In a ruling overshadowed by the more high-profile cases of its recently concluded term, the Supreme Court delivered a clear victory for state tax competition. Denying an appeal by New York and three other high-tax states, the Court didn’t bite on a claim that a $10,000 federal cap on state and local tax (SALT) deductions was an infringement on state sovereignty. The SALT cap stands.
Without action from Congress, the SALT cap will expire in 2025. Making it permanent would be a prudent step. Doing so would encourage healthy competition between the states as a way to ensure that they don’t lurch into fiscal extremes. And the federal government could use the added revenue to pay for tax reforms to improve America’s global competitiveness.
New York’s economic policies are costly, and the proof is in the tax exodus. New York saw a net loss of $19.5 billion in annual income from 2019 to 2020 as a result of New Yorkers decamping to live elsewhere—a stunning loss of 2.5 percent of the state’s income in just one year. The Empire State risks an ongoing tax flight as high-skill workers become increasingly mobile and New York becomes ever-more expensive.
The SALT cap put high-tax states in an uproar by exposing how they overtax their residents. Yet in 2021, New York raised its top income-tax rate from 8.8 percent to 10.9 percent. That undermined the state’s own legal argument that the SALT cap would force states to adopt more moderate tax policies. Residents of New York City now pay a top state and local rate of 14.8 percent after local income taxes are included. No wonder wealthy residents are looking elsewhere.
Americans voting with their feet in response to poor governance are heading to better-managed states where they get a higher return on their tax dollar. Florida does not impose a personal income tax, and it led all states in netting $23.7 billion of annual income from other states from 2019 to 2020, adding 3.3 percent to its total state income. New York was the biggest contributor of income and human capital to Florida. State tax competition gives Americans clear choices on the cost of different governance systems, ensuring that states are held accountable and making the U.S. more prosperous in the long run.
Of course, permanently capping the SALT deduction with no offsets would be a significant tax hike for high earners in high-tax regions, raising anywhere between $1.5 trillion and $2 trillion over ten years for Washington. This revenue should be used for tax reductions in other areas that can make the U.S. more globally competitive.
Consider full expensing as an example. Allowing businesses immediately to write off the cost of new capital expenditures in the U.S. would not only boost GDP growth (according to a Tax Foundation analysis) but also encourage reshoring. Full expensing could include investments in research and development, machinery and equipment, and physical structures. A permanent SALT cap would produce more than enough revenue to pay for the reform. Without full expensing, high inflation will drive businesses to continue moving their supply chains out of the U.S.: assuming 5 percent annual inflation, the present value of business deductions for cost recovery is only 50 cents on the dollar for a 20-year asset, and 31 cents on the dollar for a 39-year asset. If businesses cannot recover their investment costs, they’ll be less likely to invest domestically.
A permanent SALT cap paired with full expensing would be a powerful one-two tax punch to enhance American competitiveness. The SALT cap fosters competition between the states, while full expensing would encourage entrepreneurs to invest in domestic production. Competition is a fact of life, and America’s tax policy should adapt accordingly.
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