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Posts Tagged ‘Tax Reform’

There are three reasons why the right kind of tax reform can help the economy grow faster.

  1. Lower tax rates give people more incentive to earn income.
  2. Less double taxation boosts incentives to save and invest.
  3. Fewer loopholes improves incentives for economic efficiency.

Let’s focus on the third item. I don’t like special preferences in the tax code because it’s bad for growth when the tax code lures people into misallocating their labor and capital. Ethanol, for instance, shows how irrational decisions are subsidized by the IRS.

Moreover, I’d rather have smart and capable people in the private sector focusing how to create wealth instead of spending their time figuring out how to manipulate the internal revenue code.

That’s why, in my semi-dream world, I’d like to see a flat tax.* Not only would there be a low rate and no double taxation, but there also would be no distortions.

But in the real world, I’m happy to make partial progress.

That’s why I was happy that last year’s tax bill produced a $10,000 cap for the state and local tax deduction and reduced the value of other write-offs by increasing the standard deduction. Yes, I’d like to wipe out the deductions for home mortgage interest, charitable giving, and state and local taxes, but a limit is better than nothing.

And I’m also happy that lower tax rates are an indirect way of reducing the value of loopholes and other preferences.

To understand the indirect benefits of low tax rates, consider this new report from the Washington Post. Unsurprisingly, we’re discovering that a less onerous death tax means less demand for clever tax lawyers.

A single aging rich person would often hire more than a dozen people — accountants, estate administrators, insurance agents, bank attorneys, financial planners, stockbrokers — to make sure they paid as little as possible in taxes when they died. But David W. Klasing, an estate tax attorney in Orange County, Calif., said he’s seen a sharp drop in these kinds of cases. The steady erosion of the federal estate tax, shrunk again by the Republican tax law last fall, has dramatically reduced the number of Americans who have to worry about the estate tax — as well as work for those who get paid to worry about it for them, Klasing said. In 2002, about 100,000 Americans filed estate tax returns to the Internal Revenue Service, according to the IRS. In 2018, only 5,000 taxpayers are expected to file these returns… “You had almost every single tax professional trying to grab as much of that pot as they could,” Klasing said. “Now almost everybody has had to find other work.”

Needless to say, I’m delighted that these people are having to “find other work.”

By the way, I’m not against these people. They were working to protect families from an odious form of double taxation, which was a noble endeavor.

I’m simply stating that I’m glad there’s less need for their services.

Charles “Skip” Fox, president of the American College of Trust and Estate Counsel, said he frequently hears of lawyers shifting their focus away from navigating the estate tax, and adds that there has been a downturn in the number of young attorneys going into the estate tax field. Jennifer Bird-Pollan, who teaches the estate tax to law students at the University of Kentucky, said that nearly a decade ago her classes were packed with dozens of students. Now, only a handful of students every so often may be interested in the subject or pursuing it as a career. “There’s about as much interest in [the class] law and literature,” Pollan said. “The very, very wealthy are still hiring estate tax lawyers, but basically people are no longer paying $1,000 an hour for advice about this stuff. They don’t need it.”

Though I am glad one lawyer is losing business.

Stacey Schlitz, a tax attorney in Nashville, said when she got out of law school about a decade ago roughly 80 percent of her clients were seeking help with their estate taxes. Now, less than 1 percent are, she said, adding that Tennessee’s state inheritance tax was eliminated by 2016. “It is disappointing that this area of my business dried up so that such a small segment of society could get even richer,” Schlitz said in an email.

I hope every rich person in Nashville sees this story and steers clear of Ms. Schlitz, who apparently wants her clients to be victimized by government.

Now let’s shift to the business side of the tax code and consider another example showing why lower tax rates produce more sensible behavior.

Now that the corporate tax rate has been reduced, American companies no longer have as much desire to invest in Ireland.

US investment in Ireland declined by €45bn ($51bn) in 2017, in another sign that sweeping tax reforms introduced by US president Donald Trump have impacted the decisions of American multinational companies. …Economists have been warning that…Trump’s overhaul of the US tax code, which aimed to reduce the use of foreign low-tax jurisdictions by US companies, would dent inward investment in Ireland. …In November 2017, Trump went so far as to single out Ireland, saying it was one of several countries that corporations used to offshore profits. “For too long our tax code has incentivised companies to leave our country in search of lower tax rates. It happens—many, many companies. They’re going to Ireland. They’re going all over,” he said.

Incidentally, I’m a qualified fan of Ireland’s low corporate rate. Indeed, I hope Irish lawmakers lower the rate in response to the change in American law.

And I’d like to see the US rate fall even further since it’s still too high compared to other nations.

Heck, it would be wonderful to see tax competition produce a virtuous cycle of rate reductions all over the world.

But that’s a topic I’ve addressed before.

Today’s lesson is simply that lower tax rates reduce incentives to engage in tax planning. I’ll close with simple thought experiment showing the difference between a punitive tax system and reasonable tax system.

  • 60 percent tax rate – If you do nothing, you only get to keep 40 cents of every additional dollar you earn. But if you find some sort of deduction, exemption, or exclusion, you increase your take-home pay by an additional 60 cents. That’s a good deal even if the tax preference loses 30 cents of economic value.
  • 20 percent tax rate – If you do nothing, you get to keep 80 cents of every dollar you earn. With that reasonable rate, you may not even care about seeking out deductions, exemptions, and exclusions. And if you do look for a tax preference, you certainly won’t pick one where you lose anything close to 20 cents of economic value.

The bottom line is that lower tax rates are a “two-fer.” They directly help economic growth by increasing incentives to earn income and they indirectly help economic growth by reducing incentives to engage in inefficient tax planning.

*My semi-dream world is a flat tax. My dream world is when the federal government is so small (as America’s Founders envisioned) that there’s no need for any broad-based tax.

P.S. It’s not the focus of today’s column, but since I talked about loopholes, it’s worth pointing out that they should be properly defined. Sadly, that simple task is too challenging for the Joint Committee on Taxation, the Government Accountability Office, and the Congressional Budget Office (or even the Republican party).

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Politicians who preach class warfare repeatedly assert that we need higher taxes on “the rich.”

Indeed, that’s been the biggest political issue (and oftentimes biggest economic issue) in every recent tax fight (the Trump tax reform and Obama’s fiscal cliff), as well as the issue that generates the most controversy when discussing tax reform.

So it seems almost inconceivable that the class-warfare crowd would support a change to the tax code that would only benefit the top-10 percent, right?

Yet that’s exactly what’s happening in the fight over the deduction for state and local taxes.

Democrats want to restore an unlimited deduction, thereby enabling people to shield more of their income from tax. But, as the Tax Foundation notes, that change only produces benefits for upper-income taxpayers.

Itemized deductions such as the SALT deduction are mostly utilized by higher-income individuals. As such, any change to the SALT deduction will chiefly impact them. In addition, the value of a deduction increases as a taxpayer’s statutory tax rate increases. A deduction against the top rate of 37 percent is more valuable than a deduction against the 32 percent tax rate. We estimate that eliminating the SALT deduction cap would have no impact on taxpayers in the bottom two income quintiles and a negligible impact on taxpayers in the third and fourth quintiles. …However, taxpayers in the top 5 and 1 percent of income earners would see an increase in after-tax income of 1.6 percent and 3.7 percent respectively.

And if restoring the deduction is “paid for” by raising the corporate tax rate, the net effect is to raise taxes on the bottom-90 percent in order to give a tax to top-10 percent.

Or, to be more precise, to give a tax cut to the top-1 percent.

Some of you may be thinking that the Tax Foundation leans right and therefore can’t be trusted.

So let’s look at some research from the Tax Policy Center, which is a joint project of the left-leaning Urban Institute and left-leaning Brookings Institution.

Only about 9 percent of households would benefit from repeal of the Tax Cuts and Jobs Act’s (TCJA) $10,000 cap on the state and local property tax (SALT) deduction, and more than 96 percent of the tax cut would go to the highest-income 20 percent of households… For all middle-income taxpayers, the average tax cut would be $10. Those in the top 1 percent would pay an average of $31,000, or 2 percent of after-tax income, less.

And here’s the TPC chart showing how almost all the tax relief goes to upper-income taxpayers.

So what’s going on? Why are Democrats fighting for an idea that would give the rich a $31,000 tax cut while only providing $10 of relief for middle-class taxpayers?!?

The simple answer is that they think the loophole is a very valuable way of facilitating higher taxes and bigger government at the state and local level. And they’re right, so I don’t blame them.

But it’s nonetheless very revealing that they are willing to jettison their tax-the-rich rhetoric when it interferes with their make-government-bigger agenda.

P.S. This “SALT” debate strikes me as being similar to the Laffer-Curve debate, which requires folks on the left to choose whether it’s more important to punish rich people or to get more revenue to spend.

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Earlier this month, I talked about the economy’s positive job numbers. I said the data is unambiguously good, but warned that protectionism and wasteful spending will offset some of the good news from last year’s tax reform.

This is what’s frustrating about the Trump presidency.

Good policies in some areas are being offset by bad policies in other areas, so it’s not easy assigning an overall grade.

And it’s also difficult to predict the effect on economic performance. If you look at the formula for a prosperous economy, there’s no way of predicting whether Trump is a net positive or a net negative. At least in my humble opinion.

As such, I’ll be very curious to see what happens to America’s score in subsequent issues of Economic Freedom of the World.

It would be nice if the United States got back into the Top 10. For what it’s worth, I’m guessing America’s score won’t measurably improve.

That being said, if there was a pro-con debate on Trump’s performance, some people would be quite confident about declaring victory.

Mike Solon, a former budget staffer on Capitol Hill, offers the “pro” assessment in the Wall Street Journal.

Are low taxes key to a booming economy? Their success is harder than ever to deny after Friday’s report that the U.S. economy grew 4.1% in the second quarter, bringing the average quarterly growth rate during the Trump presidency to 2.9%. …In the first five quarters of the Trump presidency, growth has been almost 40% higher than the average rate during the Obama years, and per capita growth in gross domestic product has been 63% faster. …The CBO now projects that additional revenue from this economic surge will offset 88.2% of the estimated 10-year cost of the tax cut. …The CBO’s April revision projected an extra $6.1 trillion in GDP over the next decade—more than $18,000 of growth for every man, woman and child in America. …the Labor Department reports that worker bonuses have hit the highest level ever recorded. The Commerce Department reports that wages and salaries are growing almost 25% faster under President Trump than under Mr. Obama.

Since I have great confidence that lower tax rates are good for growth and that Laffer Curve-type feedback effects are real, I want to applaud what Mike wrote.

And since I’ve also dissed the idea of “secular stagnation,” I also like this part of his column.

Perhaps the most important narrative discredited by the economic revival is the “secular stagnation” excuse. Throughout the Obama years, progressive economists said Americans had become too old, lazy and complacent to achieve the growth that was regular before 2009. But somehow American workers overcame all of these supposed weaknesses when Mr. Trump changed federal policy. The problem was not our people but our government. Stagnation is not fate but a political choice.

Amen to that final sentence. Stagnation is the result of bad policy.

But my problem is that Trump has some bad policies that are offsetting his good tax reform. So I can’t help but think Mike is being too optimistic.

Let’s look at another perspective. It would be an exaggeration to state that Jimmy Pethokoukis of the American Enterprise Institute is in the “con” camp, but he definitely is skeptical.

GOP hot takes will come as fast and furious as the economic growth. “The tax cuts worked!” “Trumponomics rocks!” …Celebrating a stronger economy is not a bad thing, of course. Over the long run, sustainable economic growth is what generates higher living standards and greater social mobility. But drawing sweeping conclusions from a single three-month period is problematic…it doesn’t necessarily tell you a whole lot about where the economy is heading. There were eight quarters of 3 percent growth or faster scattered across the Obama presidency, including four of 4 percent or faster and one of 5.2 percent. But there was never much follow-through, and overall the expansion muddled through at roughly a 2 percent annual pace. …even a very strong report won’t tell us whether the Trump tax cuts, passed in December, are “working.” It’s just too soon. …that process will play out over a numbers of years.

This is a very sensible perspective. I’ve repeatedly warned not to overstate the importance of short-run data. And I also fully agree that there’s often a time lag between the adoption of good policy and the evidence of good results.

But I have the same complaint about the Pethokoukis column as I did about the Solon column. There’s a sin of omission because both focused on the tax reform.

As I noted above, we also need to consider the other policies that have changed in the last 18 months.

I don’t know the answer, but maybe this image will illustrate why we should hesitate before making sweeping assessments.

And also keep in mind that we have no way of knowing whether there’s a Fed-created bubble in the economy. As I said in the interview, what if 2018 is akin to 2006? Back then, most people underestimated the possibility that easy money and Fannie-Freddie subsidies had created an unsustainable housing boom.

But even if we ignore that wild card, I can’t help but wonder whether Trump’s pro-growth polices and Trump’s anti-growth policies are resulting in a wash.

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Guided by the principles of a simple and fair flat tax, I’ve been toiling for decades in the vineyard of tax reform. At the risk of mixing my metaphors, I usually feel like Don Quixote, engaged in a futile quest. Convincing politicians to reduce their power is not an easy task, after all.

But it is possible to make incremental progress. I’ve argued, ad nauseam, about the need to lower the corporate tax rate and the benefits of ending the state and local tax deduction, and we actually took big steps in the right direction last year.

Indeed, while the final legislation was far from perfect, it was certainly better than I expected.

But there’s no such thing as a permanent victory in Washington. The debate has now shifted from “is the tax plan a good idea?” to “is the tax plan working?” And that was the focus of my recent CNBC debate with Austan Goolsbee, the former Chairman of Obama’s Council of Economic Advisers.

Interestingly, Austan and I agreed on several issues.

At the risk of digressing, I should have mentioned that Trump’s corporate rate cut, while a big step in the right direction, should be viewed as a first step. As illustrated by this chart, the overall US corporate rate is still higher than the average for other advanced nations.

Let’s now get back to the interview. Goolsbee and I didn’t agree on everything.

  • Austan is fixated on class warfare, which I think is very bad economics because it means high marginal tax rates and/or a heavier tax bias against saving and investment.
  • He also frets about deficits, which is rather ironic since he didn’t seem to worry about red ink when Obama was pushing his failed stimulus scheme. In any event, I pointed out that there is no long-run tax cut.

Last but not least, here are some additional points from the interview

  • I repeatedly expressed concern that good tax policy won’t be very sustainable unless politicians restrain the excessive growth of government spending, both in the short run and long run.
  • I also pointed out that the restriction on the state and local tax deduction will help the national economy if it deters some big states from raising taxes (though that reform certainly isn’t slowing down the big spenders in New Jersey).
  • Even small differences in economic growth, if sustained over time, can make a big difference in living standards.
  • We should be worried that Trump will sabotage his tax cut with protectionism.

The bottom line is that last year’s tax plan resulted in a less-destructive tax code. That doesn’t guarantee fast growth since we also have to look at other policies, but it will help.

P.S. I indirectly tangled with Goolsbee in about taxes in 2010 and about spending in 2012.

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Better economic performance is the most important reason to adopt pro-growth reforms such as the Tax Cuts and Jobs Act of 2017.

Even small increases in economic growth – especially if sustained over time – can translate into meaningful improvements in living standards.

But there are several reasons why it won’t be easy to “prove” that last year’s tax reform boosted the economy.

And there are probably other factors to mention as well.

The takeaway is that the nation will enjoy good results from the 2017 tax changes, but I fully expect that the class-warfare crowd will claim that any good news is for reasons other than tax reform. And if there isn’t good news, they’ll assert this is evidence against “supply-side economics” and totally ignore the harmful effect of offsetting policies such as Trump’s protectionism.

That being said, some of the benefits of tax reform are already evident and difficult to dispute.

Let’s start by looking at what’s happening Down Under, largely driven by American tax reform.

The Australian government announced Monday that the Senate will vote in June on cutting corporate tax rates after an opinion poll suggested the contentious reform had popular public support. …Prime Minister Malcolm Turnbull’s conservative coalition wants to cut the corporate tax rate by 5 percent to 25 percent by 2026-27… Cormann said the need to reduce the tax burden on businesses had become more pressing for future Australian jobs and investment since the 2016 election because the United States had reduced its top corporate tax rate from 35 percent to 21 percent. “Putting businesses in Australia at an ongoing competitive disadvantage deliberately by imposing higher taxes in Australia … puts Australian workers at an oncoming disadvantage and that is clearly the point that more and more Australians are starting to fully appreciate,” Cormann told reporters. Cormann was referring to a poll published in The Australian newspaper on Monday that showed 63 percent of respondents supported company tax cuts.

Wow.

What’s remarkable is not that Australian lawmakers are moving to lower their corporate rate. The government, after all, has known for quite some time that this reform was necessary to boost wages and improve competitiveness.

The amazing takeaway from this article is that ordinary people understand and support the need to engage in tax competition and other nations feel compelled to also cut business tax burdens.

All last year, I kept arguing that this was one of the main reasons to support Trump’s proposal for a lower corporate rate. And now we’re seeing the benefits materializing.

Now let’s look at a positive domestic effect of tax reform, with a feel-good story from New Jersey. It appears that the avarice-driven governor may not get his huge proposed tax hike, even though Democrats dominate the state legislature.

Why? Because the state and local tax deduction has been curtailed, which means the federal government is no longer aiding and abetting bad fiscal policy.

New Jersey’s new Democratic governor is finding that, even with his party in full control of Trenton, raising taxes in one of the country’s highest-taxed states is no day at the beach. Gov. Phil Murphy…has proposed a $37.4 billion budget. He wants to raise $1.7 billion in new taxes and other revenue… But some of his fellow Democrats, who control the state legislature, have balked at the governor’s proposals to raise the state’s sales tax and impose a millionaires tax. State Senate President Steve Sweeney has been particularly vocal. …Mr. Sweeney previously voted for a millionaire’s tax, but said he changed his mind after the federal tax law was passed in December. The law capped previously unlimited annual state and local tax deductions at $10,000 for individual and married filers, and Mr. Sweeney said he is concerned an additional millionaire’s tax could drive people out of the state. “I think that people that have the ability to leave are leaving,” he said.

Of course they’re leaving. New Jersey taxes a lot and it’s the understatement of the century to point out that there’s not a correspondingly high level of quality services from government.

So why not move to Florida or Texas, where you’ll pay much less and government actually works better?

The bottom line is that tax-motivated migration already was occurring and it’s going to become even more important now that federal tax reform is no longer providing a huge de facto subsidy to high-tax states. And that’s going to have a positive effect. New Jersey is just an early example.

This doesn’t mean states won’t ever again impose bad policy. New Jersey probably will adopt some sort of tax hike before the dust settles. But it won’t be as bad as Governor Murphy wanted.

We also may see Illinois undo its flat tax after this November’s election, which would mean the elimination of the only decent feature of the state’s tax system. But I also don’t doubt that there will be some Democrats in the Illinois capital who warn (at least privately) that such a change will hasten the state’s collapse.

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I had mixed feeling when I spoke yesterday in Bratislava, Slovakia, as part of the 2018 Free Market Road Show.

Last decade, Slovakia was a reform superstar, shaking off the vestiges of communism with a plethora of very attractive policies – including a flat tax, personal retirement accounts, and spending restraint.

As Marian Tupy explained last year, “…in 1998, Slovaks kicked out the nationalists and elected a reformist government, which proceeded to liberalise the economy, privatise loss-making state-owned enterprises and massively improve the country’s business environment. …In 2005, the World Bank declared Slovakia the “most reformist” country in the world.”

And these policies paid off. According to research from both Europe and the United States, Slovakia has enjoyed reasonably strong growth that has resulted in considerable “convergence” to western living standards.

But in recent years, Slovakia has gradually moved in the wrong direction, which means I have good and bad memories of my visits.

The nation’s strong rise and subsequent slippage can be seen in the data from Economic Freedom of the World.

The drop may not seem that dramatic. And in terms of Slovakia’s absolute score, it “only” fell from 7.63 to 7.31.

But what really matters (as I explained last year when writing about Italy) is the relative score. And if you take a closer look at the data, Slovakia has dropped in the rankings from #20 in 2005 to #53 in 2015.

This relative decline is not good news for a nation that wants to compete for jobs and investment. Moreover, I’m not the only one to be worried about slippage in Slovakia.

Jan Oravec is similarly concerned about a gradual erosion of competitiveness in his country.

…the World Economic forum, which compares the competitiveness of 140 countries around the world, Slovakia ranked 67th. …If we…look at the long-term evolution of the Slovak economy’s competitiveness not only in this, but in other rankings, we realize…a tragic story of a dramatic decline in our competitiveness. Let us start by looking back at our previous scores: In 2000, we ranked 38th, while in 2010 we painfully fell to 60th – today we hold the aforementioned 67th place. …If we take a look at the evolution of Slovakia’s situation from the last 10 years, we come to the conclusion that there has been a significant drop in the ranking of our competitiveness. While 10 years ago we usually ranked in the top third or quarter of the ranked countries, today we usually rank in the bottom half… An explanation to this negative trend is twofold: Other countries have been improving while our business environment has been worsening, or stagnating at best.

There are three glaring examples of slippage in Slovakia.

  • The first is that the flat tax was undone in 2012.
  • The second is that the private social security system was weakened.
  • The third is an erosion of fiscal discipline.

To be sure, it’s not as if Slovakia went hard left. The top tax rate under the new “progressive” system is 25 percent. And as I noted last month, that means high-income workers in Slovakia are still treated rather well compared to their counterparts in other industrialized nations.

And the leftist government in Slovakia weakened – but did not completely reverse – personal retirement accounts.

Jan Oravec explains the good reform that was adopted last decade.

During 2003 two main legislative acts – the Social Insurance Act and the Old-Age Pension Savings Act – were prepared by the reform team. …Prior to reform Slovaks were obliged to pay to the PAYGO system contributions of 28.75 % of their gross wages, and the system promised in exchange to pay an average old-age benefit amounting to 50 % of gross wages. The reform allowed workers to redirect a significant part of their contributions, 9 % of gross wage, to their personal retirement accounts.

Under current law, however, the amount that workers are allowed to place in private accounts has been reduced. Moreover, the government is forcing the accounts to invest in government bonds, which means workers will earn sub-par returns. These are bad changes, but at least personal accounts still exist.

Even the bad news on government spending isn’t horrible news. As you can see from this OECD data, the spending burden (measured as a share of GDP) has climbed to a higher plateau in recent years, wiping out some of the gains that were achieved thanks to a period of strong restraint early last decade. That being said, Slovakia is still in better shape than many other industrialized nations.

So where does Slovakia go from here?

That’s not clear. The Prime Minister that imposed some of the bad policies recently was forced out of office by scandal, but his replacement isn’t any better and there’s not another election scheduled until 2020.

That’s the bad news. The good news is that Slovakia has one of Europe’s best pro-market think tanks, the Institute of Economic and Social Studies. Which hopefully means another wave of reform may happen. Hopefully including some of my favorite policies, such as a pure flat tax as well as some constitutional spending restraint.

P.S. Like other nations in Central and Eastern Europe, Slovakia faces demographic decline. To avert long-term crisis, reform is a necessity, not a luxury.

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California is a lot like France. They’re both wonderful places to visit.

And they’re both great places to live if you already have a lot of money.

But neither jurisdiction is very friendly to people who want to get rich. And, thanks to tax competition, that’s having a meaningful impact on migration patterns.

I’ve previously written about the exodus of successful and/or aspirational people from France.

Today we’re going to examine the same process inside the United States.

It’s a process that is about to get more intense thanks to federal tax reform, as Art Laffer and Steve Moore explain in a column for the Wall Street Journal.

In the years to come, millions of people, thousands of businesses, and tens of billions of dollars of net income will flee high-tax blue states for low-tax red states. This migration has been happening for years. But the Trump tax bill’s cap on the deduction for state and local taxes, or SALT, will accelerate the pace. …Consider what this means if you’re a high-income earner in Silicon Valley or Hollywood. The top tax rate that you actually pay just jumped from about 8.5% to 13%. Similar figures hold if you live in Manhattan, once New York City’s income tax is factored in. If you earn $10 million or more, your taxes might increase a whopping 50%. …high earners in places with hefty income taxes—not just California and New York, but also Minnesota and New Jersey—will bear more of the true cost of their state government. Also in big trouble are Connecticut and Illinois, where the overall state and local tax burden (especially property taxes) is so onerous that high-income residents will feel the burn now that they can’t deduct these costs on their federal returns. On the other side are nine states—including Florida, Nevada, Texas and Washington—that impose no tax at all on earned income.

Art and Steve put together projections on what this will mean.

Over the past decade, about 3.5 million Americans on net have relocated from the highest-tax states to the lowest-tax ones. …Our analysis of IRS data on tax returns shows that in the past three years alone, Texas and Florida have gained a net $50 billion in income and purchasing power from other states, while California and New York have surrendered a net $23 billion. Now that the SALT subsidy is gone, how bad will it get for high-tax blue states? Very bad. We estimate, based on the historical relationship between tax rates and migration patterns, that both California and New York will lose on net about 800,000 residents over the next three years—roughly twice the number that left from 2014-16. Our calculations suggest that Connecticut, New Jersey and Minnesota combined will hemorrhage another roughly 500,000 people in the same period. …the exodus could puncture large and unexpected holes in blue-state budgets. Lawmakers in Hartford and Trenton have gotten a small taste of this in recent years as billionaire financiers have flown the coop and relocated to Florida. …Progressives should do the math: A 13% tax rate generates zero revenue from someone who leaves the state for friendlier climes.

I don’t know if their estimate is too high or too low, but there’s no question that they are correct about the direction of migration.

And every time a net taxpayer moves out, that further erodes the fiscal position of the high-tax states. Which is why I think one of the interesting questions is which state will be the first to suffer fiscal collapse.

In large part, taxpayers are making a rational cost-benefit analysis. Some states have dramatically increased the burden of government spending. Yet does anyone think that those states are providing better services than states with smaller public sectors? Or that those services are worth all the taxes they have to pay?

Consider, for instance, the difference between New York and Tennessee.

New York spends nearly twice as much on state and local government per person ($16,000) as does economically booming Tennessee ($9,000).

Anyhow, I’m guessing the new restriction on the state and local tax deduction is going to change the behavior of state politicians. At least I hope so.

But nobody ever said politicians were sensible. Ross Marchand of the Taxpayers Protection Alliance explains that Massachusetts and New Jersey are still thinking about more class-warfare taxation.

Massachusetts and New Jersey are currently considering “millionaires’ taxes,” which would significantly increase top rates and spark a “race to the top” for revenue… Instead of helping out the middle class, a millionaires’ tax will result in an exodus from the state, squeezing out opportunities for working Americans. …Prominent millionaires respond to these proposals by threatening to leave, and research shows that the well-to-do regularly follow through on these promises.  …nearly all of the migration that does happen in top brackets has to do with tax changes. Researchers at Stanford University and the Treasury Department estimate that a 10 percent increase in taxes causes a 1 percent bump in migration, assuming no change in any other policy. …If New Jersey and Massachusetts approve new millionaires’ taxes, it is difficult to predict how much will be raised and where these funds will ultimately wind up. But if New York and California are any guide, income surtaxes will be destructive. When it comes to higher taxation, interstate migration is just the tip of the iceberg. Higher-tax states, for instance, see less innovative activity and scientific research according to an analysis by economists at the Federal Reserve and UC Berkeley.

My suggestion is that politicians in Massachusetts and New Jersey should look at what’s happening to California.

CNBC reports on the growing exodus from the Golden State.

Californians may still love the beautiful weather and beaches, but more and more they are fed up with the high housing costs and taxes and deciding to flee to lower-cost states such as Nevada, Arizona and Texas. …said Dave Senser, who lives on a fixed income near San Luis Obispo, California, and now plans to move to Las Vegas. “Rents here are crazy, if you can find a place, and they’re going to tax us to death. That’s what it feels like. At least in Nevada they don’t have a state income tax. And every little bit helps.” …Data from United Van Lines show some of the most popular moving destinations for Californians from 2015 to 2017 were Texas, Arizona, Oregon, Washington and Colorado. Other experts also said Nevada remains a top destination. …Internal Revenue Service data would appear to show that the middle-class and middle-age residents are the ones leaving, according to Joel Kotkin, a presidential fellow in Urban Futures at Chapman University in Orange, California. …Furthermore, Kotkin believes the outmigration from California may start to rise among higher-income people, given that the GOP’s federal tax overhaul will result in certain California taxpayers losing from the state and local tax deduction cap.

The Legislative Analyst’s Office for the California legislature has warned the state’s lawmakers about this trend.

For many years, more people have been leaving California for other states than have been moving here. According to data from the American Community Survey, from 2007 to 2016, about 5 million people moved to California from other states, while about 6 million left California. On net, the state lost 1 million residents to domestic migration—about 2.5 percent of its total population. …Although California generally has been losing residents to the rest of the country, movement between California and some states deviates from this pattern. The figure below shows net migration between California and individual states between 2007 and 2016. California gained, on net, residents from about one-third of states, led by New York, Illinois, and New Jersey.

Here’s the chart showing where Californians are moving. Unsurprisingly, Texas is the main destination.

By the way, state-to-state migration isn’t solely a function of income taxes.

A Market Watch column looks at the impact of property taxes on migration patterns.

Harty’s clients range from first-time buyers with sticker shock to people who’ve lived in and around Chicago all their lives. Each has a different story, but they share a common theme: many believe that Chicago-area property taxes are too high, and relief is just an hour away over the state line. …if all real estate is local, all real estate taxes may be even more so. …Attom’s data show that the average tax burden ranges from $10,612 in the most expensive metro area, Bridgeport-Stamford-Norwalk, Connecticut, to $525 in Montgomery, Alabama. And those are just averages. …taxes are “the icing on the cake” in areas that are seeing strong population inflows… Among the counties that saw the biggest percentage of in-migration in 2017, according to Census data, all are in Texas, Florida, Georgia, or the Carolinas. (Texas doesn’t have particularly low property taxes, but it has no personal income tax, making the overall tax burden much more manageable.) Cook County, where Chicago is located, had the biggest number of people leaving… Blomquist’s analysis of Census data showed that among all counties that had at least a 1% population increase, the average tax bill was $2,706, while in all counties with a least a 1% decline in population, the average was $3,900.

The key sentence in that excerpt is the part about Texas having relatively high property taxes, but making up for that by having no state income tax.

The same thing is true about New Hampshire.

But just imagine what it must be like to live in a state with high income taxes and high property taxes. If this map is any indication, places such as New York and Illinois are particularly awful for taxpayers.

Let’s close with a big-picture look at factors that drive state competitiveness.

Mark Perry takes an up-close look at the characteristics of the five states with the most in-migration and out-migration.

…four of the top five outbound states (Illinois ranked No. 46, Connecticut at No. 49, New Jersey at No. 48, and California at No. 47) were among the five US states with the highest tax burden — New York was No. 50 (highest tax burden). The average tax burden of the top five outbound states was 11.2%, with an average rank of 43.2 out of 50. In contrast, the top five inbound states have an average tax burden of 8.7% and an average rank of 16.6 out of 50. As would be expected, Americans are leaving states with some of the country’s highest overall tax burdens (IL, CT, CA and NJ) and moving to states with lower tax burdens (TN, SC and AZ). …that there are significant differences between the top five inbound and top five outbound US states when they are compared on a variety of measures of economic performance, business climate, tax burdens for businesses and individuals, fiscal health, and labor market dynamism. There is empirical evidence that Americans do “vote with their feet” when they relocate from one state to another, and the evidence suggests that Americans are moving from states that are relatively more economically stagnant, Democratic-controlled fiscally unhealthy states with higher tax burdens, more regulations and with fewer economic and job opportunities to Republican-controlled, fiscally sound states that are relatively more economically vibrant, dynamic and business-friendly, with lower tax and regulatory burdens and more economic and job opportunities.

Here’s Mark’s table, based on 2017 migration data.

As Mark said, people do “vote with their feet” for smaller government.

Which is one of the reasons I’m a big fan of federalism. When there’s decentralization, people can escape bad policy. And that helps to discipline profligate governments.

P.S. I’m writing today’s column from Switzerland, which is a very successful example of genuine federalism.

P.P.S. Americans are free to move from one state to another, and the uncompetitive states can’t stop the process. Unfortunately, the IRS has laws that penalize people who want to move to other nations. In this regard, the U.S. is worse than France.

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