COVID and SALT: Why state and local incentives have never been more important for Midwest economic development
2021 was an historic year for government spending and, therefore, the American tax system. While Elon Musk generated a record-breaking $11 Billion personal tax bill, the IRS introduced and then repealed the child tax care credit, and lawmakers across the country worked to reform local policies. Nearly a third of the country — 14 states — successfully introduced cuts to personal state income taxes for residents.
Why now? And what does this mean for workers and business in the Midwest?
There are several themes we’ll be following in 2022 to find out. The first is massive federal spending on infrastructure, climate, and social programs through a $1.2 Trillion Infrastructure Bill, which will fund improvements to roads and bridges, the grid, and broadband for years to come. With additional funds in Build Back Better still pending in the Senate — and since we probably won’t be printing a $1 T coin — congress remains divided about how to pay for the expanded stimulus.
The Tax Cuts and Jobs Act from 2017 (TCJA) remains the target of reforms, bringing into question how much to tax corporations, as well as the impact of state and local taxes. In addition to lowering the corporate tax rate, the TCJA also capped state and local tax (SALT) deductions to $10,000. While it’s long been the hope of Democratic lawmakers to change the TCJA to increase the corporate tax rate, now there are four northeastern states bringing a suit against the federal government over this cap.
What is SALT? Why is it a huge part of Build Back Better?
The SALT deduction has been part of the tax system since 1913, a provision which allows individuals and businesses to receive a rebate on taxes paid to state and local governments. The SALT cap was put in place by the 2017 tax law to help defray the costs of tax rate cuts — by limiting how much one can deduct in state and local income taxes, and property taxes, from federally taxable income. While the vast majority of Americans saw their total taxes go down from the 2017 tax cuts despite this measure, the SALT cap prevented what would have been even larger tax cuts for high-income households.
At its current size — negotiations are continuing — this tax cut would be the third largest measure in the bill. Three hundred billion dollars is more than the bill spends on universal preschool, the child tax credit and the earned income tax credit combined. It is also more than the bill allocates for health care for the poor, elderly and disabled. And it’s about as much as would be spent on renewable energy tax credits.
This brings us to the second theme: the growing gap between taxes in Democratic and Republican-governed states.
While it’s true that academic research shows that historically tax policy has little effect on where people choose to live, a cap on SALT means, proportionally, state and local taxes are more important to each individual and business. It means people who earn the same annual salary in New York and Texas no longer pay the same federal taxes.
While many factors contribute to demographic shifts, states with the highest tax rates versus those with the lower saw divergent migration trends in the past year — California and New York lost 300,387 and 429,283 residents, respectively, while Texas added 382,436 new residents and Florida gained 242,94. And, notably, some of the wealthiest individuals moved away from states like California and New York, and the biggest financial firms — Goldman Sachs, Apollo Global Management, and Point72 Asset Management — followed suit.
This is hardly the first time many Americans have reshuffled geographically. It’s possible, however, that this time will be different because states have never had so much latitude and recourse to create such radically different conditions for economic development.
The combination of increased geographic elasticity in the American workforce along with a shift in the paradigm of relative government power and spending means the changes enacted at a state and local level will be more important than ever.
Midwestern states have demonstrated a willingness to take advantage of the unique situation to attract more workers and businesses. Last week, Governor Holcomb announced Indiana would pursue reducing income taxes, and Governor Whitmer announced $1 billion in tax incentives for Michigan businesses.
The trend will extend far beyond taxes in 2022, as states battle for more residents and growth. In the milieu of intensifying midterm elections, inflation concerns, and government budget surpluses, lawmakers will pull on policy levers around vaccination, individual freedoms, and infrastructure allocation to differentiate themselves. As the difference between states becomes more apparent, we may see aggressive policies to provide more incentives.
In what essentially amounts to a giant national experiment on social and economic motivation, it’s likely that states like Ohio and Indiana will sustain high growth rates. As states become more divergent in practical ways, regional economic growth will depend on lawmaker’s abilities to respond to the needs and priorities of citizens and the companies they work for. Emerging from the pandemic, Americans are voting with their feet, and the states that will “win” are those that are able to be responsive to the shifting demands and priorities of constituents, workers, and entrepreneurs alike.