One of the more controversial provisions of the One Big Beautiful Bill is the cap on SALT deductions.

The Senate has now passed its version of the bill which raises the cap for those earning under $500,000 from $10,000 to a full $40,000 until 2029, after which time it will revert back to $10,000. For those earning between $500,000 and $600,000 the $40,000 cap is gradually reduced. Those earning over $600,000 will continue to be subject to the $10,000 cap. In contrast, the House version also increased the cap to $40,000 reducing it to the base $10,000 based on income but at the same time increases it by 1% each year through 2033. Thereafter it would remain at that higher indexed level.

In concert with the above, both the House and Senate bills temporarily increase the standard deduction for taxpayers over the age of 65. The House version provides a $4,000 standard deduction while the Senate version pegs the deduction at $6,000. In both versions those earning under $75,000 benefit from the full deduction. Between $75,000 -$175,000 the deduction is reduced by 1% for every $1,000 earned over $75,000 until it is completely eliminated at $175,000. The thinking is that this deduction will narrow the number of people who choose to itemize their deductions in order to take advantage of the increased SALT cap. The benefits of this provision may, however, be illusory for those seniors who are forced to take required minimum distributions and/or who annuitized a part of their retirement savings both of which may place them over the income thresholds associated with this newly increased standard deduction. The Senate bill now goes back to the House for its consideration.

Your guess is as good as mine as to whether either of these provisions survive in their current form.

Why introduce a cap? After all, up until 2017 the SALT deduction was unlimited. The answer is pretty simple. It was and is a way to address budgetary concerns by offsetting the cost of the individual and corporate tax rate cuts that were part of the Tax Cuts and Job Act of 2017, which would be extended under the proposed bill.  In terms of its application some continue to see it as a political penalty because it primarily affects so called Blue states.  In the end the introduction of a cap was justified by an assertion that low tax states were subsidizing high tax states.  That New York and other high tax states are net contributors to the federal Treasury actually flies in the face of this justification. As net contributors, high tax states like New York send more money to the federal government than they receive in return. 

How did they arrive at the original $10,000 figure? In fact, the $10,000 was an arbitrary number that had no economic basis. The result was a tax scheme that continues to severely penalize taxpayers  in high-tax and high cost-of-living states. For example, the average uncapped deduction loss for taxpayers in New York is approximately $43,000 …significantly more than the U.S. average of $16,600. 

Instead of the various proposals being advanced by Congress I believe a more equitable and simple approach would provide for an indexed cap that takes into consideration the cost of living in each state.

Specifically, set the base cap at $10,000 and then allow taxpayers in each state to take an additional deduction equal to one-half the average uncapped deduction loss experienced by taxpayers in the state.  For example, this would produce an index adjusted cap in New York equal to $31,600. In New Jersey the adjusted cap would be $21,000, in Arkansas it would be $10,950. These amounts would vary from year to year based on the movement of property tax rates in each state. It would continue to act as a moderating influence on the tax authorities at both state and local levels.

What would the impact be in terms of overall revenue collected by the federal government? Based on the current cap, the government stands to collect $1.2 trillion over ten years. Under the indexed approach, they would instead collect $600 billion over ten years.  It is notable that if the law that gave rise to the cap sunsets and is not extended, then government stands to lose $1.2 million in revenue. Given the ever increasing deficit, I am not sure we can afford that.

As for the increase in the additional standard deduction for seniors, I propose that a flat deduction amount regardless of income makes the most sense. Perhaps the deduction amount can be tied to the basic Medicare Part B premium plus one half of the income adjusted higher premium amount in excess of the basic amount. This would effectively place seniors in the same position as those who receive their health insurance through their employers which enables them to pay premiums on a pre-tax basis. The cost of the standard deduction ranges from $60 -$90 billion over 10 years depending on the version that might survive.

In summary, both the formula driven indexed SALT cap , in contrast to the current arbitrary cap, and the indexed and formulas driven increase in the senior standard deduction are reasonable and fairer ways of providing tax relief at the same time as being fiscally responsible.

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