The Impact of a Higher Corporate Tax Rate to Fund Eliminating the SALT Deduction Cap

September 13, 2018

During the House Ways and Means Committee markup of the bill to make the individual provisions of the Tax Cuts and Jobs Act permanent, Rep. Bill Pascrell (D-NJ) introduced an amendment that would permanently eliminate the $10,000 cap on the state and local tax deduction, paid for by raising the corporate income tax rate. We estimate that the corporate income tax rate would need to be raised to 25 percent to roughly cover the cost of an uncapped SALT deduction. We also estimate that this trade would result in a smaller economy over the next ten years and would end up raising taxes on low- and middle-income taxpayers while cutting taxes for upper-middle- and high-income taxpayers.

Revenue Effect

Uncapping the state and local tax deduction (SALT) would allow individuals to fully deduct the taxes they pay to state and local governments against their federal taxable income. This would narrow the individual income tax base and reduce revenue collected by the federal government.

Using the Tax Foundation model, we estimate that uncapping the SALT deduction–relative to current law–would reduce federal revenue by $673 billion between 2019 and 2028.

In order to make this trade revenue neutral within the budget window, the corporate income tax would need to be raised to about 25 percent from the current 21 percent. A 4-percentage point increase in the corporate income tax rate would raise $733 billion over the next decade.

On net, this trade would roughly equal over ten years, raising $60 billion.

It is worth noting that in the long run this trade would raise revenue against the current law baseline because the cap on the SALT deduction is scheduled to expire anyway.

Table 1: Indexing Capital Gains to Inflation, Conventional and Dynamic Revenue Estimates

Source: Tax Foundation General Equilibrium Model, March 2018

  Eliminate SALT CAP Raise Corp Rate to 25% Total Revenue Effect

2019

-$81 $53 -$29

2020

-$86 $59 -$27

2021

-$90 $62 -$28

2022

-$95 $67 -$28

2023

-$101 $74 -$27

2024

-$107 $80 -$27

2025

-$113 $85 -$28

2026

$0 $86 $86

2027

$0 $82 $82

2028

$0 $85 $85

2019-2028

-$673 $733 $60

Economic Effect

Eliminating the SALT cap would slightly reduce the marginal effective tax rate on income. This is because the combined state, local, and federal marginal tax rate is higher when simply added together without deductions for state and local taxes paid.

An example below shows how a SALT deduction reduces the effective marginal tax rate. Under a tax code without a deduction for state and local taxes, the effective tax rate is simply the sum of the federal, state, and local tax rate. For this taxpayer it is the sum of the 37 percent federal rate, the 5 percent state income rate, and the 2 percent local income tax rate, or 44 percent. In contrast, a deduction for SALT reduces the effective federal rate in proportion to the state and local tax burden. As such, the total marginal tax rate becomes 41.4 percent because the effective federal rate drops to 34.4 percent (37 percent minus 2.6 percent).

Table 2: Effective Marginal Tax Rate with and without SALT Deduction
Federal Tax 37% 37%
Value of Deduction N/A -2.6%
State Tax 5% 5%
Local Tax 2% 2%
Total Tax 44% 41.4%

The lower effective income tax rate would lead to slightly higher output. We estimate that eliminating the SALT deduction, in isolation, would increase output by an average of 0.09 percent over the next decade.

However, the corporate income tax rate increase would more than offset that. A higher corporate tax would reduce the after-tax rate of return on investment in the United States. This would lead to a smaller capital stock and lower output. A higher corporate tax would mean an average of 0.28 percent lower output between 2019 and 2028.

Overall, we estimate that GDP would be 0.19 percent lower, on average, over the next ten years due to this swap.

Table 3: Average Change in Level of GDP, 2019-2028

Source: Tax Foundation General Equilibrium Model, March 2018

SALT Deduction Cap Elimination 0.09%
Corporate Rate to 25% -0.28%
Net -0.19%

Distributional Effect

Eliminating the SALT cap would make the tax code more regressive. Under current law, only individuals who have itemized deductions that exceed the standard deduction are likely to itemize and use the SALT deduction. Itemized deductions such as the SALT deduction are mostly utilized by higher-income individuals. As such, any change to the SALT deduction will chiefly impact them. In addition, the value of a deduction increases as a taxpayer’s statutory tax rate increases. A deduction against the top rate of 37 percent is more valuable than a deduction against the 32 percent tax rate.

We estimate that eliminating the SALT deduction cap would have no impact on taxpayers in the bottom two income quintiles and a negligible impact on taxpayers in the third and fourth quintiles. These taxpayers currently benefit from the new large standard deduction. However, taxpayers in the top 5 and 1 percent of income earners would see an increase in after-tax income of 1.6 percent and 3.7 percent respectively. This estimate is for 2025.

The corporate income tax falls on owners of capital and workers. As such, any change in the corporate tax rate would be split between those groups. Overall, we think the corporate tax is split evenly between capital and labor and has a progressive burden. According to the Tax Foundation Model, raising the corporate tax rate to 25 percent would raise taxes on all income groups. The bottom 80 percent of taxpayers would see a decline in after-tax income of between 0.38 percent and 0.42 percent, due to lower labor compensation. The largest tax increase would fall on the top 1 percent, which would see a decline in after-tax income by 1.8 percent.

Table 4: Distributional Impact of Eliminating the SALT Deduction Cap and Raising the Corporate Income Tax Rate, 2025, Percent Change in After-tax Income
  Eliminate the SALT Deduction Cap Raise the Corporate Tax to 25% Net Effect

Source: Tax Foundation General Equilibrium Model, March 2018

0% to 20% 0.0% -0.4% -0.4%
20% to 40% 0.0% -0.4% -0.4%
40% to 60% 0.0% -0.4% -0.4%
60% to 80% 0.1% -0.5% -0.4%
80% to 90% 0.2% -0.5% -0.3%
90% to 95% 0.6% -0.5% 0.1%
95% to 99% 1.7% -0.7% 1.0%
99% to 100% 3.7% -1.8% 1.9%
TOTAL 0.9% -0.7% 0.2%

In total, this tax swap would raise taxes on the bottom 90 percent of all taxpayers. Only individuals in the top ten percent would see an increase in after-tax incomes. Those in the top 1 percent of all taxpayers would see the largest increase in after-tax incomes of 1.9 percent.

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