Shortly after the U.S. House of Representatives passed the bipartisan tax deal earlier this week, Rep. Mike Lawler (R-NY) introduced the SALT Marriage PenaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples.
Elimination Act, which passed the House Rules Committee 8-5 on February 1st and may be considered on the House floor as soon as next week.
While the bill would offer incremental relief, it would increase the budget deficit, create a new cliff in the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
code, and mostly benefit higher earners, all without improving long-run economic growth.
The bill would increase the $10,000 cap on state and local tax (SALT) deductions to $20,000 for joint tax filers who earn under $500,000 in adjusted gross income for the 2023 tax year. For those earning over $500,000, the current law $10,000 cap would remain in place.
One rationale for this proposal is to eliminate the SALT deduction cap’s marriage penalty, as the cap is a fixed amount worth $10,000 for all filers under current law. However, reducing the SALT cap to $5,000 for single filers would be another way to fix this marriage penalty.
Taxpayers began to file tax returns for the 2023 tax year on January 29th. If the bill is passed into law, it would require taxpayers or the IRS to adjust already-submitted tax returns.
While the bill represents a serious effort by policymakers to address the concerns of members in SALT-sensitive districts, its design creates several problems that violate the principles of sound tax policy.
First, we estimate the proposed change to SALT deduction cap would cost about $11.7 billion using Tax Foundation’s Taxes and Growth model. If the proposed change was extended to 2024 and 2025, it would cost another $25.5 billion over those two years. The bill contains no offsets, so the revenue loss would increase the budget deficit and would accrue additional interest costs.
Second, the proposed income limit of $500,000 creates a new and massive marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax.
cliff in the tax code. Joint filers earning $499,999 would be able to deduct up to $20,000 in SALT from their return. Joint filers earning one additional dollar would see up to $10,000 in SALT deductions immediately disallowed.
Joint filers in this income range are typically in the 32 percent or 35 percent marginal income tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat.
depending on the total value of their itemized deductions. If a filer is in the 35 percent tax bracket, earning the additional dollar and losing $10,000 of deductions creates an extra $3,500 in tax liability. This creates a marginal tax rate of 350,000 percent on that additional dollar of income.
This tax cliff would create distortions in taxpayer behavior by incentivizing filers to stay just under the income limit and introduce new taxpayer frustration. The common way to avoid a tax cliff is to phaseout the deduction over a range of income, which would increase marginal tax rates over the income range but not result in a dramatic cliff.
Third, the adjustment to the SALT cap only benefits taxpayers who elect to itemize their deductions and pay more than $10,000 in state and local income or sales and property taxes. Taxpayers who do so tend to be higher earners, which means SALT relief usually makes the tax code less progressive.
Using the Tax Foundation Taxes and Growth Model, we find the proposal would increase after-tax incomes for the top 20 percent of taxpayers by 0.3 percent while the bottom 40 percent of taxpayers would see little change in after-tax incomes. The top one percent would see a relatively small 0.1 percent increase in after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize after-tax income.
because the $500,000 income limit means the highest earners don’t benefit.
In dollar terms, taxpayers who earn less than $100,000 would see nearly no benefit from the SALT cap. Only about 1.3 percent of the total tax change would accrue to taxpayers earning under $100,000, and less than 1 percent of filers in this group would see a tax cut.
On the other hand, taxpayers earning more than $200,000 receive nearly 77 percent of the total tax change and between a third and one half of those filers would get a tax cut. From a revenue standpoint, about $9 billion of the $11.7 billion in lost revenue would accrue to joint filers earning more than $200,000.
Because of the income limit, filers earning more than $500,000 would see no tax benefit.
Finally, the bill would not increase long-term economic growth or encourage additional economic activity because it changes SALT rules temporarily and retroactively in 2023 only. The SALT cap increases marginal tax rates, which discourages work and investment, but for an adjustment to encourage growth, it must be done on a permanent basis. The negative economic effects of the SALT cap could be considered when planning the design of a SALT cap post-2025, but the temporary and retroactive change considered in this bill does not alter long-run economic growth.
A temporary and retroactive change would not assuage taxpayer uncertainty headed in 2025, as the $10,000 cap is scheduled to expire under current law but may be taken back up as part of broader efforts to make the Tax Cuts and Jobs Act (TCJA) individual provisions permanent.
Taking these concerns together, the SALT Marriage Penalty Elimination Act would be a flawed way to address the SALT deduction cap. Policymakers should consider the long-term future of the cap in the context of the broader tax expirations in 2025, as they will need revenue if the TCJA tax cuts are made permanent. In the meantime, we should set aside short-term efforts to weaken the SALT cap.
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