August 7, 2021
A Federalist Case for State and Local Deductions
“I am, at the Fed level, libertarian; at the state level, Republican; at the local level, Democrat; and at the family and friends level, a socialist.” – Nassim Taleb
Rockefeller, Vanderbilt, and Phipps always come to mind when political and economic pundits talk up raising taxes on the rich. Why’s that? The answer is simple… These three extraordinarily rich families were the most prominent financial backers of the venture capitalists who created what became Silicon Valley.
Too often missed by economists, politicians, and pundits is that the rich have copious amounts of money to lose. That’s why they’re so crucial to progress. While losing $10,000 is very painful to the average investor, the rich have the capacity to lose $10,000 many times over without batting an eye. That’s why they were so instrumental and remain instrumental in what Silicon Valley was and is today. Since the vast majority of start-up companies go belly-up, only the rich have the means to back such low percentages that, with their successes and failures, power so much advance.
Rockefeller, Vanderbilt, and Phipps have certainly come to mind a lot in recent months, but surprisingly it’s while reading columns on taxation by Republicans. Consider one by the Wall Street Journal’s William McGurn… A writer normally at odds with all things Senator Bernie Sanders, McGurn observed that the Vermont socialist had “been doing the Lord’s work on taxes” with Sanders’ criticism of Democratic party efforts to revive the State and Local Tax deduction – otherwise known as “SALT.”
McGurn was pleased because back in 2017, President Donald Trump signed into law the Tax Cuts and Jobs Act. The Act included a $10,000 cap on the federal tax deduction of taxes paid by individuals to cities and states. McGurn added that Sanders “rightly appreciates that the SALT deduction is a big fat tax break for rich people.”
OK, but since when do Republicans look askance at tax cuts for the rich? Don’t they properly disdain class-warfare stances?
Much more important, any change in the tax code that reduces the burden placed on the rich is logically a very good, very pro-growth development. See the opening paragraphs… The rich aren’t like you and me. They aren’t because, as evidenced by the adjective attached to them, they have enormous amounts of unspent wealth. Which is another way of saying that the rich uniquely have the resources to fund gigantic commercial leaps.
Putting Wealth to Work
Short of stuffing their immense wealth under a mattress or into endless coffee cans, the rich have no choice but to put their wealth to work. Yes, what the rich don’t spend is, logically, invested, often in intrepid ventures that most of us lack the means to put money behind. The savings of the middle class could never have created Silicon Valley.
It’s all a reminder that tax cuts for the rich amount to tax cuts for all of us. When they get to keep what’s theirs, whether earned or inherited, we all get a boost in pay by virtue of unspent wealth being used to boost existing businesses, or to vivify entrepreneurial concepts that were formerly just that: concepts.
In the words of Adam Smith:
It is by means of an additional capital only that the undertaker of any work can provide his workmen with better machinery, or make a more proper distribution of employment among them.
There are no companies, no jobs, and no advances in how we work absent investment first. Tax cuts for the rich are a raise for all of us. Period.
Now, it should be clarified that most who view the revival of the SALT deduction in critical fashion would nod their heads along to what I just wrote. Try as Paul Krugman might to pour cold water on the genius of savings, no economic school can get around the basic truth that companies, jobs, and progress are preceded by capital commitments that the rich are uniquely situated to make.
Despite this, it’s accepted wisdom on the Right that revival of the SALT deduction is wrongheaded. Again, it’s a tax cut for the rich, plus it’s a subsidy for high-tax blue states. If SALT is revived, blue, Democratically run states like California, Illinois, and New York will get a tax break on the back of red, Republican-run states not so wasteful on the local level.
At first glance, the arguments are compelling. But only at first glance… Given a second pass, these confidently pronounced arguments against re-introducing the deduction start to lose their luster.
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Where the Right Is Wrong
For one, members of the Right can’t have it both ways. Yet with SALT, that’s what they seem to want. Lest we forget, members of the Right have for the longest time properly ridiculed calls by Obama, Biden, Elizabeth Warren, Nancy Pelosi, Krugman, et al., for higher taxes on the rich. According to the leading minds of the Left and the Democratic Party, the rich need to pay their “fair share.”
In response, the Right-leaning have routinely (and once again, properly) pointed out that the top 1% of taxpayers already account for 40% of total federal tax revenues. So what could the Dems possibly mean by “fair share”? The question is crucial but also demands to be asked of Republicans so eager to keep the SALT cap in place. Their answer seems to be no tax breaks for the rich and no subsidies for Democratic-led states.
Except that states don’t pay taxes… People pay taxes. In the U.S., the richest Americans once again account for a gargantuan portion of the annual federal tax take. All the revival of SALT would mean is that the heavily overtaxed rich would get a partial break from their annual fleecing. For the Right-leaning to pretend SALT’s revival would amount to “a big fat tax break for the rich” is for them to speak with a forked tongue.
If the rich already pay the majority of federal taxes (and they do), the revival of the SALT deduction would amount to tax relief for a tiny part of the population that creates or invests in the most economic progress and that is heavily overtaxed for doing so.
Now, some who disagree will respond that Americans in low-tax, allegedly parsimonious states shouldn’t have to suffer reduced deductions against federal taxes paid in concert with blue states enjoying large deductions. Such a change in the tax code wouldn’t be “fair.” That’s one way of looking at it, but it’s much less fair that so many of the blue-state rich folks endure so much federal taxation simply because they’re rich.
Indeed, while the top 1% account for roughly 40% of total federal tax revenue, Loyola University economics professor Walter Block calculates that the top one-tenth of 1% of Americans account for 19.5% of total federal revenues. Talk about unfair! And that’s only part of the story.
Too often those red states which are worried about “a big fat tax break for the rich” miss the fact that federal taxes paid by the rich are very much a tax on all of us. Lest readers forget, every dollar that the U.S. Treasury collects in taxes is an extra dollar of control that Pelosi, Kevin McCarthy, Chuck Schumer, Mitch McConnell, and President Biden have over the economy.
Government spending is a tax. And contrary to Keynesian economic theory that says spending is an economic stimulant, logic indicates the exact opposite. Politicized allocation of wealth, which is all government spending is, is by its very name an economic somnolent. Looked at from this angle, Americans should cheer any scenario that reduces the flow of dollars to Washington. A revival of SALT would obviously shrink the flow. Simplified, a tax on Mark Zuckerberg is a tax on you, me, and the fellow behind the tree.
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The Free Market Versus Political Waste
To which critics will ask an obvious question: If state and local taxes are once again fully deductible against the federal tax bill, what’s to keep states from taxing and spending with abandon as a way of shielding their citizens from federal taxes? The question is a good one, but one that unwittingly supports SALT’s revival. For one, conservatives should be much more confident about their economic view of the way the world works. Government spending, whether by city, state, or national governments, is economically harmful. What will limit city and state spending is the basic truth that market-driven wealth allocation always and everywhere trumps politicized allocation.
Still not convinced? Ironically, what has you skeptical should have you supporting SALT revival. Think about what happens if cities and states choose excessive spending to massively shrink the federal tax bill of their citizens. The local waste will limit the flow of dollars to the U.S. Treasury, which means that the economic damage will be more limited (think local) in scope… which is kind of the point. The 10th Amendment in the Constitution wasn’t some inkblot. Rather, it was clear that the vast majority of legislating should take place in states. So let it happen. States are precisely where the government spending should be…
And what about the deficits? Treasury debt is already $30 trillion and growing. Policies meant to reduce federal tax collections would make a bad situation worse, wouldn’t they? Quite the opposite, really… and for obvious reasons.
Indeed, readers need only ask why the Treasury is $30 trillion in the red, but Russia is “only” out $190 billion. Is Vladimir Putin a closet Adam Smith? More realistically, the buyers of government debt don’t trust Russia’s economy enough in order to buy debt that is a purchase of future government tax collections. It’s all a reminder that U.S. debt is of nosebleed proportions not because of too little government revenue, but an obvious consequence of government collecting way too much. Investors are so confident in Treasury collections now and in the future that they’re willing to buy the debt at the lowest interest rates in the world. Investors wouldn’t be as sanguine if policy were more focused on pushing taxation and government spending back to cities and states. In short, full SALT deductibility would logically limit federal borrowing… Soaring revenues encourage it.
After which, it’s worth pointing out what’s long been true: Conservatives prefer local government, states’ rights, and anything else that centralizes legislative power as close to voters as possible. The design of the Founding Fathers was pretty clear – the federal government would have powers “few and defined” so that Americans could choose their legislative bliss. Which is what deduction of state and local taxes would at least encourage.
This isn’t to say that revival of SALT would bring back the early 19th century in a states’ rights sense, but it would at least create incentives for states to do more for themselves, and for their citizens to be rewarded with a lower federal tax bill by virtue of their politicians taking back legislative and spending power.
At present, the opposite is being encouraged… Right now, red states in particular are cheering one another on to see which can push state taxes the lowest (tax competition and all that). It sounds good at first glance. And even at second glance. Really, why should citizens of Texas, Florida, and Tennessee pay more federal taxes so that taxpayers in California, New Jersey, and New York can lower their federal tax bills?
The arguments are always very compelling until it’s remembered that when it comes to federal tax collections by state, California, New York, Illinois, New Jersey, and Massachusetts are already No. 1, 3, 4, 6, and 9. Again, federal tax collections are made large by a tiny and very well-to-do portion of the total tax base. These individuals often reside in blue states. Republicans seem to want to penalize them… Some would call this class warfare.
Put another way, the tax competition among states that is presently cheered is being subsidized by – you guessed it – the federal tax code. The arguments on the matter of SALT are backwards and upside down. This will only get worse. If the cap on SALT deductions is maintained, incentives will grow for cities and states to shrink taxes as much as possible with an eye on pushing as much government activity and spending as possible to the federal government. Why not? If local spending is going to be discouraged by the tax code, why not move it to the federal government? Such a scenario is one Democrats would love, but Republicans would logically despise. Again, Republicans want local government, yet they’re paradoxically encouraging the opposite with a form of taxation that once again subsidizes the flow of dollars away from state and local governments and into the hands of Washington.
America’s Taxes: In a Broken State
The simple truth is that a revival of the SALT deduction would, far from subsidizing blue states, actually make it more difficult for taxpayers to live off of one another. That’s unfortunate when it’s remembered that the American ideal was always for taxation to be higher the closer the government is to us. If realistic, and with the latter in mind, the true call should be for a state and local tax credit to push government and its funding even more local than any deduction would.
Sadly, however, what’s proposed doesn’t seem to be in the cards. In modern times we’ve turned this laudable model of local government on its head. No doubt the arguments in favor of state competition have merit, but that’s not what we’re seeing now. State competition on taxes is perilously pushing more tax and spending power to the federal government, all at the expense of cities’ and states’ rights, along with the rich. This is once again backwards. It suffocates local government, plus never forget the Rockefellers, Vanderbilts, and Phipps.
John Tamny is the editor of RealClearMarkets, and author of many books on finance including Popular Economics, Who Needs the Fed, and They’re Both Wrong.
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Managing Editor, American Consequences
With Editorial Staff
August 7, 2021