Housing USA: A Connection Between SALT Caps & Home Affordability?

6 min read

In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), the signature tax reform of former President Donald Trump. The law lowered income tax rates, reduced households subject to the estate tax, and generally decreased the burden that various interest groups must pay, using different tweaks and carveouts.

But one exception to this mindset was TCJA’s approach to the state and local tax (SALT) deduction, which lets residents deduct SALT payments on their federal tax returns. The law capped the allowable deduction to $10,000, in exchange for an increase in the standard deduction. This measure was controversial in high-tax states like New York, New Jersey and California, which is why Senate Majority Leader Chuck Schumer (D-NY) and Rep. Thomas Suozzi (D-NY) filed legislation in late January to eliminate the SALT deduction cap. Perhaps more interesting, at least for readers of Tax Credit Advisor, is whether the cap reduces home prices in these states, and whether that could change if it’s lifted under President Joe Biden.

The theory about the SALT cap’s relation to home prices goes like this: if you’re a high earner in, say, New York City, you may pay five-, six- or even seven-figure annual SALT burdens, due to the city’s high property taxes and the state’s 8.82 percent top income tax rate. When there’s a cap on how much of that can be deducted from a household’s federal tax burden, it makes living in these high-tax states more expensive…which causes an exodus of wealthy people to low-tax states, like Florida…which causes a cooling of home prices in those high-tax markets. Is there anything to this theory?

Possibly. Adam Michel, a Heritage Foundation fellow on tax policy, says that the cap does in fact increase the burden for high earners in these states, since they tend to itemize deductions rather than use the standard deduction. And SALT, he notes, was not the only deduction being curtailed under TCJA – so too were mortgage interest write-offs for homes above $750,000.

There is some evidence that this led to lower home sales and prices. Fox Business reports that in the year following the cap’s passage, home sales in high-tax states decreased significantly. In New York City, prices dropped at the fastest level since the 2008-12 downturn and sales dropped nearly three percent a year after the cap went into effect. Anthony Wright, reporting for Quanex, a building products manufacturer, notes that sales drops in excess of 50 percent occurred throughout the Northeast, writing in early 2019 that “because of the tax reform bill, homeowners in New Jersey, New Hampshire, Connecticut, New York and Vermont with the biggest per-capita property tax bills will see much bigger tax bills as a result.” Southern California, continues Wright, was also impacted, with an 18 percent decline in home and condominium sales.

And the impact could well have spread beyond high-tax states. Single-family home sales nationwide decreased by 7.6 percent between late 2017 and 2018. Federal Reserve research suggests that the SALT cap played a role, because decreases were sharper than recent prior ones.

“For both of these past episodes,” the New York Fed authors write, “the increase in the marginal user cost of capital is less than in the most recent one, particularly under the assumptions for higher-priced homes in high-tax jurisdictions.”

Another sign that the SALT deduction cap is impacting high-end home sales comes from the corporation Toll Brothers, which reported substantially fewer high-end home sales in 2018.

Not everyone believes, however, that the SALT deduction cap is causing some dramatic price drop in these markets, many of which still have huge housing affordability issues. Michel notes that organizations, like the National Association of Realtors® (NAR), predicted dire consequences for housing prices due to the cap; but ultimately, prices nationwide increased by five-and-a-half percent from 2018 to 2019. This was somewhat of a slowdown from prior years, but only a slight one; prices were previously increasing at a six to seven percent annual rate. Even the aforementioned three percent drop in New York City did not approach the eight to 12 percent decrease NAR predicted.

“Overall, I think the sort of doomsday [speculations that] these changes are going to devastate the housing market ultimately didn’t come to fruition,” says Michel.

Aside from the SALT deduction cap’s impact on housing affordability, there’s a wider debate on whether or not it’s good policy. Tax Foundation research finds that the deduction overwhelmingly benefits high-income earners. Michel argues that lifting the cap amounts to a tax break for them that isn’t enjoyed by others. He also believes the deduction is “implicitly subsidizing” high-tax cities and states for their largesse, rather than driving them towards fiscal discipline. That is, these states can engage in reckless spending and cover for it with high taxes, and the people paying the taxes can write them off on their federal returns. That creates revenue shortfalls in federal coffers—the Tax Foundation estimates it at $67 billion annually—which is then covered for by high earners in low-tax states.

In a Heritage policy brief, Michel writes that pre-cap, “a taxpayer in New York making between $50,000 and $75,000 a year deducted on average $3,375…A taxpayer in Tennessee making the same income only deducted $924 on average, which increased his federal taxes by about $400 compared to his identical New York counterpart.”

For this reason, he calls for the SALT deduction to be eliminated.

“Before the TCJA came into place, the average benefit from the SALT cap in California or New York was hundreds of thousands of dollars,” he told me. “It’s a regressive tax benefit.”

The Center on Budget and Policy Priorities concurs, writing that “repealing the cap would be regressive and costly. The top one percent of households would receive 56 percent of the benefit of repeal, and the top five percent of households would receive over 80 percent of the benefit, while the bottom 80 percent of households would receive just four percent.”

In sum, the SALT deduction cap may, to some degree, lower home sales and drive out high earners from high-tax states. But home prices are still very high in these markets, and on the other hand, the cap may worsen that problem by cooling home starts. State and local policymakers can reform the problem by liberalizing zoning and, where appropriate, increasing subsidies for affordable housing. The effect that federal deductions have on the issue are tough to pinpoint and will be ever-changing anyway, depending on which party is in power.