Limitations on the State and Local Tax Deduction Hurt Pennsylvania in Two Ways

Marc Stier |

A major issue in the debate over the Republican tax cut bill is whether the deduction for state and local taxes (the SALT deduction) should be eliminated or reduced. The conference committee bill released on Friday proposes a “compromise” that would allow individuals to deduct up to $10,000 in some combination of state and local property and income or sales taxes.

That compromise is deeply problematic for Pennsylvania and many Pennsylvanians, in two different ways.

First, substantial numbers of upper middle-class Pennsylvanians will see their taxes go up as a result of the limitation on state and local tax deductions in the conference committee bill. These taxpayers are likely to be concentrated in the suburbs of Philadelphia, where a high percentage of taxpayers take the state and local deduction.

Second, the state as a whole will suffer because the limitation on the state and local tax deduction will make it more difficult for the state to raise taxes. This is a serious issue, especially at a time when the state suffers from both recurring budget deficits and a deep public investment deficit and yet there is little political will in the General Assembly to raise taxes.

We consider these two problems in order after the break.

Unfair individual tax increases

The following table contains an analysis of the impact of the provisions of the Senate tax bill with the compromise proposal on State and Local Tax Deductions contained in the conference committee legislation. It does not take into account other changes from the Senate bill in the conference committee legislation, most of which are expected to reduce taxes even more for the richest 1% of Pennsylvanians while not having a significant impact on anyone else.

Source: Americans for Tax Fairness based on data from the Institute for Tax and Economic Policy.

The table shows that in 2019 11.8% of Pennsylvanians in the 81st to 95th percentile will see their taxes go up by an average of $1,420. In the fourth quintile, that is, the 61st to 80th percentile, 6.2% of taxpayers will pay an average increase of $950. Overall, 5.7% of taxpayers will pay more under this “tax cut” bill, with an average increase of $890.

Now, normally, we at the Pennsylvania Budget and Policy Center would not complain about upper middle-class taxpayers paying more. We believe that given the serious public investment deficit in the country as a whole, those with higher incomes should pay more. However, we do think it is grossly unfair for upper middle-class taxpayers to pay more in taxes in order to give unnecessary tax cuts to the richest Pennsylvanians and wealthy businesses.
States and congressional districts are more likely to be affected by the elimination of the deduction than others. Although Pennsylvania is not among the states with the highest level of state and local taxation, the tax burden is higher in the parts of the state with higher incomes and wealth and that raise more local revenues for their schools.
If we look at the likely geographic location of the taxpayers who will pay more in Pennsylvania, the burden clearly falls in Southeast Pennsylvania which is represented by Republican members of the House of Representatives who have not yet announced their position on the tax bill, Ryan Costello (PA-6), Pat Meehan (PA-7), and Brian Fitzpatrick (PA-8).
The table below shows that the percent of taxpayers that currently use the state and local tax deduction is much higher in some congressional districts than others. Among Pennsylvania taxpayers as a whole, 28% use the state and local deduction for sales and income taxes. There is substantial variation among Congressional districts, however. In the fifth district in central Pennsylvania, only  17.2% of taxpayers used the state and local tax deduction. The percent of taxpayers who used the state and local tax deduction is highest in the three districts in the Philadelphia suburbs, with all of them at 42% or above. Similar variation can be found in the average deduction for those who take state and local tax deduction. The average in the entire state is $11,170. In the three suburban Philadelphia congressional districts the average state and local tax deduction is $13,547.  (Note that variation from one district to another in the average deduction is going to be limited because we are only looking at taxpayers whose state and local taxes are high enough for them to make use of the deduction.)
 Source: PBPC calculations based on the data found in Michael Leachman, House District Map: Partial SALT Repeal Kills Most Valuable Part of Deduction, Center on Budget and Policy, December 5, 2017.
We do not have numbers on the percentage of taxpayers in the three congressional districts in the Philadelphia suburbs who will see their taxes go up under the GOP tax bill. But we do know that the main reason some taxpayers will see their taxes go up under the GOP tax bill is that they will lose part of the state and local tax deduction. So we can make fairly assuem taht the assumption that the percentage of  taxpayers who will see their taxes go up will be proportional to the percent of taxpayers who take advantage of state and local tax deduction. This gives us a rough estimate that 8.75% of all taxpayers in these three districts will pay higher taxes in 2019 as a result of this tax legislation and that 18% of taxpayers in the 81st to 95th percentile in these three districts will pay more.
Again, we don’t in principle oppose asking upper middle-class taxpayers to pay more. But we don’t think their taxes should go up in order to cut taxes for the richest corporations and other businesses and the top 1%. This tax bill is unfair, not just to the bottom sixty percent of household who will y 2027 see their taxes go up, but is also to upper middle class taxpayers who will see their taxes go up even sooner in 2019.
The impact on Pennsylvania as a whole
The second serious consequences of limiting the SALT deduction is for the the state as a whole. Limiting the SALT deduction makes it more difficult for the state to increase taxes as the SALT deduction substantially reduces the burden on taxpayers of state and local taxes. Yet at least some increase in taxes is necessary to resolve Pennsylvania’s long term structural budget deficit.
Last month the General Assembly decided to borrow $1.5 billion based on tobacco settlement funds to pay for last year’s budget deficit. Over half of the new revenues used to balance this year’s budget deficit are non-recurring. The Independent Fiscal Office expects a deficit of at least $1 billion in the fiscal year that begins on July 1, 2018 and increasing deficits in the future.
As we have pointed out many times before, the source of the structural deficit is not that spending has increased—it has declined as a share of the economy—but that corporate and business taxes have been drastically reduced. And, whatever the cause, resolving the state’s deficit problem will require some combination of cutting spending and raising taxes, which is politically difficult as well.
If raising taxes becomes more difficult the General Assembly will have to look to budget cuts to resolve the state’s structural deficit. It is difficult to cut an already austere state budget in which a great deal of spending is mandated by state contractual obligations, pension costs., debt service, and the requirements of meeting federal matching funds. The areas in which cuts are easiest to make are education and in human services. Republicans in the General Assembly have already sought cuts to Medicaid (Medical Assistance in PA) this year.
But the problem created for the state by limiting the SALT deduction is not just likely reductions in spending on education and human services. There are many areas in which Pennsylvania faces a public investment deficit. On almost every measure of education spending Pennsylvania ranks among the bottom ten states. Spending on environmental protection has fallen by a third since 2007. Our roads and bridges and public transit systems are in serious disrepair. We are lagging behind neighboring states in Pre-K education. And we continue to have the most unequally funded K-12 schools in the country. Resolving all of these problems will be more difficult if the SALT deduction is even partially eliminated.
And, as Michael Bloomberg pointed out in a recent article, reducing public investment by the states will undermine economic growth in the future which. That is to say that limitations on the state and local deduction totally undermines the supposed benefit of the tax cut bill.
Yet reducing spending by states like Pennsylvania is exactly what Republicans in Congress seek. They have targeted the SALT deduction for elimination for two malignant reasons. First, they want to reduce spending and taxes not just at the federal level but in state governments as well. The hypocrisy of seeking this result appears to be lost on them since, during the fight over repealing the ACA they claimed that states should be doing more to fund Medicaid.
The second reason Republicans support a limitation on the state and local tax deduction is that the states that have higher spending and taxes and who citizens take the most advantage of the deduction elect more Democrats than Republicans to both state and federal office. This proposal is certainly bad public policy for many reasons. That it’s highly partisan public policy is one more.