The Great Tax Migration

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With the elimination of most state and local tax (SALT) deductions, Congress has put a bull’s-eye on high-tax states like California and New York.  While there’s a reasonable federalist argument that states are exactly where most spending and taxation should take place, that’s almost beside the point now.  By eliminating SALT deductions without a commensurate shrinkage of federal income tax rates, Congress has set the stage for what could be the greatest migration since the aftermath of World War II, with roughly 15 million people moving from high-tax states to low-tax states in the coming decade.  

Some critics will say that people don’t move because of taxes.  And they have a point.  As has been reported in the New York Times, over half of all venture capital investment migrates to California alone, despite nosebleed marginal tax rates there.  Talent is the ultimate driver of economic growth, and it’s hard for us to fathom a scenario whereby San Francisco is substantially depopulated to the benefit of Orlando.  

At the same time, the notion that tax rates don’t matter ignores basic economics: Taxes are a cost imposed on success, and people respond to higher prices. Our forecast of a 15 million person migration from high- to low-tax states is hardly alarmist. Academic research has repeatedly shown that taxes are a driving force when it comes to decisions made about where to live and work.  We’re merely predicting that the pace of past migration will roughly double, because the tax difference between states has abruptly widened.  

As Milton Friedman famously observed, the only thing more mobile than the wealthy is their money.  Between 2000 and 2017, net migration between states was roughly 13.6 million people, and has been accelerating.  Over 80 percent of the net migration between states, some 12 million people, moved out of high-tax states and into low-tax states. As a result, the zero-tax states collectively saw their population grow by 32 percent, while the 10 highest-tax states saw only 10 percent population growth.  

In 2012, the top federal rate was 36 percent, once we count the phase-out of deductions.  For those in Texas, Florida and other states with no income tax, this was their total income tax.  For those in California and New York City, the combined marginal tax rates topped out at 44.6 percent and 45.6 percent, respectively, once we adjust for the SALT deductions and other nuances.  A spread of 8 percent between the zero-tax and the highest-tax states was evidently enough to encourage large-scale migration. 

Fast-forward to 2018, and we’ve just seen a federal tax “cut” to 37 percent. Uncapped Medicare taxes push the effective rate to 39.4 percent, 3.4 percentage points higher than in 2012.  California and a few other states have also boosted state tax rates since 2012.  Because state and local taxes are no longer deductible against federal taxes, the affluent now pay combined marginal taxes of 39.4 percent in Texas and Florida, versus 51.8 percent for New York City taxpayers and 53.4 percent for Californians.  This faux “tax cut for the rich” signed into law by President Trump has delivered a spread of 14 percent between the zero-tax and highest-taxed states.  

Crucial here is that a spread of half that size was linked to the outmigration from high-tax states of 12 million people before Trump signed the recent tax legislation into law. More than some would like to admit, Trump wasn’t lying when he said that passage of legislation most associated with him would hurt New Yorkers like him. By doubling the tax spread between high- and low-tax states, the rate of out-migration stands to grow, perhaps more than proportionally.  

Indeed, let’s look at these tax hikes through the prism of a Silicon Valley entrepreneur.  He now keeps 46.6 percent of his income, down from 55.4 percent in just six years, which is a 16 percent pay cut since 2012. The wealthy dislike a pay cut as much as the rest of us. It gets even more interesting from the vantage point of the “raise” the entrepreneur gets by moving.  He can keep 60.6 percent of his earned income in Texas or Florida, versus 46.6 percent in California.  That’s a 30 percent raise! While the tax treatment of stock options and capital gains is different, the result is much the same.  The innovative in California and New York face much higher prices for the privilege of living and working in either state.  

Let’s try to quantify this.  Because high and rising taxes tend to make people mad, let’s define a state’s “madness score” as its top marginal tax rate plus the 10-year change in the top tax rate. California and New York City have had an average madness score in recent years of 17 percent and 14 percent, respectively, while the seven states that stayed the course with zero income tax had a madness score of zero.  The elimination of the SALT deduction boosts these scores by a huge margin, even with no change in marginal state tax rates.  This is no small thing.  California would have had to boost its top tax rate from 13.3 percent to 21.1 percent in order to match the impact that the elimination of the SALT deduction will have on its taxpayers. California now sports a madness score north of 30. 

Let’s now roll the clock forward 10 years.  If the link between tax policy and migration from 2000 to 2017 is any kind of guide, the outmigration from high tax states in the coming decade should dwarf those of the previous 17 years.  If tax migration is proportional to the tax difference, the highest-tax states should lose about 6 percent of their population by 2028, while the zero-tax states should experience about 23 percent population growth. 

What will this mean for state and local budgets, either for new infrastructure in the low-tax states, or to maintain old infrastructure in the high-tax states?  For public workers’ pensions, most of which are frightfully underfunded even after a nine-year bull market?  For municipal bonds?  For housing prices?  It’s not hard to pick the winners and the losers. 

Important here is that if high-tax states want to shrink the incentive for out-migration, it’s shockingly easy to do so.  California, for example, could garner just as much revenue as it does now with a flat tax of 5.5 percent, with all current deductions still allowed.  Rather than letting tax-code machinations in Washington, D.C., define their future, state politicians in California and New York should send a pre-emptive message right back to Congress that they’re ready to do what it takes to keep the world’s most creative and successful people. 

Rather than penalize hard work and innovation, California and New York must take steps to reward it.  Most of all, politicians in high tax states must recognize that the very opportunity that has long served as a lure for the best and brightest could be snuffed out if they allow the cost of success to skyrocket in the Empire and Golden states.  

Rob Arnott is chairman Research Affiliates.

John Tamny is editor of RealClearMarkets and director of the Center for Economic Freedom at FreedomWorks.

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