SALT in old wounds: California’s taxes on wealth may hinge on how Trump treats deductions

California’s state budget is inordinately dependent on taxing the incomes of wealthy residents.

Gov. Gavin Newsom’s proposed 2025-26 budget assumes that the state will receive $133.7 billion in personal income taxes, more than 60% of general fund revenues. Nearly half of that would be paid by the 1% of Californians sitting atop the taxable income ladder.

The downside risk of such dependency is that taxes on the rich tend to swing up and down more than taxes on ordinary wage earners, because earnings on investments are substantial portions of wealthy people’s taxable incomes.

When the rich are getting richer, California sees multi-billion-dollar revenue windfalls. But downturns in their investments often result in sharp declines in tax receipts. In his budget, Newsom mentions the “swings in revenues and uncertainty that are a hallmark of California’s volatile tax system.”

The new budget cites a recent uptick in revenues that allowed Newsom’s budget to expand some categories of spending, such as a big increase in tax subsidies for the beleaguered Southern California film and video industry, one of his pet programs.

The validity of the new budget’s revenue assumptions is in doubt because of the wildfires that have afflicted Los Angeles County. But regardless of their impact, the state will continue to depend on volatile revenues from the wealthy, including those who lost their homes in Pacific Palisades and Malibu.

By happenstance, just as the new budget and the wildfires become prominent items on the Capitol’s political agenda, something else is happening in Washington that could affect California’s harvest of taxes on the rich.

With Donald Trump back in the White House, negotiations are underway on repeal or retention of a 2017 change in federal tax law that adversely affected states such as California and New York, whose budgets depend on taxing the incomes of the rich.

The change, part of a much larger overhaul of tax policy, limited deductions for state and local taxes – SALT in the political vernacular – on federal tax returns to $10,000.

The limit has the indirect effect of increasing federal levies on taxpayers who pay more than $10,000 in SALT each year. Other aspects of the 2017 tax bill, signed by Trump, benefited the wealthy but even so, California’s tax officials estimated that the net impact on California taxpayers would be a $12 billion annual increase in their federal tax obligations.

New York and California legislators and governors saw it as a deliberate hit by Republicans, including Trump, on blue state finances and have tried, on and off, to have it repealed ever since, to no avail. They worried aloud that the much-reduced SALT deduction would encourage wealthy taxpayers to move to states with low or no income taxes, such as Nevada, Texas and Florida.

The SALT provision and other parts of the 2017 legislation will automatically vanish at the end of this year unless renewed by Trump and a Republican-dominated Congress. Most of its provisions probably will be extended, but the fate of SALT is up in the air.

Trump now appears amenable to letting it die but may want concessions of some kind from the blue states. Meanwhile, Politico reports that a group of Republican congressional members dubbed the Freedom Caucus is proposing to repeal the SALT limit if blue states would agree to impose it on corporate income taxes to offset the cost.

By raising taxes on corporate incomes, however, such a deal would damage the relationship between blue state politicians such as Newsom and their corporations, including his pals in Hollywood.

It would be another GOP political hit — rubbing salt in their wounds, as it were.