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Do High Earners Really Flee From State Tax Hikes?

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Marginal rates in high-tax states will undoubtedly rise because of the economic impact of the COVID-19 pandemic, but wealthy residents may not flee as a result, according to two Pimco muni market analysts.

Related: Tax Planning in an Election Year

Sean McCarthy, head of Pimco’s the municipal credit research team, and Tom Schuette, the co-head of Investment Research and Strategy at Gurtin Municipal Bond Management, a Pimco company, wrote in a recent blog post that even though the risk of future out-migration from higher-tax states still exists, “individual mobility is often overstated.” Taxpayers, they explain, are often reluctant to leave jobs, abandon cultural institutions or pull their children from school despite state tax increases.

“Each year, approximately 1% to 2% of Americans move across state borders, [but] the majority cite employment and family as their primary motivation — not higher income taxes,” according to the analysts. 

They also note that academic research on the subject is inconclusive, with studies focused primarily on California and New Jersey finding limited migration from high-tax to lower tax states, especially by wealthy residents.

New and Proposed State Tax Hikes

Several states have proposed or instituted higher taxes on wealthy residents.

New Jersey recently implemented a 20% increase in personal income tax rate for residents earning between $1 million and $5 million to 10.75%, creating parity with the rate already charged to residents earning more than $5 million.

(Related: What New Jersey’s Tax Hike on Millionaires Means for Clients)

California suspended the use of net operating loss carry-forwards for individuals and corporations with more than $1 million of taxable income.

In Illinois, the legislature passed a bill that would replace the flat 4.95% flat income tax with a progressive tax, but voters first have to approve the change in a referendum, which will be included on the upcoming election ballot.

The new marginal tax rate ranges between 7.75% and 7.85% for single filers with incomes above $250,000 up to $750,000, and for joint filers with incomes above $250,000 up to $1 million. Above those two top thresholds, the rate rises 7.99% on their entire income.

This election season also includes a voter referendum in Arizona that would impose a 3.5% surtax on single taxpayers with incomes above $250,000 and on couples with incomes above $500,000 to help fund schools. 

Proposition 15 in California asks voters to lift the caps on property taxes for commercial and industrial properties, except apartment buildings, that were instituted with passage of Proposition 13 in 1978, also to support school funding.

Investors should not be surprised when tax increases are instituted during times of economic crisis, according to the Pimco analysts. “We remind clients that following the global financial crisis, most states enacted some form of a tax hike, including temporary (California, Illinois) and permanent (New York) increases in personal income taxes.”

There wasn’t massive migration from those tax increases, though Pimco analysts note that “higher personal income taxes could, on the margin, accelerate some out-migration from high-tax states.” They said the jury is also still out on whether there will be material migration from cities to the suburbs because of the pandemic. “We believe the jury is still out on how pronounced this out-migration will be and whether it will prove ephemeral or longer lasting.

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