Today was supposed to be the day House Republicans unveiled their tax-reform bill. Instead, the roll-out has been delayed until (at least) Thursday. There seem to be two major hang-ups, one that the GOP should push past and one where lawmakers should tread extremely carefully.
The deduction for paying state and local taxes, often abbreviated as SALT, is one where Republicans need to bite the bullet and proceed. The deduction essentially subsidizes high-tax states and localities, because it offsets part of the over-sized tax burden they place on their residents. As Jason Pye of FreedomWorks points out, 39 percent of the tax benefits from the SALT deduction accrue to people in just three states: California, New Jersey and New York. About 18 percent of the U.S. population lives in those states, so that’s quite the lopsided deal in their favor. Far better to spread that benefit more evenly through lower marginal tax rates across the board.
On the other hand, the GOP’s flirtation with capping the tax benefits of 401(k) contributions is just about the dumbest approach they could take, as a matter of both policy and politics. Tax-advantaged retirement programs are not only popular, but they are a relatively inexpensive way (compared to, say, increasing Social Security benefits) for the government to help enhance Americans’ retirement income. The 401(k) program is one of the main ways through which the middle class participates in equity markets — important, given that for the past several years folks on both sides of the aisle have pointed to stock market gains as signs of the economy’s health. That’s debatable as a useful economic indicator, but it’s not debatable that 401(k)s (as well as IRAs) help more Americans participate in markets, which has proven over the long haul to be a solid way to build wealth.
Think about it this way. Although tax policy should be foremost about finding the least economically damaging way to fund the government, it also provides incentives (intended or not) for certain behaviors. It’s best to limit the latter, in large part because the government isn’t always good at anticipating unintended incentives, but certain tax-code incentives do make sense.
If states, counties or cities want to maintain a high level of taxation and their residents are willing to tolerate that, fine. But if residents’ tolerance for these policies hinge on what amounts to a federal tax subsidy, how is that in the national interest? It isn’t. All the more so when one considers that some of the state and local taxes subsidized in this way are levied for the express purpose of drawing down additional federal funds through grants or welfare programs — essentially allowing those governments to double-dip. It also shouldn’t escape our notice that many of the states with the highest taxes also have the most precarious finances when it comes to debt, because even with the SALT deduction subsidy they aren’t willing to tax at the level needed to maintain their extraordinary levels of spending. There’s nothing about this situation we should want to encourage. On the contrary: Perhaps eliminating this artificial fiscal sweetener would create the opposite incentive, for state and local governments to deal realistically with their finances.
Saving money for retirement, however, is exactly the kind of behavior the federal government should want to encourage. That’s particularly true when, for better or worse, the federal government is entrenched as a guarantor of retirement security. Congressional Republicans are saying the right things about spurring growth through tax reform, and one might argue that there are better ways to encourage economic growth than encouraging retirement savings (although I think there’s a substantive counter-argument that our low personal savings rate and obsession with consumption have actually contributed to economic stagnation). That said, the need for near-term growth does have to be balanced against what makes sense in the long term, which is why I’ve also suggested the key in tax reform is to cut rates, not necessarily revenues. And while it may be possible to make tax benefits such as 401(k)s work better, or for more people, it’s highly unlikely that a contribution cap is the way to do that. That’s particularly true when it appears the main rationale for a cap is to generate tax revenue now, at the expense of the future. A cap would be bad policy for today and tomorrow.
We’ll see how all this shakes out when the bill is finally released. But seeing how the bill treats these two issues will be a quick way to gauge just how serious congressional Republicans are about meaningful tax reform.