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Econometric Advisors' blog

The Tax Reform Act: The impact of the SALT deduction on real estate

Feb 2, 2018, 00:31 AM by Bill Wheaton

Eliminating the SALT deduction will ultimately reduce aggregate spending on public education, infrastructure, public safety and other locally and state-funded services. Many in Congress believe improving such services is necessary to make the U.S. more productive and competitive and to grow its economy. Ironically, eliminating SALT could have the opposite effect.

The cost of local public services (CLPS)

There are a number of ways in which a dollar of state or local government spending costs households less than the dollar spent. One way is the percentage that the Federal government reimburses local governments for their spending on school lunches, highways, law enforcement training and more. Because these grants are sized based on a portion of the local effort, they make local spending appear cheaper to local voters. This tends to increase the total amount spent (grant + local effort) on such programs. One-minus-the-grant-rate is often called the Cost of Local Public Services (CLPS).

Economic studies demonstrating the stimulating impact of such “matching grant” programs are plentiful. When higher-level governments want lower-level governments to spend more on a particular service, they create a matching grant program. If higher-level governments simply want to ease the financial burden of local services, they create “block grants,” which provide fixed dollar amounts of aid per capita, per pupil, or per patient. This type of grant mostly reduces local effort (and taxes), as grant dollars are simply substituted for local effort.

The SALT deduction

The SALT deduction works like a matching grant. Not only does it ease the burden of state and local taxes, it encourages government spending by reducing the cost to local constituents of a dollar spent on those services. Eliminating the deduction increases the CLPS—so rather than stimulating local spending on public services, it will dampen it.

The effects of eliminating the SALT deduction will be felt most strongly in cities and towns with greater homeownership and less renting, since landlords will continue to deduct property taxes as a business expense. It will hurt suburbs more than central cities, and it will be felt more in higher-income communities where the deductions were larger because residents are in higher income tax brackets. Towns that have benefited more from SALT deductions will suffer the change more deeply than those where the benefits have been smaller.

There is also a literature in economics suggesting that increases in the CLPS—and the consequent reductions in local public service outlays—can only lower house prices, though the magnitude of this “capitalization” effect is open to some debate. This also would be felt most in the communities where the deduction has been largest.

Eliminating the SALT deduction will reduce aggregate state and local spending on primary and secondary schools, infrastructure, public safety, and more, running counter to the need to improve such services and ultimately lowering the value of local real estate.


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