Tax Exporting through Federal Deductibility of State and Local Taxes: A Cross-state Analysis

Abstract

Federal deductibility of certain state and local taxes (SALT) creates an opportunity for state and local governments to export their deductible taxes. Using the Internal Revenue Service's Statistics of Income data, this research estimates the extent to which a state can export its tax burden. The research furthermore shows that a state with higher levels of deductible taxes exports more of its tax burden, and relevant state tax structure features and federal tax reforms infuence the exportability of state and local taxes. The empirical evidence reveals that tax exporting through federal deductibility creates a moral hazard because it incentivizes states and localities to increase their broad-based taxes in the belief that a part of the tax burden will be borne by other jurisdictions. The findings shed light on the ongoing debate on federal policies constraining the deductibility of certain state and local taxes.