Red State, Blue State: Examining the Tax Law's Spending Effects
States where a majority of citizens voted Republican in recent U.S. presidential elections stand to benefit more from the 2017 U.S. tax law than those that favored Democrats, an analysis by a research team including Federal Reserve Bank of Atlanta economists has found.
The study calculated effects of the changes in disposable personal income from the legislation and concluded that tax reductions and the resulting rise in spending for households in so-called red states—those that leaned Republican in the last five presidential elections—were greater compared with blue states, where most people voted Democratic during that time.
That higher benefit for the red states flows largely from the Tax Cut and Jobs Act's limitation on the deductibility of state and local taxes, known as SALT. The tax law capped the deduction at $10,000 for taxpayers who itemize their federal returns. Prior to the tax reform law, there was no restriction on the SALT deduction. The U.S. law, passed in December 2017, significantly cut the income tax rate for businesses and reduced tax rates for most individual brackets. It also nearly doubled the federal standard deduction from prior levels but eliminated the personal exemption that filers could exclude from their yearly taxable income.
“We did find that most people are going to benefit” from the tax law, said Ellyn Terry, an economic policy specialist at the Atlanta Fed who was part of the research team that analyzed the law's effects, which were detailed in an April 2019 Atlanta Fed working paper.
Spending increases ongoing but uneven
The study concluded that permanent implementation of the tax law would produce an average lifetime spending increase for households in all states. However, for red states, the average spending gain came to 1.6 percent, compared with a 1.3 percent rise for blue-state households. The spending gain for states that were neither red or blue—designated as purple—was also 1.6 percent.
The researchers examined household data from the Federal Reserve Board's 2016 Survey of Consumer Finances with a tool developed by economists Alan Auerbach at the University of California–Berkeley and Laurence Kotlikoff of Boston University called the Fiscal Analyzer. The tool calculates how much households would spend over their lifetime based on their wealth, future earnings, taxes, and government benefits. The analyzer includes current and projected federal and state taxes, social security payouts, and other government benefits in its calculations.
Among all states, the study found that California, a blue state, had the smallest percentage increase in lifetime spending as a result of the tax law, at 0.9 percent. Wyoming, a red state, had the largest percentage boost in spending from the tax reform, at 2.1 percent. Of the 10 states with the highest average spending gain from the tax law, only one—Washington—was blue. The 10 areas with the smallest percentage spending increase were all blue, including the states of New York, New Jersey, and Hawaii, as well as the District of Columbia.
Winning or losing: The vantage point matters
The significance of the $10,000 cap on the deduction for state and local property, income, and sales taxes depends on where you live. States with the highest 2019 local and state taxes include New York, New Jersey, and Connecticut—all blue states. The Atlanta Fed working paper looked at tax rates, home values, and state and local taxes for a median-income household and noted that blue states had the heaviest tax burdens. By contrast, states with some of the lowest tax obligations were Alabama, Montana, Tennessee, and West Virginia—all red states.
The researchers calculated the spending increase that households in each state would have realized if the SALT deduction limit had not been imposed. Under that scenario, California households, for example, would have had a lifetime spending gain of 2.2 percent from the tax law—a significant improvement over the estimated 0.9 percent increase with the $10,000 SALT limit. With no change in SALT, the spending increase for New York households would be 2.1 percent, compared with 1.3 percent with the SALT cap that the 2017 tax law put in place, the study found.
The six southeastern states in the Atlanta Fed's district had similar lifetime spending increases based on the effects of the tax law, according to the analysis. Alabama, Georgia, and Louisiana—all red states—stand to see a spending gain of 1.5 percent because of the tax law. Mississippi and Tennessee, also red states, had spending gains of 1.6 percent and 1.7 percent, respectively. The calculated spending increase for Florida, a purple state, came to 1.8 percent (see the table).
Adding SALT to the Southeast
Calculations by a research team including Atlanta Fed economists showed the effects on U.S. households of the 2017 tax law that limited the deductibility of state and local taxes. The chart below shows the average percentage spending gains for the six states in the Atlanta Fed’s district.
|State||With SALT Limitation||Without SALT Limitation|
Source: Atlanta Fed calculations, the Fiscal Analyzer
Under the no-SALT limit scenario, the analysis showed most of those states would gain a little bit more. Mississippi, Alabama, and Louisiana would each see a spending increase of 1.7 percent, while Georgia residents would gain 1.9 percent. Tennessee's spending increase with no cap on SALT would be 1.8 percent, and Florida's gain would be the same, 1.8 percent, as it stands under the current law. The study found that, overall, U.S. states would experience an average spending increase of 2 percent with no SALT limitation, compared with a 1.5 percent gain under the tax law with the SALT cap.
The research also showed that the wealthiest households did not fare as well under the tax law largely because of the cap on the SALT deduction. The average gain in spending with no SALT limitation for the top 10th percentile of U.S. households came to 2.6 percent, compared with 1.5 percent under the tax law, the research calculations showed. In red Georgia, for example, the analysis found that that the wealthiest 10 percent stands to gain a lifetime spending increase of 1.6 percent under the current tax law. But if the state and local tax deduction cap were not in place, those households would realize a spending gain of 2.7 percent.
Even so, the tax law appears to leave rich people living in red states better off than their counterparts in blue states. Among the top 10 percent, those in red states stand to see a 2 percent rise in remaining lifetime spending under the tax law, compared with a 1.2 percent increase for the wealthy in blue states.
The results of the study raise a host of questions tied to the political economy, such as whether voters have incentives to support certain candidates based on expected tax benefits, the researchers said.