Recent federal tax reform proposals reflect strikingly different visions for future revenue policy. But they have one feature in common: Nearly all would eliminate or limit existing tax preferences, including the federal deduction for state and local taxes (SALT).

Eliminating that deduction is not only an important feature of federal tax reform, it also has important implications for state tax and budget policy. Just in time for tax day, the Tax Policy Center has released a new report on the SALT deduction and alternative policies for reforming it.

First, a bit of background: Almost all taxpayers who itemize claim the deduction for state and local real estate, personal property, and either income or general sales taxes. In effect, this means they can get back some, but not all, of these taxes from the federal government—unless they’re on the alternative minimum tax (AMT), in which case they lose the preference.  

The Joint Committee on Taxation estimates the deduction will cost the Treasury $527 billion over five years, making it one of the largest tax preferences and a big target for those looking for ways to raise revenue.

About 45 percent of the benefit of the deduction goes to taxpayers with incomes over $200,000, and thus the benefits are concentrated in states with more high income households, especially those states with high taxes or steep house prices.

California and New York account for about one-fifth of all returns claiming the SALT deduction, and almost one-third of the total deduction claimed. Slightly more than half of the returns claiming the deduction and 63 percent of the value come from the top 10 states. And a map highlighting the states claiming the largest share would look very blue. This may partially explain why Republican presidential candidates seem willing to eliminate the deduction.

But there are other reasons. The SALT deduction is a significant federal subsidy to state and local governments. By lowering the net cost of state and local taxes it allows those jurisdictions to levy higher taxes and provide more services than they otherwise would.

It also encourages states to use deductible taxes in place of non-deductible taxes, fees, and other charges. And because taxpayers can deduct either sales or income taxes, it should lead states to levy one tax or the other but not both.

The deduction also encourages states to rely more heavily on progressive income taxes. Because high-income taxpayers are more likely to itemize and the because their higher federal marginal tax rate increases the amount they save from each dollar deducted, states can capture a larger subsidy by having high-income residents pay a greater share of taxes.

That leaves two important questions: Should Congress continue this federal subsidy to states and, if so, what should it look like?

Most federal assistance to the states comes through grants. Although states have some leeway in how they use those funds, most are subject to significant federal oversight and control and some require that states share the costs of the programs the grants support.

In contrast, the SALT deduction is an open-ended subsidy available to all taxpayers who can claim it. The cost is not subject to annual appropriations by Congress and is not directly recognized in the federal budget. Moreover, there is no federal oversight of the way state and local governments use the subsidy from the deduction.

While federal grants and other funding might be better than the SALT deduction as a means of supporting states, getting there could be politically difficult because it would create winners and losers across different states.

Short of eliminating the deduction, there are ways to reduce the deduction’s cost and make it fairer. Hillary Clinton and Bernie Sanders both propose limiting the deduction’s tax benefits for high-income taxpayers. Alternatively, capping the deduction would limit its cost and reduce the disparity in its use across states. Replacing the deduction with a tax credit would distribute the benefits even more uniformly among households and across the states.

The state and local tax deduction is just one way federal tax policy interacts with states. But it is an important one. Remember: What happens in Washington doesn’t just stay in Washington, but affects policy choices by other governments in our federalist system.