The current tax debate in Congress is fundamentally a fight over whether most of us will sacrifice to pay for tax cuts for the wealthy and corporations. The Republican tax bill that has already passed both houses of Congress and is now in conference committee is the latest manifestation of a long-term conservative goal to enact so called “tax reforms” that will further redistribute wealth upward.
One of the many ways the bill does this is by eliminating state and local tax (SALT) deductions. Not only will this change amount to a regressive redistribution of wealth — since it would effectively take money from all of us and give it to a small group of rich people — it will also be a handout to big banks and wealthy bondholders.
Because eliminating the SALT deduction at the federal level will raise taxes on working families, it will make it harder for state and local governments to maintain their current tax rates. This will lead to declining tax revenues at the state and local levels, and likely force public officials to borrow money to fill budget shortfalls. As a result, Wall Street banks and law firms will be able to collect massive fees and bondholders will be able to take in billions in interest payments while cities and states cut vital services and become mired deeper in debt.
Currently, families can deduct the income, sales and property taxes they pay to state and local governments from their federal taxes, meaning they don’t have to pay federal taxes on the income they use to pay state and local taxes. The SALT deduction is intended as a subsidy for state and local governments since it helps reduce opposition to state and local taxes by making them less costly to taxpayers.
The Republican tax bill proposes to eliminate the federal tax deduction for state and local income and sales taxes and to limit the deduction for property taxes. The bill exempts most businesses from this change, which means they will continue to be able to use the SALT deduction.
As a result of this bill becoming law, and the SALT deduction being eliminated, working families stand to see their federal taxes increase. According to a report by the Government Finance Officers Association, in 2015, taxpayers deducted $552 billion in state and local taxes. If this deduction had not existed, the additional tax burden would have been an estimated $167 billion.
If federal taxes were to suddenly spike by $167 billion, state and local governments would have a choice to make: They could either let taxpayers absorb the additional expense, potentially causing a political backlash, or they could lower tax rates to offset the increased expense for taxpayers. Lowering state and local tax rates would force public officials to either cut public services in order to make up for the lost revenue or increase borrowing in the form of bonds.
Borrowing to close budget gaps is particularly problematic because it creates even more opportunities for the upward redistribution of wealth by forcing taxpayers to pay issuance fees and interest on the bonds. Issuance fees are the costs that cities and states pay to the financial and legal firms involved in the process of issuing a bond.
For example, a 2015 study by the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the ReFund America Project (of which I am the director) looked at issuance fees for 812 bond issuances from around the country. The study found that the weighted average for issuance fees in the sample was 1.02% of the initial bond principal. Based on these findings, if state and local governments decided to borrow the entire $167 billion to offset the impact of eliminating the SALT deduction, they would likely pay $1.7 billion in issuance fees to the banks that underwrite the bonds, along with the other financial and legal firms involved. That is another $1.7 billion local governments will not be able to spend on public services like education and healthcare.
And the issuance fees are just the tip of the iceberg. On a conventional 30-year, fixed-interest rate bond, the interest payments over the life of the bond are roughly equal to the original principal. So if state and local governments borrow $167 billion, they will likely have to pay another $167 billion in interest to bondholders. This additional $167 billion would similarly come at the expense of public services.
Because most municipal bonds offer relatively modest returns but are exempt from federal taxes, the bondholders that invest in them are often wealthy individuals whose main interest is to use such bonds as a tax shelter. If state and local governments were forced to take out $167 billion in additional debt, much of the interest from those bonds would go to these rich investors.
In reality, it is unlikely that the additional tax burden from eliminating the SALT deduction would have a one-to-one correlation with increased state and local government borrowing. If the SALT deduction is eliminated and federal taxes shoot up by $167 billion, state and local governments will likely borrow only a portion of that amount to offset the cost for taxpayers. The rest would likely come from spending cuts and the pushing of costs on to working families.
However, we can expect that local governments will be forced to borrow tens of billions of dollars, which would result in a windfall for the Wall Street banks, law firms and wealthy bondholders who stand to collect tens of billions of dollars in issuance fees and interest payments.
Not coincidentally, the executives of these financial and legal firms — and the wealthy individuals who invest in municipal bonds — are some of the same people who will be the prime beneficiaries of the Republican tax bill. Eliminating the SALT deduction is just another way the GOP tax bill will take from poor and working people to further enrich the wealthy and powerful.