile, the so-called “standard deduction” is $25,000 for married couples who choose not to itemise tax deductions. Imagine a household earning $500,000 with $50,000 of Salt deductions prior to the rule change. At a 35 per cent federal tax rate, the household is $14,000 poorer with no Salt deduction.

A stacked bar showing value of the Salt deduction, by income as a percentage of gross income

The country’s wealthiest are most affected. According to IRS data analysed by Congress, tax returns with income greater than $1m accounted for less than 1 per cent of tax returns but claimed more than a quarter of Salt deductions. If the Salt deduction were to be reinstated virtually no benefits would accrue to 90 per cent of Americans, estimated the Tax Foundation think-tank.

High-income Democrats are influential and several Congress members are pressing to reinstate deductions. The issue has added salience given that taxes for millionaires in New York have just increased. As Wall Street soars and big banks and law firms report higher profits, those soaked in cash are looking for ways to reduce their tax bills.

Income distribution of Salt deduction benefit, By income category, 2017 ($bn)

Yet according to Congress’s joint committee on taxation, the Salt deduction cost the US Treasury $100bn in revenue in 2017, the year before the change in tax law. That figure fell to roughly $25bn this year, with only a limited deduction in place. That $75bn increment going to the US Treasury will come in handy when it comes to paying for a trillion-dollar infrastructure plan.

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