The SALT deduction limit has been a hot topic recently.
Some say it makes federal tax burden more uniform across states and makes the tax code cleaner / simpler / more fair. Others say it unfairly burdens those in states with high income taxes and high property taxes – Or that it even hurts the middle class especially in those high tax states.
Does the SALT deduction limit impact middle-class households? Should it be increased or repealed, or is it fine as is?
Let’s explore.
A recent Jonathan Swan interview of Bernie Sanders described the SALT deduction as “a tax people for rich people in blue states.”
A clip of this interview went a bit viral on Twitter and the comments are interesting (and enlightening.)
They say don’t read the comments, but I learned a lot doing so and it led me to the following analysis.
SALT deduction limit background
The Tax Cuts and Jobs Act of 2017 placed a $10,000 cap on State and Local Tax (SALT) deductions. Previously the deduction was unlimited.
To be impacted by the limit, 3 things must be true:
- You pay more than $10,000 in State and Local Taxes (or you haven’t reached the limit, obviously)
- State income tax
- Property taxes
- You have total deductions that exceed the standard deduction (else you would just claim the larger standard deduction)
- $25,100 for Married filing Jointly in 2021
- $12,550 for Single
- Your tax burden under the TCJA must be greater than it would have been under prior tax law
The first 2 generally apply only to homeowners with a mortgage living in a State with both high income tax and high property taxes.
Two examples
Let’s look at 2 examples involving married couples earning $400,000 per year, one living in New Jersey and the other in California. This is the 98th percentile for US households in 2020 (only 2% earn more.)
They both own homes worth $1.6 million and have mortgages at the 3% interest rates.
This buys you either an “absolutely enchanting” 1 bedroom 1 bath 636 sq. ft. house in Palo Alto, CA, or a “spectacular 2300 sq. ft. brownstone on one of the prettiest tree-lined streets” in Hoboken, New Jersey.
Palo Alto, California
Hoboken, New Jersey
Here we come across the first change from the TCJA. Pre-TCJA it was possible to deduct interest on a mortgage up to $1 million. Now that ceiling is $750k. At 3% interest rates, this alone reduces deductions by ~$7,000/year for a deduction of ~$20,000 on $750,000.
The SALT deduction cap also raises its head here. The California couple would pay state income tax and local property taxes of ~$41,000. The New Jersey example would pay ~$61,000. However, they are both able to deduct only $10,000.
All totaled we get itemized deductions of about $30,000, which is ~only 20% more than the standard deduction of $25,100 (2021.) Imagine… paying $95k + in mortgage interest, property taxes, and state income taxes, and all you get for it is a lousy extra $5k deduction.
TCJA w/ SALT limit | California | New Jersey | Notes |
---|---|---|---|
Income | $400,000 | $400,000 | Married filing jointly |
Home value | $1,600,000 | $1,600,000 | 20% down, 3% 30-year fixed mortgage |
Mortgage interest | $34,060 | $34,060 | average annual interest in 1st 10 years |
Property taxes | $10,560 | $40,160 | CA: 0.66% NJ: 2.51% |
State income tax | $30,657 | $21,313 | |
Itemized deductions | $29,958 | $29,958 | Total, approximate |
Mortgage interest | $19,958 | $19,958 | Interest on $750k only |
SALT (state and property tax) | $10,000 | $10,000 | capped |
Taxable income | $370,043 | $370,043 | |
Federal tax | $80,067 | $80,067 | tax tables only ~20% effective rate |
Federal tax (Standard deduction) | $81,622 | $81,622 |
It takes some significant expenditure to make itemizing worthwhile, which is why the TCJA resulted in far fewer tax filers doing so.
“By increasing the standard deduction and limiting certain itemized deductions, the TCJA reduced the percentage of taxpayers that itemize and limited how much the tax code can award tax relief to taxpayers who spend in particular ways.” (source)
Now when losing tens of thousands of dollars of deductions, you might think that this would increase tax burden significantly. And you would be right.
Using the tax tables and the standard deduction, with $400k income the IRS would collect federal tax of $81,622, an effective tax rate of about 20%.
With an extra $5k deduction as a result of itemizing, total tax would be reduced to $80,067… a savings of $1,555.
By contrast, pre-TCJA with full deductions for interest on a $1 million mortgage and no SALT limits, using the standard tax tables the California household would pay federal tax of ~$45,000, and the New Jersey couple would pay ~$38,000. Which is about HALF!
But… another change from the TCJA was an increase in exemptions and phase-out thresholds in the Alternative Minimum Tax. The AMT is a way for the government to ensure households don’t get too many deductions by… eliminating SALT deductions, amongst other things.
With the TCJA, neither household would be impacted by the AMT. Pre-TCJA, however, the AMT would push total tax burden to $82,500 for both households, which by my math is MORE than what they pay under the TCJA.
pre-TCJA | California | New Jersey | Notes |
---|---|---|---|
Income | $400,000 | $400,000 | Married filing jointly |
Home value | $1,600,000 | $1,600,000 | 20% down, 3% 30-year fixed mortgage |
Mortgage interest | $34,060 | $34,060 | average annual interest in 1st 10 years |
Property taxes | $10,560 | $40,160 | CA: 0.66% NJ: 2.51% |
State income tax | $30,657 | $21,313 | |
Itemized deductions | $67,827 | $88,083 | Total, approximate |
Mortgage interest | $26,610 | $26,610 | Interest on $1,000,000 |
SALT (state and property tax) | $41,217 | $61,473 | NOT capped |
Taxable income | $312,216 | $291,960 | |
Federal tax | $44,863 | $38,178 | tax tables only CA: ~11% effective rate NJ: ~9.5% |
But... | |||
AMT | $82,437 | $82,437 | ~20.6% effective |
But wait… it gets even better.
Pre-TCJA, the Child Tax Credit was $1,000/child and phased-out starting at an AGI of $110,000 for MFJ. Now (you guessed it) the phase-out begins at an AGI of $400,000 and the CTC is worth $2,000/child ($3,000+ in 2021.)
Pre-TCJA a household would benefit by ~$1,400/child from having an extra exemption at the 33% marginal rate. Post TCJA that benefit is $600 higher.
Without a doubt these households benefit from the TCJA (albeit modestly.)
Why are people complaining about the SALT deduction limit?
There is a lot of press recently about how the SALT deduction limit is hurting the middle class.
My opinion…
If prior to the TCJA you could write a very large number in the deduction box for state and local taxes but now you can only write $10,000, you probably feel a bit miffed.
But looking solely at this box is a bit myopic – marginal tax rates were reduced across the board, the child tax credit was expanded, and the AMT was largely eliminated for all but the highest earning households.
Therefore, even those impacted by SALT caps paid less tax.
Here is an example from “high tax” New York – if you made less than $1 million, you federal tax burden decreased (more on this later.)
But if you are in that $1+ million income bracket and you paid 27% of income in federal tax instead of 26.5% and you have a congressperson who owes you a favor, then the best thing you can do is aggressively market that the SALT deduction limit is hurting the middle class. It certainly has better optics than “I can’t deduct all of my million dollar mortgage anymore” and “Can you believe the AMT no longer increases by taxes by 10s of thousands of dollars?!” or “I could never get the Child Tax Credit before because I make so much money, but this year the IRS gave me $4,000!”
But another reason we hear that the SALT deduction limit hurts the middle class is because, unfortunately, in some cases it is true.”
Middle Class SALT deduction limit impact
For most people in most places, the SALT deduction limit is a non-issue. This is clear from this CRFB analysis of who would benefit from a repeal.
Clearly most of the benefit goes to “the wealthy and the powerful.”
But some benefit goes to those making $50k+, and since the numbers in this chart are averages… some middle-class people would get a bigger benefit.
For example, on Long Island. In Nassau county, the median income is ~$120k and the median house price is $575k. These are just the numbers that come up on Google. (The median household income for the country is ~$68k. 75th percentile household income in 2020 was ~$120k.)
The property tax rate in Nassau county is high at 2.21% – the property tax bill on the median property is $12,700/year, so the SALT cap has an impact even before State income taxes.
If you have kids and benefit from the Child Tax Credit, you pay less federal tax. But if you don’t… often times you pay more. I modeled this extensively, and in the income range from $100k-$150k the tax curves cross over multiple times with a deviation of $500 +/-.
At the $120k income level using the standard deduction, a MFJ household might pay $12,375 in federal tax. Where most households in the country pay less, maybe you, a Long Island resident, pay $500 more. (But if you no longer itemize, maybe you do your taxes yourself instead of paying somebody $500?)
This house will probably sell for $575k. Is it a middle-class home at 2 bedroom, 2 bath, 1,165 sq. ft?
A Median home in Nassau county, Long Island, NY
Fix the SALT limit?
There are some issues with the SALT deduction limit – does it need to be fixed? Or are property taxes and state taxes special expenses that deserve special treatment by the tax code? That is a matter for debate over a few beers, or perhaps in the comments…
Some things to consider:
More middle class households are likely to be impacted somewhat by the limit over time as the $10,000 threshold is not indexed for inflation. In 2021 the value of $10k is already 4.5% lower than it was in 2018 when the TCJA was passed, and it is unlikely that anybody has lower property tax bills. I suspect this is by design so the trend is towards fewer people itemizing.
Married households are far more likely to be impacted – the $10k limit is per tax return not per person. Making the limit per person would be more in line with the rest of the tax code. Change the per person value accordingly.
That most middle-class households have had their tax burden reduced by the TCJA, is it fair that childless households in states with high income taxes and high property taxes may have a higher federal tax burden? Or is a more uniform tax code more appropriate?
Summary
The TCJA disincentivized itemizing by increasing the standard deduction and limiting certain itemized deductions (e.g. SALT.) This means federal tax burden is more uniform across States – a household in California making $x will pay the same amount of federal tax as a household in New Jersey or Tennessee or Alaska, more often than not.
Despite the limit to SALT deductions, most households across the income spectrum saw federal tax burden decrease with the TCJA. In fact, many who are upset that they can no longer deduct 10s of thousand of dollars in state and local taxes actually pay less tax than pre-TCJA thanks to reduced marginal tax rates, an expanded child tax credit, and changes to the Alternative Minimum Tax.
There are some exceptions – very high income households in states with high income tax and high property taxes, and some middle class households in those same states.
The SALT deduction should be abolished entirely, not just capped. It is nothing more than a way for states to “justify” higher tax rates by the fact that they’re taking (a large fraction of) the money from the federal government instead of the taxpayer.
The SALT deduction is nothing more than a federal subsidy for states with high taxes.
If taxpayers are unhappy now that they’re feeling the pinch of their states’ high tax rates, perhaps they’ll do something about it when they go to the ballot box.
I dunno, this seems like missing the forest for the trees. Most of the complaints about paying more tax because of the SALT deduction limit are inaccurate – people notice their deduction was reduced but not that their tax bill is LOWER due to the sum of all changes (CTC, AMT, reduced marginal rates, etc…)
Similarly, the high tax states typically send more money to the federal government than they get in return. The low tax states often get subsidized by the high tax states as that is just where the people who make high incomes live. It is necessary to look at the system as a whole.
But if you are a very high income person in a high tax state, it is politically sophisticated to convince the majority of voters that they are impacted so you can get all of the benefit of change.
Although I am a conservative on most issues, I was incensed recently while reading “Kochland”, the expose of the Koch brothers business practices and impact on the Federal government. Charles Koch has been a master at convincing many that he is a libertarian when in reality he influences tax policy to protect his company and his own personal wealth, period. Unfortunately Americans are gullible to the pronouncements from such people as well as the politicians on both sides of the aisle, who are ALL looking out only for themselves and their wealthy benefactors. The sooner the taxpayers realize this, including the “debate” that takes place around the SALT deduction, the better off the vast majority will be, and perhaps the proper demand for changes can be started.
I agree that ditching the SALT deduction is the way to go. And also ditching the charitable donation deduction and mortgage interest deduction, especially on second homes. I would gladly give up deductions in favor of lower rate. Increase the tax base and lower the rates.
I think older mortgages are grandfathered in. So the deductibility limit for new mortgages is 750k, but if you had a bigger one (1M as a married filing jointly couple), you can keep deducting all the interest. Feel free to check that!
Dunno – the SALT issue is the same either way
I don’t understand why the government persists in enacting tax laws that are not indexed to inflation. Is it simply shortsightedness or something more nefarious?
It’s intentional – over time more people will just take the standard deduction making the whole thing less complex.
The nefarious part was they changed the inflation calculation in the TCJA (it rises more slowly) so by year 6 or 7 more people will pay more tax than pre-TCJA.
Any time they say they are simplifying the tax code, they are NOT !
I will vote for the first politition that says he will raise my taxes ( they all lie )
Often it’s because they are trying to hit “pay for” targets and not indexing helps do that.
On the nefarious side: they sometimes are trying to make the bill come up again (or every year!) so they can get paid multiple times by the lobbyists.
So as a person who just bought a 625K house in Nassau County with an AGI of 170K, I should be really mad or just a little mad?
That seems like a matter of personal preference. I would probably go with option C, build a life where $500/yr doesn’t matter one way or another. Anger just slowly eats away at your soul.
If you have kids you most definitely come out ahead with the TCJA
Good examples on the overall tax burden for a higher income earning household actually being flat or down due to AMT reduction and lower marginal tax rates.
Too bad the child tax credit phase is out for household who make over $150,000 a year, which is extremely common in places like New York and California. College graduates are making $150,000 a year. So by the time they are going to have kids in their late 20s or 30s, they are surely going to be making over $150,000 a year.
If you guys come back to the states and live in a bigger city,I think you may be surprised with how much more money people really make.
Sam
CTC starts to phase out at $400k
I think the Samurai is correct on this one. In 2021, the credit begins phasing out at $150,000 for MFJ. 75K for single. It’s also 3K for children between ages 6-17 and 3,600 for kids under 6. And how would that change your numbers?
Not really.
The CTC was increased for 2021 in the American Rescue Plan (details here.) The phase-our for the increased amount only begins at $150k MFJ.
The $2,000 CTC is the fall-back with a phase-out that begins at $400k MFJ.
In the examples above, the TCJA results in less tax paid even without the CTC. The $2k is a bonus.
Another change in the TCJA was the elimination of the personal exemption, including for kids. So that offsets at least some of the increased CTC.
Yes, no exemptions post-TCJA (this is factored into the analysis above.)
For somebody in the 32-35% tax bracket, a ~$4,350 exemption for a child is worth about $1,400-$1,500
Another way to look at the TCJA is to compare the impact between residents of higher tax states (blue) to lower tax states (red).
While your examples show minimal tax impact in high tax states, residents of low tax states get a big reduction.
It is pretty clear that the TCJA was designed with this as one of the goals – much larger benefit to residents of red states.
The rhetoric says this, sure. The data doesn’t really support it.
Thank you, sir. Getting tired of the whole “blue state good”, “red state bad” nonsense.
I’ve not read all of it yet, but Dan Rather’s What Unites Us is pretty good
I’m not sure… this analysis / data seems to suggest it isn’t only rhetoric:
https://eml.berkeley.edu/~auerbach/did-the-2017-tax-reform-discriminate-against-blue-state-voters_NTJ_071720.pdf
Charts on pages 24-27 give a good view of the SALT impact. Yes, this is mostly a ‘rich’ (top 10%) impact but clearly there is a difference between red & blue, as designed.
The whole phrasing of things as red vs blue states is super lazy thinking – there are no red states or blue states, there are people who vote Democrat or Republican living in every state and elections are won by single digit margins.
The situation is as thus:
Post-TCJA, guy in New York making $x pays the same federal tax as guy making $x in Texas or (pick a state.)
But guy in New York is butt hurt because, even though he pays less tax than he used to, it turns out the guy in Texas pays less also, but his tax savings is 1% more.
There is a phrase that goes something like, if you are accustomed to privilege then equality feels like persecution.
So what needs to change next for guy to feel like things are fair? Because he lives in a higher cost of living area the federal government should tax him less? Or the Child Tax Credit should be $4000 for someone living in NYC but $1500 for somebody living in Wyoming?
There are other instances of the NY guy getting much greater benefits – there is no tax on the cost of employer provided health insurance benefits. Insurance costs much more in NYC than in Wyoming. Same goes for ACA policies – the NY guy gets greater subsidies. But we don’t go around saying the ACA is designed to punish red states and reward blue states.
The rest is all conjecture.
As a liberal-minded person making a good income in California, I had very mixed feelings about all this stuff.
I noticed the effects that you describe in this post – that our deductions went down the drain, but overall tax burden also decreased quite a bit. There was a bit of funny feeling about how those of us in expensive states got the short end of the stick relative to those with lower state taxes, but the sense of relief was also real that not having to deal with itemized deductions or AMT made tax filing a lot easier.
More importantly, I cringed at the TCJA lowering our taxes… I mean, sure, I was happy to keep more to myself. However, it seemed fundamentally flawed that while (1) the party in power complained about growing national debt, (2) wealth inequality continued worsening, and (3) government services were inadequately funded, the most comfortable few percent of Americans including myself should be contributing less. I didn’t love that my acceleration toward early retirement was to come at the expense of shifting more of the society’s burdens onto the less privileged.
Aside from the overarching theme of TCJA being a tax cut for the rich, I think it’s important to recognize that all changes require gives and takes. It’s impossible to “fix” a system or simplify a process without producing some winners and losers. IMO the law’s impact on deductions and AMT is at least a move in the right direction and should be welcomed by most people.
Scrap the entire federal tax code and put in a flat tax for both personal and business.
Steve Forbes is a proponent of this and has some good content on it for anyone interested.
If you are Steve Forbes, the best part of a flat tax is all of the poor and middle-class people pay more tax and you pay less.
It would kick in above a certain income level so lower income folk would not need to pay.
Jeff Bezos, Trump and others would not get away without paying taxes through creative loop holes so the rich would actually pay more than under the current regime.
Simplifying the tax code would eliminate all the special interests. Not to mention freeing up a ton of intellectual capital that spends countless hours trying to avoid paying taxes : )
This is what the flat tax marketing department says, I agree.
First, this isn’t a flat tax – it’s a progressive tax with 2 rates, 0% and Whatever%.
If you are going to have 2 marginal rates, there is no issue with having more than 2 (currently 8.)
More importantly, the math doesn’t work. If you tax upper earners at rates lower than today then you have to tax lower earners at rates higher than today.
But there will be fewer exemptions and deductions… that’s fine, but the main exemption the ultra-wealthy have is just not realizing income. You need a wealth tax in addition to an income tax if you are going to capture that. The flat tax does nothing here.
The tax system we have today didn’t start out with infinite complexity and nuance. A flat tax system wouldn’t either. But every year more changes would be implemented, some good intentioned.
I’ve heard the US spends as much as 6-8% of GDP on tax compliance. Freeing that up would be nice. Most of this could just be tackled by having the IRS send you a completed tax return each year as is done in Norway and more. (More info)
“the main exemption the ultra-wealthy have is just not realizing income. You need a wealth tax”
Often difficult to quantify wealth as it relies in part on valuations.
Profits (income) can be quantified more precisely.
Because USA does not credit (impute) company tax to shareholders – unlike wage tax – USA companies seek to reduce profits by incurring interest expense by borrowing – often from lower tax countries.
Profits can be quantified more precisely, yes. A flat tax would therefore not make the rich pay more.
Overall tax burden USA / Aus similar. USA burden on lower incomers higher. Aus burden on high incomers higher.
Aus Commonwealth receives Goods & Services Tax of 10%, re-distributed to States by formula. No State or Local income tax.
No compelling case for something like ‘$10,000 limit on SALT deductions’.
It’s certainly a tricky topic, but I like the idea of SALT being gone (or gone for a large % of people) because it doesn’t encourage mortgage debt. Especially with today’s housing prices, I think it is too easy to think having a high mortgage is a benefit. Some of these states need to get their finances in order or more people will go south. I’m from PA, outside of school property taxes, I would say we are medium of the road for taxes. That said their is a reason that people are migrating to Texas and Florida that have no state income tax. They are getting the full standard and pay no state income taxes….I expect their populations will continue to increase.
What do you think of this article? – Wait, California Has Lower Middle-Class Taxes Than Texas?
No state income tax doesn’t mean free. It just means the state gets its revenue elsewhere.
My guess is the housing prices have become even more unattainable for lower / middle income people in CA. The article references the move benefiting higher incomes more which makes sense. If a lower / middle income is taxed more but their housing is more affordable even with those increased taxes that would make sense. At some point high tax states CA,NY,NJ need to make some changes or I predict this exodus will accelerate. Heck I hope I’m wrong and they stay so they don’t keep inflating prices outside of these states ! The number of NY/NJ people retiring in Myrtle Beach area is staggering to me, I imagine FL is the same, I simply don’t travel there to see it first hand.
But the middle class person would pay more tax in Texas – thus California is not a high-tax state, it is a state with many areas with high cost of housing.
Removing single-family zoning and other NIMBY methods to restrict building at the Federal level would help.
This just goes to show that people will still hate something that the opposing political party does regardless of it changing their lives at all, even very minimally or for the better.
America is so politic now, and it makes me happy to be living in Japan. So sick of how politics dominates the lives of Americans. People need to relax and enjoy life more.
Relaxing and enjoying life are good. But fascism and insurrection are bad, so…
One thing not mentioned is the possibility of doubling up on paying property tax every other year in order to take a larger deduction in those years.
Also, I’m skeptical that the standard deduction (indexed to inflation) will rise as quickly as property values (and thus property taxes) and mortgage rates in the coming years.
The latter part is by design I think. Over time 99% of people should use the standard deduction.
What is an example of doubling up on property tax payments being beneficial? When you are nowhere near the SALT cap but still have a lot of itemized deductions?
This was a technique that worked for one year. When the tax changes had been approved but not yet implemented many of us paid property tax and quarterly state tax in December (when it would be fully deductible) rather than waiting until the following year when 10K SALT limitation kicked in.
Not an on-going solution as you pointed out unless a person has a low SALT.
The TCJA did not reduce marginal tax rates across the board. Some of us (HOH filers) saw marginal rates increase up to 7% on the same amount of taxable income.
From 15% to 22%? What income ranges for that?
Thanks!
No, from 28% to 32%/35%.
There is a visual in this paper. https://fas.org/sgp/crs/misc/IN11039.pdf
I would love to see you run your analysis for an HOH filer.
Thank you for writing and posting about this. No one else that I know of thinks about taxes like you do–it is very practical and to be honest, very very helpful. Thanks again for the great work!
I’m weird like that. Glad it helps!