A Tax Gift to the Rich Divides Democrats

President Joe Biden and Speaker of the House Nancy Pelosi depart following a meeting with the Democratic caucus at the U.S. Capitol in Washington on Oct. 28, 2021. Nicholas Kamm/AFP via Getty Images

Commentary

President Joe Biden repeatedly said he would raise taxes only on the rich to pay for his Build Back Better plan, but now he’s backing a tax break for millionaires and billionaires, contradicting his promises.

While the White House calls it a “compromise” to move the president’s agenda forward, this is a big deal, according to critics, as Biden and Democrats will likely face a messaging problem heading into the 2022 elections.

House Democrats on Nov. 19 passed Biden’s nearly $2 trillion social and climate spending plan. The bill, called the Build Back Better Act, contains a wide variety of tax provisions, including an increased federal deduction for state and local taxes, or SALT.

The plan allows taxpayers to deduct up to $80,000 of state and local taxes against their federal income taxes, a sharp increase from the current $10,000 cap. This means many among the rich would pay lower federal income taxes than they currently pay.

President Donald Trump’s 2017 Tax Cuts and Jobs Act limited individuals’ deduction for SALT payments to $10,000 per year. This cap on deductions, the studies show, has increased the tax bill for residents of high-tax states, especially those who earn more than $500,000.

Blue states with higher individual income and property tax rates, such as New York, New Jersey, and California, objected to the cap imposed under the 2017 tax overhaul, saying it’s unfair to their residents. Since the passage of tax reform, they’ve tried various tax maneuvers to avoid the limitation.

Critics on both sides of the aisle, however, have for years said that eliminating or raising the SALT deduction cap would be a handout to the rich.

Under the House plan, roughly one-third of the tax benefits would go to the richest 1 percent and three-quarters would go to the richest 5 percent, according to an analysis by the left-leaning Institute on Taxation and Economic Policy.

Another analysis, by the right-leaning Tax Foundation, found that “the top 1 percent of earners would experience a 0.8 percent increase in after-tax income in 2022 due to a more generous SALT deduction.”

The handout to the rich in the first few years would be much higher than the money spent on child tax credits, which is “pretty unbelievable,” says Garrett Watson, a senior policy analyst at the Tax Foundation.

The House bill would increase the cap to $80,000 from 2021 through 2030 and drop it back to $10,000 in 2031. Without changes, the current $10,000 limit is set to expire by the end of 2025. So the change proposed by the House would result in a tax cut for higher earners for 2021 through 2025, and a tax hike for 2026 through 2031, Watson said.

The SALT break in the first few years, however, will likely hit a Senate wall, as key senators have already voiced opposition. Sens. Bernie Sanders (I-Vt.) and Robert Menendez (D-N.J.) say that any SALT relief should benefit those earning less than $400,000 rather than the very wealthy.

Sanders criticized Democrats over their “hypocrisy.”

“You can’t be a political party that talks about demanding the wealthy pay their fair share of taxes and then end up with a bill that gives large tax breaks to many millionaires,” Sanders wrote on Twitter on Nov. 18.

“The hypocrisy is too strong. It’s bad policy, it’s bad politics.”

But this reform is especially important for lawmakers in high-tax states, including Senate Majority Leader Chuck Schumer (D-N.Y.), who vowed to eliminate the SALT cap “forever.”

“It will be dead, gone, and buried,” he said last year.

High tax states are losing residents and congressional seats as migration to low-tax states continues. California, for example, will lose one seat in Congress next year for the first time in state history. Goldman Sachs estimated that the SALT deduction cap may have lowered tax revenues in high-tax states by up to 1 percent due to tax revenue declines from emigration.

It remains to be seen who wins the SALT battle, but it has already become a divisive issue among Democrats.

Progressives have got “a real messaging problem,” said Jonathan Williams, chief economist at the conservative American Legislative Exchange Council.

Hence, there’s going to be “some heartburn” on the Senate side, he said.

In addition, he said, many state legislators, particularly in low-tax states, feel strongly that any reform to repeal or increase the SALT cap “amounts to a subsidy for high tax, high spend states.”