When state taxes get too high, many wealthy taxpayers will move elsewhere. This was the finding of a 74-page paper from the National Bureau of Economic Research. The paper, “Behavioral Responses to State Income Taxation of High Earners: Evidence from California,” by Joshua Rauh, of Stanford University and the Hoover Institute, with Ryan J. Shyu, looked at California’s Proposition 30 tax hike, approved by voters in 2012, to determine if high taxes could provoke the richest of the state’s population to flee.
It seems the tax increase — topping out at 3 percentage points for taxpayers earning more than $1 million — spurred an exodus of residents who would have been affected, with most moving to states with zero income tax, according to the study. Further, the study estimated that due to this outward migration of high earners prior to the tax hike taking effect, the windfall the state planned on from the tax was eroded by just over 45%.
Proposition 30 was an effort to raise taxes on the wealthiest taxpayers in the state to preserve statewide education funding. In total, California’s Department of Finance believed that the new tax rates would result in an overall increase in combined tax revenue of $8.5 billion over the tax years 2011-2012 and 2012-2013.
The study found “a substantial one-time out-migration response to increased state tax rates. Relative to the pre-period 2000-10, the taxable income weighted rate of departures among top-bracket taxpayers was abnormally high by 0.8% in 2012-13. Consistent with the theoretical prediction that migration decisions respond to average tax rates, this migration effect increases with income and is concentrated among taxpayers earning over $2 million.”
Where did these wealthy taxpayers move? Largely to states with no income tax, such as Washington, Texas and Nevada, as well as other western states like Idaho, Colorado and Arizona. New York was also a destination, despite its high tax rates.
The bottom line: Although there was strong behavioral response among the highest earners to the tax hike, the study wasn’t able to find “convincing evidence as to the normative implications of the results.” The authors state several factors could account for the change and exploring these would involve further study.
Separately, Moody’s Investors Service announced this week it has upgraded California’s general obligation bonds to Aa2 from Aa3. This occurred just a couple of months after Fitch Ratings upgraded the state’s bond rating to AA from AA-.
Moody’s noted in its evaluation, “the upgrade of California’s GO bonds to Aa2 incorporates continued expansion of the state’s massive, diverse and dynamic economy and corresponding growth in revenue.” It also praised “the state government’s disciplined approach to managing revenue growth indicated by its use of surplus funds to build reserves and pay down long-term liabilities.”
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