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The Tax Policy Center's

Briefing Book

A citizen’s guide to the fascinating (though often complex) elements of the US tax system.

Tax Policy Center Briefing Book

The State of State (and Local) Tax Policy

  • Briefing Book
  • Fiscal Federalism and Fiscal Institutions
  • How does the deduction for state and local taxes work?
  • Chapters
    • Introduction
      • Introduction
        • Introduction
    • Some Background
      • Federal Budget
        • What are the sources of revenue for the federal government?
        • How does the federal government spend its money?
        • What is the breakdown of revenues among federal, state, and local governments?
        • How do US taxes compare internationally?
      • Federal Budget Process
        • How does the federal budget process work?
        • What is the history of the federal budget process?
        • What is the schedule for the federal budget process?
        • What is reconciliation?
        • How is a budget resolution enforced?
        • What is PAYGO?
        • What are rescissions?
      • Federal Budget Outlook
        • How accurate are long-run budget projections?
        • What have budget trends been over the short and long term?
        • How much spending is uncontrollable?
        • What are tax extenders?
        • What options would increase federal revenues?
        • What does it mean for a government program to be off-budget?
        • How did the TCJA affect the federal budget outlook?
      • Taxes and the Economy
        • How do taxes affect the economy in the short run?
        • How do taxes affect the economy in the long run?
        • What are dynamic scoring and dynamic analysis?
        • Do tax cuts pay for themselves?
        • On what do economists agree and disagree about the effects of taxes on economic growth?
        • What are the economic effects of the Tax Cuts and Jobs Act?
      • Economic Stimulus
        • What is the role of monetary policy in alleviating economic downturns?
        • What are automatic stabilizers and how do they work?
        • What characteristics make fiscal stimulus most effective?
      • Distribution of Tax Burdens
        • How are federal taxes distributed?
        • Are federal taxes progressive?
        • How should progressivity be measured?
        • What is the difference between marginal and average tax rates?
        • What criticisms are levied against standard distributional analysis?
        • How should distributional tables be interpreted?
        • Who bears the burden of the corporate income tax?
        • Who bears the burden of federal excise taxes?
        • How do financing methods affect the distributional analyses of tax cuts?
        • How do taxes affect income inequality?
      • Tax Expenditures
        • What are tax expenditures and how are they structured?
        • What is the tax expenditure budget?
        • Why are tax expenditures controversial?
        • What are the largest tax expenditures?
        • How did the TCJA affect tax expenditures?
      • Tax Gap and Tax Shelters
        • What is the tax gap?
        • What does the IRS do and how can it be improved?
        • What is a tax shelter?
      • Recent History of the Tax Code
        • What did the 2008–10 tax stimulus acts do?
        • What did the American Taxpayer Relief Act of 2012 do?
        • How did the Tax Cuts and Jobs Act change personal taxes?
        • How did the Tax Cuts and Jobs Act change business taxes?
    • Key Elements of the U.S. Tax System
      • Individual Income Tax
        • What is the standard deduction?
        • What are itemized deductions and who claims them?
        • How did the TCJA change the standard deduction and itemized deductions?
        • What are personal exemptions?
        • How do federal income tax rates work?
        • What are tax credits and how do they differ from tax deductions?
        • How do phaseouts of tax provisions affect taxpayers?
      • Capital Gains and Dividends
        • How are capital gains taxed?
        • What is the effect of a lower tax rate for capital gains?
        • What is carried interest, and how is it taxed?
        • How might the taxation of capital gains be improved?
      • AMT
        • What is the AMT?
        • Who pays the AMT?
        • How much revenue does the AMT raise?
        • How did the TCJA change the AMT?
      • Taxes and the Family
        • What is the child tax credit?
        • What is the adoption tax credit?
        • What is the earned income tax credit?
        • Do all people eligible for the EITC participate?
        • How does the tax system subsidize child care expenses?
        • What are marriage penalties and bonuses?
        • How did the TCJA change taxes of families with children?
      • Taxes and the Poor
        • How does the federal tax system affect low-income households?
        • What is the difference between refundable and nonrefundable credits?
        • Can poor families benefit from the child tax credit?
        • Why do low-income families use tax preparers?
        • How does the earned income tax credit affect poor families?
        • What are error rates for refundable credits and what causes them?
        • How do IRS audits affect low-income families?
      • Taxes and Retirement Saving
        • What kinds of tax-favored retirement arrangements are there?
        • How large are the tax expenditures for retirement saving?
        • What are defined benefit retirement plans?
        • What are defined contribution retirement plans?
        • What types of nonemployer-sponsored retirement savings accounts are available?
        • What are Roth individual retirement accounts?
        • Who uses individual retirement accounts?
        • How does the availability of tax-favored retirement saving affect national saving?
        • What’s the difference between front-loaded and back-loaded retirement accounts?
        • What is an automatic 401(k)?
        • How might low- and middle-income households be encouraged to save?
      • Taxes and Charitable Giving
        • What is the tax treatment of charitable contributions?
        • What entities are tax-exempt?
        • Who benefits from the deduction for charitable contributions?
        • How would various proposals affect incentives for charitable giving?
        • How large are individual income tax incentives for charitable giving?
        • How did the TCJA affect incentives for charitable giving?
      • Taxes and Health Care
        • How much does the federal government spend on health care?
        • Who has health insurance coverage?
        • Which tax provisions subsidize the cost of health care?
        • How does the tax exclusion for employer-sponsored health insurance work?
        • What are premium tax credits?
        • What tax changes did the Affordable Care Act make?
        • How do health savings accounts work?
        • How do flexible spending accounts for health care expenses work?
        • What are health reimbursement arrangements and how do they work?
        • How might the tax exclusion for employer-sponsored health insurance (ESI) be reformed?
      • Taxes and Homeownership
        • What are the tax benefits of homeownership?
        • Do existing tax incentives increase homeownership?
      • Taxes and Education
        • What tax incentives exist for higher education?
        • What tax incentives exist to help families pay for college?
        • What tax incentives exist to help families save for education expenses?
        • What is the tax treatment of college and university endowments?
      • Tax Complexity
        • Why are taxes so complicated?
        • What are the benefits of simpler taxes?
        • What policy reforms could simplify the tax code?
      • Wealth Transfer Taxes
        • How do the estate, gift, and generation-skipping transfer taxes work?
        • Who pays the estate tax?
        • How many people pay the estate tax?
        • What is the difference between carryover basis and a step-up in basis?
        • How could we reform the estate tax?
        • What are the options for taxing wealth transfers?
        • What is an inheritance tax?
      • Payroll Taxes
        • What are the major federal payroll taxes, and how much money do they raise?
        • What is the unemployment insurance trust fund, and how is it financed?
        • What are the Social Security trust funds, and how are they financed?
        • Are the Social Security trust funds real?
        • What is the Medicare trust fund, and how is it financed?
      • Excise Taxes
        • What are the major federal excise taxes, and how much money do they raise?
        • What is the Highway Trust Fund, and how is it financed?
      • Energy and Environmental Taxes
        • What tax incentives encourage energy production from fossil fuels?
        • What tax incentives encourage alternatives to fossil fuels?
        • What is a carbon tax?
      • Business Taxes
        • How does the corporate income tax work?
        • What are pass-through businesses?
        • How are pass-through businesses taxed?
        • Is corporate income double-taxed?
      • Tax Incentives for Economic Development
        • What is the new markets tax credit, and how does it work?
        • What is the Low-Income Housing Tax Credit and how does it work?
        • What are Opportunity Zones and how do they work?
      • Taxes and Multinational Corporations
        • How does the current system of international taxation work?
        • How do US corporate income tax rates and revenues compare with other countries’?
        • What are the consequences of the new US international tax system?
        • How does the tax system affect US competitiveness?
        • How would formulary apportionment work?
        • What are inversions, and how will TCJA affect them?
        • What is a territorial tax and does the United States have one now?
        • What is the TCJA repatriation tax and how does it work?
        • What is the TCJA base erosion and anti-abuse tax and how does it work?
        • What is global intangible low-taxed income and how is it taxed under the TCJA?
        • What is foreign-derived intangible income and how is it taxed under the TCJA?
    • How Could We Improve the Federal Tax System?
      • Comprehensive Tax Reform
        • What is comprehensive tax reform?
        • What are the major options for comprehensive tax reform?
      • Broad-Based Income Tax
        • What is a broad-based income tax?
        • What would and would not be taxed under a broad-based income tax?
        • What would the tax rate be under a broad-based income tax?
      • National Retail Sales Tax
        • What is a national retail sales tax?
        • What would and would not be taxed under a national retail sales tax?
        • What would the tax rate be under a national retail sales tax?
        • What is the difference between a tax-exclusive and tax-inclusive sales tax rate?
        • Who bears the burden of a national retail sales tax?
        • Would tax evasion and avoidance be a significant problem for a national retail sales tax?
        • What would be the effect of a national retail sales tax on economic growth?
        • What transition rules would be needed for a national retail sales tax?
        • Would a national retail sales tax simplify the tax code?
        • What can state and local sales taxes tell us about a national retail sales tax?
        • What is the experience of other countries with national retail sales taxes?
        • What did the President’s Advisory Panel on Federal Tax Reform say about the national retail sales tax?
      • Value Added Tax (VAT)
        • What is a VAT?
        • How would a VAT be collected?
        • What would and would not be taxed under a VAT?
        • What would the tax rate be under a VAT?
        • What is the difference between zero rating and exempting a good in the VAT?
        • Who would bear the burden of a VAT?
        • Is the VAT a money machine?
        • How would small businesses be treated under a VAT?
        • What is the Canadian experience with a VAT?
        • Why is the VAT administratively superior to a retail sales tax?
        • What is the history of the VAT?
        • How are different consumption taxes related?
      • Other Comprehensive Tax Reforms
        • What is the flat tax?
        • What is the X-tax?
      • Recent Comprehensive Tax Reform Proposals
        • Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System, Report of the President’s Advisory Panel on Federal Tax Reform, November 2005
        • The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform, December 2010
        • Debt Reduction Task Force, “Restoring America’s Future,” Bipartisan Policy Center, November 2010
        • The Tax Reform Act of 2014: Fixing Our Broken Tax Code So That It Works for American Families and Job Creators, House Ways and Means Committee
        • The Graetz Competitive Tax Plan, Updated for 2015
      • Return-Free Tax Filing
        • What is return-free filing and how would it work?
        • What are the benefits of return-free filing?
        • What are the drawbacks of return-free filing?
        • How would the tax system need to change with return-free filing?
        • Who would qualify for return-free filing?
        • Would return-free filing raise taxes?
        • What was the experience with return-free filing in California?
        • What other countries use return-free filing?
    • The State of State (and Local) Tax Policy
      • State and Local Revenues
        • What are the sources of revenue for state governments?
        • What are the sources of revenue for local governments?
      • Specific State and Local Taxes
        • How do state and local individual income taxes work?
        • How do state and local sales taxes work?
        • How do state and local property taxes work?
        • How do state and local corporate income taxes work?
        • How do state estate and inheritance taxes work?
        • How do state earned income tax credits work?
        • How do state and local severance taxes work?
        • How do state and local soda taxes work?
        • How do marijuana taxes work?
      • Fiscal Federalism and Fiscal Institutions
        • How does the deduction for state and local taxes work?
        • What are municipal bonds and how are they used?
        • What types of federal grants are made to state and local governments and how do they work?
        • What are state rainy day funds, and how do they work?
        • What are tax and expenditure limits?
        • What are state balanced budget requirements and how do they work?
    • Glossary
      • Glossary
        • Glossary

How does the deduction for state and local taxes work?

Fiscal Federalism and Fiscal Institutions

1/6>
Q.

How does the deduction for state and local taxes work?

A.

Taxpayers who itemize deductions on their federal income tax returns can deduct state and local real estate and personal property taxes, as well as either income taxes or general sales taxes. The Tax Cuts and Jobs Act limits the total state and local tax deduction to $10,000.

The state and local tax (SALT) deduction previously was one of the largest federal tax expenditures, with an estimated revenue cost of $100.9 billion in fiscal year 2017. The estimated revenue cost for fiscal year 2019 dropped to $21.2 billion because the Tax Cuts and Jobs Act (TCJA) significantly increased standard deduction amounts (thereby reducing the number of taxpayers who will itemize deductions) and capped the total SALT deduction at $10,000.

State and local taxes have been deductible since the inception of the federal income tax in 1913. Initially, all state and local taxes not directly tied to a benefit were deductible against federal taxable income. In 1964, deductible taxes were limited to state and local property (real and personal property), income, general sales, and motor fuels taxes.

Congress eliminated the deduction for taxes on motor fuels in 1978, and eliminated the deduction for general sales tax in 1986. It temporarily reinstated the sales tax deduction in 2004, allowing taxpayers to deduct either income taxes or sales taxes but not both. Subsequent legislation made that provision permanent starting in 2015. Starting in tax year 2018, taxpayers cannot deduct more than $10,000 of total state and local taxes. That provision of the law is scheduled to expire after 2025.

Who Claims the SALT Deduction?

Before the TCJA, about 30 percent of tax filers opted to itemize deductions on their federal income tax returns. Virtually all who itemized claimed a deduction for state and local taxes paid. High-income households were more likely than low- or moderate-income households to benefit from the SALT deduction. The amount of state and local taxes paid, the probability that taxpayers itemize deductions, and the reduction in federal income taxes for each dollar of state and local taxes deducted all increase with income.

Sixteen percent of tax filers with income between $20,000 and $50,000 claimed the SALT deduction in 2017, compared to 76 percent for tax filers with income between $100,000 and $200,000 and over 90 percent of tax filers with income above $200,000 (figure 1). Tax filers with income above $100,000 were 18 percent of all tax filers, but accounted for about 78 percent of the total dollar amount of SALT deductions reported. The average claim in this group was of about $22,000.

Although most high-income taxpayers claimed a SALT deduction, the federal individual alternative minimum tax (AMT) limited or eliminated the benefit for many of them. The AMT is a parallel income tax system with fewer exemptions and deductions than the regular income tax as well as a narrower set of tax rates. Taxpayers potentially subject to the AMT must calculate their taxes under both the regular income tax and the AMT and pay the higher amount. Taxpayers cannot claim the SALT deduction when calculating their AMT liability, and under tax law prior to 2018, the disallowance of the deduction was the major reason why taxpayers were required to pay the AMT.

Although some taxpayers in every state and DC claim the deduction, taxpayers in states with a disproportionate share of high-income taxpayers and relatively high state and local taxes are more likely to claim the deduction (figure 2). The percentage claiming the deduction ranged from 17 percent in West Virginia to 47 percent in Maryland in 2017. In general, a higher share of taxpayers in Northeast and West states claimed the deduction than in other regions. The average deduction claimed was also higher in those regions.

The Effect of TCJA on the salt Deduction

The TCJA has had a significant effect on the average tax saving from the SALT deduction. Both the percentage of taxpayers claiming the deduction and the average amount claimed fell dramatically in 2018 because of the changes enacted. Figure 3 compares the tax saving from claiming the deduction in 2017 and 2018, before and after the new tax law. The tax benefit is measured as the reduction in tax liability from the deduction, which considers the applicable tax rates in each year, the effects of the alternative minimum tax (which disallows the SALT deduction), and the limit on itemized deductions (the “Pease” limit) that was in place in 2017 but eliminated for 2018 by TCJA.

Measured as a percentage of after-tax income, the tax saving from the SALT deduction in 2018 was about one-quarter of what it was in 2017 overall. For taxpayers in the top 1 percent of the income distribution, the tax saving in 2018 was about one-tenth of the tax saving in 2017.

Effects of the Deduction

The SALT deduction provides state and local governments with an indirect federal subsidy by decreasing the net cost of nonfederal taxes for those who pay them. For example, if state income taxes increase by $100 for families in the 37 percent federal income tax bracket claiming the SALT deduction, the net cost to them is $63; that is, state taxes go up by $100, but federal taxes go down by $37. This federal tax expenditure encourages state and local governments to levy higher taxes (and, presumably, provide more services) than they otherwise would. It also encourages those entities to use deductible taxes in place of nondeductible taxes (such as selective sales taxes on alcohol, tobacco, and gasoline), fees, and other charges.

Critics of the deduction argue that state and local taxes simply reflect payments for the services those jurisdictions provide and, as such, should be treated no differently than other spending. They also point to the uneven distribution of benefits across income groups and states.

Proponents of the deduction counter that the portion of an individual’s income claimed by state and local taxes is not disposable income, and that taxing it at the federal level is double taxation. Moreover, they argue that federal subsidies are warranted because a significant portion of state and local government spending is for education, health, public welfare, and transportation, all of which benefit the population in other jurisdictions as well. A counterargument, however, is that while federal support may be warranted, the substantial revenues gained by eliminating or limiting the deduction could be used to provide direct support through federal grants and loans.

Updated May 2020
Data Sources

Internal Revenue Service. 2019. “SOI Tax Stats—Historic Table 2.”

———. SOI Tax Stats—Individual Income Tax Returns, Publication 1304. Table 1.2. “All Returns: Adjusted Gross Income, Exemptions, Deductions, and Tax Items, Tax Year 2017”; and Table 2.1. “Returns with Itemized Deductions: Sources of Income, Adjustments, Itemized Deductions by Type, Exemptions, and Tax Items, Tax Year 2017.”

Urban-Brookings Tax Policy Center. “TPC Microsimulation Model, version 0718-1.” Washington, DC: Urban-Brookings Tax Policy Center.

———. Table T18-0161. “Tax Benefit of the Itemized Deduction for State and Local Taxes, Baseline: Current Law, Distribution of Federal Tax Change by Expanded Cash Income Percentile, 2017”; and Table T18-0163. “Tax Benefit of the Itemized Deduction for State and Local Taxes, Baseline: Current Law, Distribution of Federal Tax Change by Expanded Cash Income Percentile, 2018.” Washington, DC: Urban-Brookings Tax Policy Center.

Further Reading

Burman, Leonard E., and Frank Sammartino. 2018. “State Responses to the TCJA’s SALT Deduction Limit May Be Costly and Favor High-Income Residents.” TaxVox (blog). January 30.

Dadayan, Lucy, and Noah Zwiefel. 2019. “We Don’t Know If The SALT Cap Is Driving Away Residents Of High-Tax States.” TaxVox (blog). October 8.

Gordon, Tracy. 2018. “The Price We Pay for Capping the SALT Deduction.” TaxVox (blog). February 15. Washington, DC: Urban-Brookings Tax Policy Center.

Joint Committee on Taxation. 2019. "Estimates of Federal Tax Expenditures for Fiscal Years 2019-2023." JCX-55-19. Washington, DC: Joint Committee on Taxation.

 ———. 2018. “Estimates of Federal Tax Expenditures for Fiscal Years 2018–2022.” JCX-81-18. Washington, DC: Joint Committee on Taxation.

Sammartino, Frank. 2016. “A Closer Look at the State and Local Tax Deduction.” TaxVox (blog). April 16.

———. 2018. “How New York State Responded to The SALT Deduction Limit.” TaxVox (blog). May 14.

Sammartino, Frank and Eric Toder. 2019. "What are the Largest Nonbusiness Tax Expenditures?" Washington, DC: Urban-Brookings Tax Policy Center.

Sammartino, Frank, and Kim Rueben. 2016. “Revisiting the State and Local Tax Deduction.” Washington, DC: Urban-Brookings Tax Policy Center.

Urban-Brookings Tax Policy Center. 2020. “Tax Expenditures” (feature). Washington, DC: Urban-Brookings Tax Policy Center.

Zwiefel, Noah. 2019. “Did SALT-y Voters Punish Republicans in 2018?” TaxVox (blog). October 8. 

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