Tuesday, September 08, 2020

Political Vendettas versus Progressive Policy

by Neil H. Buchanan
 
I honestly did not expect the op-ed page of The New York Times to give space this week to an argument about an obscure tax provision -- not with so many threats to the future of the republic under intense discussion -- but apparently the relevant editors are still suckers for counter-intuitive nonsense.  In particular, liberals criticizing other liberals is like catnip for these people, it seems.

The clickbait headline of the piece in question is: "The Tax Cut for the Rich That Democrats Love," supported by the sub-headline: "Why are party leaders fighting to get rid of one surprisingly progressive element of the 2017 tax bill?"  Juicy!  The authors (Richard V. Reeves and are affiliated with the Brookings Institution, which has a reputation for being friendly to Democrats in the very non-progressive sense that that party's establishment still embodies.

But whether or not these guys are progressive avatars (they are not), surely the Democratic Party's leaders are not pushing a "tax cut for the rich," are they?  Well, yes, in a very narrow and incomplete sense, they are.  Yet RP completely fail to understand the bigger issues at play (including constitutional questions), and even when they purport to address one (but only one) argument on the other side, they brush it off with barely an effort to engage with it honestly.

I admit that this setup of my topic today is quite vague, but I wanted to be clear that this is not merely an argument about taxes.  This is a great example of how smart people can become enamored with a technical/mathematical curiosum and then run with it, ignoring the larger picture.  In any case, what are RP talking about?
 
It is indeed true that Senate Minority Leader Chuck Schumer and other Democrats have promised to eliminate a recently added limit on the federal income tax deduction for state and local tax payments.  Viewed in very narrow terms, that limitation did increase taxes for some richer people, such that repealing the limitation could be called "regressive" in the sense that it will help those rich people almost exclusively.  Again, however, that is a disastrously narrow way to conceive of the problem.

The limitation in question was included as part of the reviled 2017 tax bill that Republicans rammed through Congress without hearings, mark-up, or any other aspect of "regular order."  Because an external procedural rule forced them to limit the size of their overall giveaway to rich people, Republicans tried to find various provisions that would reduce the net revenue loss.  Most famously, they put time limits on the personal income tax cuts (the only parts of the bill that included crumbs for non-rich people), even as they made the business tax cuts permanent.

One of the direct revenue raisers, however, put a $10,000 limit on the amount that a taxpayer can deduct for state-and-local taxes (the so-called SALT deduction).  Who should care about that?  Most people do not itemize deductions at all (and the 2017 bill reduced that number even further), so a limitation on any deduction would affect only a small, relatively affluent number of people.  A person in, say, the 32 percent marginal tax bracket who was deducting $25,000 per year for state and local taxes was saving $8000 per year in federal taxes, but the $10,000 limit would mean that she would save only $3200.
 
The SALT limitation thus increases the taxpayer's net federal tax liability by $4800.  However, given that the 32 percent bracket applies to taxable income in the range from $321,451 to $408,200, it is difficult to feel too much sympathy for this person.  Yes, $4800 is real money, but are people in this tax bracket truly worthy of Democrats' concern?

Well, yes.  The tax increase that these people faced was not being used to finance something socially useful.  If I were in the 32 percent bracket and someone told me, for example, that my taxes were to go up by x dollars to be used to support front-line workers in the pandemic, that would be quite different than learning that my tax increase was being used to reduce taxes for people in even higher tax brackets -- which is exactly what the 2017 tax bill was all about.

Also, notice that I said above that this tax increase applied only to some rich people.  Taxpayers who are otherwise similarly situated -- that is, relatively equally higher-income people -- in different states would see very different outcomes, depending on how much they were paying in state-and-local taxes.  A New Jersey taxpayer and a Texas taxpayer, both with upper-middle-class incomes and large enough mortgages to make itemizing worthwhile, are now treated quite differently.

Why?  Because New Jersey's state taxes include an income tax as well as local property taxes, whereas Texas is one of the states with no income tax.  This is the sense in which the SALT deduction effectively transfers money from the federal government to the state government.  Under the old rule, a Garden Stater who was required to pay $25,000 to his state and local governments would get $8000 back from the feds, so that the state's sub-federal budgets were being subsidized.  The NJ taxpayer would still pay $17,000 net to in-state governments, but the sub-federal governments would receive $25,000.
 
The states with the highest state and local taxes are almost all "blue," prominently including Massachusetts, New York, New Jersey, Maryland, Illinois, and California.  Republicans thus touted their tax-the-blue-state-richer-people SALT limitation as a matter of fairness: Why should people in the rest of the country subsidize the state governments of liberal states?  I wrote a few columns about this issue at the time (see, e.g., here), and one of the points I made again and again is that this subsidy to states with higher sub-federal taxes is more than completely offset by the way that the federal government spends its money.
 
That is, even taking all direct and indirect tax subsidies into account, blue states are net payers into the federal government, whereas most red states are net receivers.  The differences are not small, with New Jersey's net tax payments to the federal estimated at $2368 per resident last year, while Kentuckians receive $9,145 apiece.  So the "it's only fair" argument radically cuts the other way, with Republicans isolating one small subsidy that helps blue states but ignoring the bigger picture.

Moreover, the point of the federal subsidy is that it allows states and cities to impose higher taxes and thus to provide more services.  And because these blue states are more likely to prefer progressive (or, at least, less regressive) tax systems, it is obviously true that those states' budgets are going to be financed with more money from upper-middle and upper-income taxpayers.  Eliminating the subsidy by its very nature will only affect upper income people, and only (or almost only) in blue states

But that is by no means the whole story.  States will feel pressure to reduce their sub-federal taxes as a result of this change, which means that it is not only the upper-middle and upper-income people who will be affected.  People who receive money from their states' and cities' budgets -- police, firefighters, schools, hospitals, Medicaid recipients, and on and on -- will be affected when their non-federal governments start to cut back (even setting aside the enormous state-level budget crisis that Republicans' intransigence during the pandemic is causing right now).

RP, the authors of the misbegotten Times op-ed noted above, spend virtually all of their time going through the details of proving that the SALT deduction helps upper income people and then pleading to the heavens for an explanation as to why Democrats would go on record as favoring a regressive tax cut.  The one time that they try to address the objection that I laid out a moment ago -- that the SALT deduction is one way that the federal government transfers money to the states -- this is the best response that they can come up with:
"Previous Democratic arguments for a generous SALT deduction have included the idea that it encourages states to spend more by making it easier for them to tax more. State coffers are certainly squeezed in 2020, as they will be in 2021. But if the goal is for the federal government to provide additional support to state and local governments, far better to do so directly, rather than by the roundabout route of offering a tax break to the rich."
They even cite a study by the Economic Policy Institute, a genuinely progressive think tank, to support the claim that the first-best method of subsidizing state investments is with direct federal grants.  But again, this is RP's entire argument: There's a better way to do it, folks!  They are thus apparently satisfied to make the perfect the enemy of the good.
 
Would it be better if we subsidized states and cities in one way rather than another?  Sure.  It would also be better if we, say, financed Social Security entirely with a wealth tax.  And we would be better off with single-payer health care than with the Affordable Care Act.  But until we are sure that the first-best approach is political possible, we should not abandon next-best solutions.

The biggest issue here, however, is something that RP miss entirely.  The most powerful objection to the Republicans' decision to limit the SALT deduction has nothing to do with progressivity or with state budgets.  It is that Republicans did so for nakedly political reasons -- not "political" in the sense of liberal or conservative but in the sense that they used the tax system to harm their political opponents.

RP might have a point, after all, if Republicans had done something that raised taxes on all upper-income people and if Democrats wanted to repeal that provision.  But that is not what happened.  Republicans increased taxes on wealthy-ish and wealthy Democrats (more accurately, they increased taxes on such people in states that vote for Democrats) while leaving their Republican friends untouched.

Professor Dorf, in columns on Verdict and here on Dorf on Law, discussed this unequal treatment problem and found that there were serious constitutional issues raised by the Republicans' approach.  There are both First Amendment issues (disfavored political views resulting in higher taxes) and questions of equal state sovereignty (deliciously supported by the otherwise reprehensible Supreme Court decision in Shelby County v. Holder).  In his Verdict piece, he wrote: "Accordingly, whether under the First Amendment or in the application of general principles of federalism, the courts should be prepared to invalidate provisions of the tax code that discriminate against blue states out of hostility to those states or the voters who live there."

Notably, however, Professor Dorf concluded that Republicans would probably be smart enough not to admit that they were targeting Democrats -- although Mitch McConnell's snarling claim earlier this summer that aid to state and local governments would merely be a "blue state bailout" suggests that Republicans are starting to follow Trump in saying the quiet part out loud -- which means that "[t]he difficulty would arise when attempting to prove illicit intent."  He then pointedly added:
"Were a court to order discovery aimed at uncovering Republican congressional defendants’ true motives, they could probably get away with pointing to some non-partisan rationale for capping SALT deductibility. 
"The key phrase there is “get away with.” Due to difficulties of proof, the courts probably won’t end up ruling that the SALT deductibility cap violates the First Amendment or a core principle of federalism. But no one should be fooled by the limits of what can be proven in court."
In short, Senator Schumer and other Democrats are in no way violating deep principles of fairness by committing to repealing the Republicans' illicit shifting of the tax burden onto people -- even relatively well off people -- in blue states.  The Republicans pursued a political vendetta aimed at people on the basis of their states' political leanings.  Even if repealing that gambit has a marginally regressive impact, there is nonetheless every good reason to undo the Republicans' misdeed.
 
While RP and others are debating the very best way to change the tax and spending decisions under a Biden Administration, they are certainly free to propose policies that might even include entirely eliminating the deductibility of state and local taxes.  But hiding behind a narrow progressivity argument to validate a Republican hit job should be no one's idea of fair play or smart politics.