Moderate Democrats want the $3.5 trillion spending plan to remove the limit on state and local tax deductions

• A host of moderate Democrats say they won't support President Joe Biden's $3.5 trillion package without a repeal of the cap on state and local tax deductions, known as SALT.
• The Democrats, many from New York and New Jersey, are angry that former President Donald Trump's tax law capped SALT deductions at $10,000.
• A spokesman for House Speaker Nancy Pelosi says a SALT cap repeal is an "important priority in the reconciliation bill."
• "We need to have this state and local tax deduction. We built a whole system around it," said New York Democrat Thomas Suozzi.

A fight over the cap on state and local tax deductions could prove Democrats' next hurdle in passing their $3.5 trillion budget reconciliation package.

A host of moderate Democrats — many from New York and New Jersey — have protested former President Donald Trump's 2017 tax cuts for capping how much taxpayers in their states can deduct from their federal tax obligation.

Reps. Josh Gottheimer, Mikie Sherrill, Bill Pascrell of New Jersey and New York's Thomas Suozzi say they won't support any legislation that doesn't restore the full deduction for state and local taxes, known as SALT.

"We need to have this state and local tax deduction. We built a whole system around it," said Suozzi, who since 2017 has represented parts of Long Island and northeastern sections of Queens, New York. "People are leaving our states. And when they leave, it leaves behind a hole in our revenues."

"We're in a competition with states that do not insure their children, do not pay their teachers, do not have mass transit and think that climate change is a hoax," he said. "And as a result, their costs are cheaper."

Trump's tax law limited SALT deductions to $10,000, meaning that residents in higher-tax states like New York and New Jersey could no longer deduct the full value of their state tax obligation from their federal bill. No limit existed before the Trump tax cuts.

While some politicians had left room for negotiating the cap higher, Sherrill doubled down on her view that the limit ought to be completely eradicated.

"I really think that what is required here is a full repeal," Sherrill said in a phone interview.

"Because I think not only is it something that would be helpful as we try to recover the economic engine that is New Jersey … but I also think that it is a value in our tax system," she added. "That if we are going to fund things like our teachers, and our cops, and our schools through state and local taxes, that you don't hinder a state's ability to do so."

Suozzi also wants a full repeal.

"I am completely opposed to an increase to the cap. That would be a great political victory because it would help a lot of people in my district and in many districts throughout the country," he said. "But it wouldn't address the policy issue, which is that people are leaving our states. And that's bad policy for us."

Gottheimer, Sherrill, Pascrell and Suozzi all represent wealthy districts compared with the national average. Of the four, Pascrell is the only one to represent a district with a median household income below $100,000, according to recent Census data.

Some of their more-progressive peers say that lifting the cap would disproportionately benefit the wealthiest American households.

Rep. Alexandria Ocasio-Cortez, D-N.Y., said in April that doing away with the cap would be "a giveaway to the rich." The progressive lawmaker noted at the time that she is open to "a conversation" about edits, but that a full repeal is excessive.

Ocasio-Cortez represents a district with a median household income of $66,700, according to Census data. Her office declined to comment for this story.

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Progressives also contend that a full repeal would undermine their party's attempts to find ways to pay for President Joe Biden's ambitious policy agenda. Asked for comment, the White House on Tuesday referred CNBC to prior remarks from press secretary Jen Psaki that the administration is open to discussions about the SALT cap.

But with conservative Democrat Sen. Joe Manchin insisting that Biden's $4.5 trillion in spending, including the infrastructure bill, be fully paid for, it's unclear how much of the added federal revenues the White House would be willing to surrender back to state and local governments.

Republicans have mostly supported the SALT cap as a way of keeping blue states from what they criticize as a wasteful tax and spend model. Democrats counter by pointing out declines in crime rates, the prestige of public school systems, greater access to affordable housing and other taxpayer-funded initiatives.

Whether the Democrats follow through on their demands for a full repeal or settle for a simple cap hike remains to be seen and is expected to be hashed out in private discussions with leadership throughout September.

Congressional aides who spoke with CNBC suggested that the Democrats may be asking for a full repeal but privately expecting a satisfactory compromise that would raise the cap from $10,000. They spoke on condition of anonymity to speak about fluid private discussions.

Still, any threat from within the party carries weight in a chamber controlled by just a few votes. House Speaker Nancy Pelosi, D-Calif., must find a way to persuade — or force — members of her own caucus to vote for the $3.5 trillion bill and the $1 trillion infrastructure legislation that her party campaigned on in 2020.

Republicans are unified in their opposition to transformative legislation, intended to rewrite the laws underpinning the aging U.S. social safety net for the first time in decades.

"The SALT deduction cap was a bald-faced Republican scheme to double tax blue communities and not red ones in order to choke off the revenue that high-cost progressive states and cities need to sustain services and meet the needs of their residents," Pelosi spokesman Henry Connelly told CNBC on Tuesday.

"Under Speaker Pelosi's leadership," Connelly continued, "the House passed legislation including repeals of the SALT deduction twice in the previous Congress, and Democrats continue to work on a path forward for this important priority in the reconciliation bill."

Senate Majority Leader Charles Schumer, D-N.Y., also supports a repeal of the SALT cap and offered measured remarks on Wednesday.

"There's strong sentiment among many people in our caucus … that the SALT cap should be lifted and we're working toward that goal," he said during a news conference.

The remarks from the House speaker's office may be her most supportive of a SALT deduction cap repeal to date and are likely welcome reinforcement for Gottheimer, co-chair of the Problem Solvers Caucus.

"This fight for a full reinstatement of SALT is existential to states like Jersey, whose taxes went up, not down, after the 2017 Tax Hike Bill. As a result, we have had a mass exodus of people and jobs out of our state," he said Tuesday evening.

Last month, Gottheimer and Pelosi sparred over whether the chamber should first pass the bipartisan infrastructure package or prioritize the $3.5 trillion reconciliation plan.

Gottheimer noted that, according to New Jersey-based newspaper The Star-Ledger, a full reinstatement of the deduction would provide tax relief to nearly a third of the Garden State's families, close to 3 million people.

"Eighty percent of those folks make $216,000 or less," he said. "Those are our teachers and firefighters. In high cost states like ours, this is about middle class families being able to afford New Jersey or not."

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