Indirect Federal Subsidy and Tax Exportation through State and Local Tax Deduction: Understanding the Impact of the 2017 Tax Reform on State and Local Governments

Abstract

The deduction of certain state and local taxes (SALT) from the U.S. federal income tax base provides substantial amounts of indirect federal subsidy to state and local governments and also allows cross-state exportation of deductible state and local taxes. The Tax Cuts and Jobs Act of 2017 (TCJA) limits the SALT deduction and increases standard deduction per filer each year. This study examines the impact of TCJA on the distribution of this indirect federal subsidy and exportation of major state and local taxes. Using individual income tax data from the Internal Revenue Service, this research shows that the law narrows the disparity in states’ receipt of the indirect federal subsidy and reduces the capacity of high-tax states to export their taxes to other states. The findings shed light on the continued debate regarding the effectiveness and fairness of this important type of intergovernmental transfer in the United States.