Many details of the Republicans’ proposed overhaul of the federal tax code remain murky, but one piece of the plan that emerged last week would eliminate a deduction worth $2 billion for 200,000 Hawaii taxpayers in 2015.
The “framework” for tax reform unveiled by President Donald Trump and his fellow Republicans last week would eliminate the federal income tax deduction for payments of state and local taxes, an idea that was also promoted by previous Republican presidents, including Ronald Reagan and George W. Bush.
But it also has some powerful critics, including the National Governors Association and the U.S. Conference of Mayors, which last week labeled elimination of the deduction as “unacceptable.”
Democratic New York Gov. Andrew Cuomo branded the proposal as a de facto tax increase on middle- and upper-class New Yorkers, and warned it could drive residents and businesses out of the state.
Tax Foundation economist Nicole M. Kaeding said New York was instrumental in killing a similar proposal to eliminate the deduction for state and local taxes in 1986, but cautioned that it is still unclear how eliminating the deduction would affect ordinary taxpayers in Hawaii or anywhere else.
NO SALTThe Republican tax reform proposal would eliminate the federal income tax deduction for state and local taxes, also known as SALT.
>> That federal deduction was claimed by 200,000 Hawaii taxpayers in 2015
>> 95 percent of Hawaii taxpayers making more than $500,000 claimed the deduction
>> 19 percent of Hawaii taxpayers making less than $100,000 claimed the deduction
>> SALT reduced taxable incomes for Hawaii taxpayers by $2 billion
Source: Tax Foundation
Currently, taxpayers who file itemized returns are allowed to deduct some taxes paid to state and local governments from their gross incomes, which reduces their federal tax liabilities.
Eliminating that state and local tax deduction, sometimes referred to as SALT, is a key component of the new federal tax proposal because it would offset some of the cost of Republicans’ plans to reduce income tax rates, Kaeding said. The Tax Foundation estimates eliminating the deduction would save the federal government $1.8 trillion over the next decade.
It isn’t possible yet to calculate the impact of eliminating SALT on any specific taxpayer because under the Republican plan “an individual might lose this deduction, but their marginal income tax rate at the federal level would be decreasing at the same time,” Kaeding said. No one knows exactly how that will play out.
“Unfortunately, the framework is not incredibly specific on some of these points, so we can’t say for certain that everyone will be better off, but many people would be better off under this trade — their tax rates come down, versus still being able to claim that deduction,” Kaeding said. “This helps finance tax cuts for everyone.”
About 28 percent of U.S. taxpayers claim the SALT deduction on their itemized returns, she said, and it tends to be a perk for higher-income taxpayers in high-tax jurisdictions.
The Joint Committee on Taxation of the U.S. Congress calculated that taxpayers with incomes greater than $100,000 enjoyed more than 90 percent of the benefit of the deduction in 2014, while taxpayers earning less than $50,000 enjoyed less than 1 percent of those benefits.
Mixed benefits
Eliminating the deduction is quickly emerging as one of the most controversial pieces of the Republicans’ plan.
A major complaint about the SALT deduction historically has been that it effectively forces lower- and middle-income taxpayers across the country to subsidize higher state and local government spending in wealthier states such as California and New York.
The deduction has the effect of “reducing the felt cost of higher taxes in those states” by reducing the federal tax burden for taxpayers from those states, according to the Tax Foundation. Kaeding said eliminating the deduction would make the tax system more progressive by forcing wealthier people to pay more federal income tax.
A major concern with wiping out the deduction is it would increase the federal tax burden on taxpayers in states and cities with higher state and local taxes. And that is politically complicated because that includes many communities that are represented by Republicans.
High taxes in Hawaii
Hawaii, meanwhile, has one of the highest marginal state income tax rates for upper-income taxpayers in the country, and also has one of the most broad-based state taxes in the nation in its general excise tax.
According to a draft study for the state Tax Review Commission done this year by PFM Group Consulting, per capita state and local taxes for Hawaii were the ninth highest in the nation in 2014 at $5,708 per resident.
Gov. David Ige said last week he is “definitely concerned” about the proposal to eliminate the state and local tax deduction. If the Republicans are able to push a tax package through Congress without significant input from the Democrats, Ige said he worries that “it would definitely end up being a package that benefits big business and the affluent at the expense of everybody else.”
“What I hope to see in this tax reform package from the Congress is that it truly helps the middle class, that it helps the small businesses,” Ige said. “We know that in this changing economy, the job creation is coming from that small-business sector, and I know when I talk to people in the state of Hawaii, it’s the middle class that’s being squeezed out.
“They don’t have a whole lot, and they don’t benefit from a lot of state and federal programs, and they bear the brunt of the cost of running the federal government,” he said.
More pressure on poor
The Tax Policy Center of the Urban Institute & Brookings Institution published estimates Friday that the overall “potential impact” of the Republicans’ proposals would be a $2.4 trillion reduction in federal revenue over the next decade. It would also provide a windfall for the richest taxpayers because they would receive the largest tax cuts, according to the report.
University of Hawaii economist Carl Bonham said he is concerned about the possible impact of another round of tax cuts on the federal deficit, and the fallout from that.
“If you blow a big hole in the government’s source of revenue, then you suddenly have all this motivation, particularly by the Republican Party, to reduce government spending,” Bonham said. “When you do that, the pressure for reduced spending tends to fall disproportionately on the lower-income households, on the middle-income and below.”
He added: “Imagine reduced spending on education, reduced spending on infrastructure. … These are all things that will affect predominantly lower-income households. If you basically cut the source of revenue, then you have this momentum of reducing spending on things we really need, things that could help to raise productivity, which then helps to raise wages, which then helps to deal with the inequality.”
Still, the Republicans’ tax proposals have a long road ahead in Congress.
Todd Belt, political science professor at the University of Hawaii at Hilo, said the Republican package will be a “hard sell,” especially if the Democrats can focus public attention on aspects of the plan that benefit the wealthy. Those include Republican proposals to lower income tax rates for the highest earners and to eliminate the estate tax, he said.
“Tax cuts are very popular in general, but once you get into the specifics is when things start falling apart,” Belt said. “When people realize that the lowest tax rate is actually going to go up, that can generate some problems.”
The lowest federal income tax rate today is 10 percent for low-income taxpayers, while the outline of the Republican plan released Wednesday indicates the lowest tax rate under the new plan would be 12 percent.
That higher bottom tax rate is supposed to be offset by other Republican proposals to double the size of taxpayers’ standard deductions and an increase in the earned-income tax credit for low-income families, but Belt said those kinds of complexities present political problems.
“That’s kind of difficult to explain to people, and the whole idea was they were going to try to simplify the code and simplify the process,” Belt said. “There’s an old saying in politics that if you’re explaining, you’re losing.”
