How to Fix the SALT Cap

By Tom Walton

House Republicans are debating the cap on state and local tax deductions, which has boosted economic growth and tax revenue but penalized itemizers in high-cost-of-living congressional districts. A straightforward fix for the current stalemate is to adjust the standard deduction according to the differing living costs across congressional districts.

In the Wealth of Nations, Adam Smith said taxes should be levied in proportion to a person’s ability to pay (fairness) and in a way that minimizes administrative costs and adverse effects on productive economic activity (efficiency). The cap on State and Local Tax (SALT) deductions was an integral part of the Tax Cuts and Jobs ACT (TCJA) of 2017, the brainchild of then-House Speaker Paul Ryan (R-WI), whose focus was on efficiency. But as efficient as it was, the legislation fell short on both accounts. What’s more, there’s an easy fix that remedies the problem.

To his great credit, Ryan recognized that lawmakers of both parties had historically used the tax code to advance the interests of their constituents at the expense of overall productive economic activity — at the expense of economic growth and the wealth of the nation. Today, the nation’s taxpayers waste more than $500 billion a year filling out tax returns, hiring accountants to steer them through the complexities, and paying lobbyists to preserve and expand their tax breaks or “incentives,” as the legislators call them.

This is not the worst of it. The tax preferences divert investments from their most productive uses, such as when they are given to this or that business at the expense of others that are more productive, who contribute more to the nation’s gross national product.

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Blue state Republican supporters of raising the SALT cap argue it unfairly burdens middle-class families in high-cost districts compared to those in lower-cost areas. Why should a couple with two dependents and an adjusted gross income of $200,000 in New York receive the same $30,000 standard deduction as a family of four in Des Moines, despite different living costs?

The existing limit on state and local tax deductions for itemizers is inequitable. It leads to businesses and workers relocating from districts where the cost of living is increased due to the distortionary SALT cap. This is not what Adam Smith had in mind. The greatest economist of all time would likely suggest keeping the cap but adjusting each district’s standard deduction based on its cost of living.

Start with a base of $30,000 for the 2025 tax year and adjust it annually for national CPI increases. But make geographical, not just temporal, adjustments according to differences in the cost of living among different parts of the country. Residents in New York metro area congressional districts would receive twice the annual amount, $60,000, that taxpayers get in the average district. Residents of Des Moines would receive approximately 10 percent less than the specified amount of $30,000.

It’s really very simple. Use a table like that provided by The Council for Community and Economic Research (C2ER) Cost of Living Index (COLI). Taxpayers in each Congressional district can be identified via https://www.coli.org. Ensure no tax increase for any taxpayer in the first year, and then gradually adjust the amount each year to achieve a fair and efficient system for everyone. If still deemed unfair, use some of the increased tax revenues to balance it out.

Tom Walton ([email protected]) is a policy advisor with The Heartland Institute.

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