February 5, 2019 11:50AM

Will Tax Competition Restrain Bloated State Budgets?

Governor Andrew Cuomo announced yesterday “a dramatic drop in state income tax revenue of $2.8 billion.” More high earners appear to be leaving New York than expected in response to the 2017 federal tax reform. “Cuomo said the law’s cap on deductions for state and local taxes at $10,000 was to blame and suggested it is, anecdotally, triggering high-earners to leave New York.”

Data from both the Census Bureau and Internal Revenue Service have long shown that Americans are, on net, moving from higher-tax states such as New York to lower-tax states such as Florida. The issue now is whether the 2017 tax law has accelerated the trend.

Newsday notes, “Cuomo blames Trump and his 2017 tax cut legislation for prompting New York’s wealthiest taxpayers to change their legal address to another state to avoid a big federal tax hit. He said he bases this on anecdotal stories, not hard facts yet, but that the behavior of just a few thousand of these high-earners could have a significant impact on state revenues.”

One way to get a real-time glimpse of migration patterns is to see where real estate prices and purchases are rising and falling. The Wall Street Journal reports:

A growing list of public officials in high-tax states are expressing alarm that big earners are bolting to low-tax states as new data suggests some home buyers are moving in response to the year-old change in the federal tax law.

… Preliminary data show a jump in Florida home purchases by buyers from high-tax states. Home values in lower-tax areas have been rising faster than those in places where limiting the ability to deduct high state and local taxes eroded some of the savings from the federal tax reduction, according to an analysis by real estate and data firm Zillow.

One of the biggest winners from this shift has been Miami. The city is experiencing more activity than usual from buyers living in states like New York, New Jersey and Illinois. People are drawn to the city by mild weather—as always—and by deals on condos and lower taxes.

… While high-end condo prices in Miami have flattened out or even declined a bit in recent months as foreign buyers have pulled back, the market is holding up much better than New York City’s. Manhattan co-op and condo sales last year were down 12% from 2017 to their lowest level since 2009, a Wall Street Journal analysis found.

Other low-tax cities are also doing well. Las Vegas and Phoenix have slowed a bit recently but still have the fastest home-price growth among major metropolitan areas, according to the S&P CoreLogic Case-Shiller home-price indexes. Brokers credit Californians fleeing rising home prices and tax changes.

… Nelson Gonzalez, a senior vice president at EWM Realty International in Miami, said that in the past year most of the buyers for high-end listings that he encounters are from high-tax states in the U. S.—a big change from several years ago when he mostly saw foreigners. “Ninety percent of all the deals over $10 million were tax refugees,” he said.

… “A lot of rich people are trying to find a way out of New York,” said Barry Horowitz, an accountant who specializes in helping clients switch residency to lower-tax states. 

… Carney Shegerian, a 54-year-old lawyer from Los Angeles, recently bought a three-bedroom condo in the Aria on the Bay tower in Miami for about $1.5 million. He said he plans to move there permanently and open a new branch of his law practice. The unit “is a great value compared with what you’d get in Los Angeles,” Mr. Shegerian said. And the lack of income tax in Florida is “attractive to anyone,” he said.

These new moves have likely strengthened existing migration patterns, which are shown in the chart. Each blue dot is a state. The vertical axis shows the mid-2017 to mid-2018 Census net interstate migration figure as a percentage of state population. The horizontal axis shows state and local household taxes as a percentage of personal income. Household taxes include individual income, sales, and property taxes. The red line shows the fitted relationship between the two variables.

On the right, most of the high-tax states have net out-migration. The blue dot on the far right is New York with a tax burden of 13 percent and a net migration loss of nearly 1 percent (0.92) over the year.

On the left, nearly all the net in-migration states have tax loads of less than 8.5 percent. If policymakers want their states to be attractive, they should reduce their household tax burdens to 8.5 percent or less of personal income.

Governor Cuomo recognizes the out-migration problem, but what will he do about it? Newsday says that he is considering spending cuts to balance the state budget, which would be a good start.

The new federal tax law should be a wakeup call for out-migration states to improve their tax climates and trim their governments. High-tax states should aim to create simpler, lower-rate tax codes and improve the quality and efficiency of government services.

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More here and here.

December 21, 2017 12:00PM

How Can Republicans Entrench the Tax Cuts?

The peculiarity of Congressional 10-year budgeting has left its mark on the tax debate. In the UK, if something like the Republican bill had passed, it would be regarded as a significant tax cut, pretty much across the board. And rightly so.

As JCT analysis has shown, in 2019, 44 percent would see tax cuts of more than $500, 17 percent tax cuts between $100 and $500, with just 8.1 percent seeing tax increases greater than $100. Even by 2025, just before most of the individual income tax cuts would expire, 56 percent would see tax cuts of more than $100, with just 13.5 percent seeing tax increases of $100 or more. And this includes as “tax rises” the reduction in subsidies paid out as the removal of the individual mandate penalty leads to fewer people opting for health insurance.

As Chris Edwards has explained, even on the JCT’s own figures (which attribute most of the burden of corporate income taxes to the rich), the biggest financial winners in terms of a reduction in the proportion of federal income and corporate taxes they bear will be the middle-class.

Yet the 10-year budget, with expirations of income tax changes required to pass the bill through Senate reconciliation procedures, means Democrats and much of the media have effectively portrayed the reforms as tax cuts for the wealthy. As the income tax cuts and the increase in standard deduction evaporate, the penalty associated with the individual mandate is removed (reducing the extent of subsidies) and the new lower inflation rate for uprating tax band thresholds is maintained, more and more households lower down notionally face a “tax increase” in financial terms according to the law.

The way the media has not explained this distinction between the short and longer-term implications of the law (and how it would be up to Congress to let provisions expire) is breathtaking. On Tuesday, for example, the Associated Press tweeted “BREAKING: House passes first rewrite of nation's tax laws in three decades, providing steep tax cuts for businesses, the wealthy.” No wonder just 17 percent of people think they are getting tax cuts in 2018, against the 80 percent estimated to actually be getting a tax cut of any amount. Liberal economists such as Paul Krugman have embraced the seeming unpopularity of the reform package, and believe the political and electoral implications for Republicans will only be worse once they now start proposing spending cuts.

The Republicans say they want to keep the provisions in the bill in the longer term, making the tax cuts permanent. So what should their message be to voters to make tax reform durable?

First, it seems clear they need to make a huge deal of the expanded paychecks most people will see in February. Given how warped people’s view is of the bill now, critics of the bill will have their credibility undermined if individual voters suddenly realize they really have seen higher take-home pay.

But, second, and more importantly, Republican proponents need to flip critics' attack lines around. Yes, under the law the income tax changes do expire, they should say. But we do not want that to happen. If you like your tax cut, and want to keep your tax cut, then you need to ensure it has Congressional support, and you should pressure your congressmen and congresswomen to curb spending growth so that the tax cuts can be locked-in sustainably.

In other words, they need to use the new baseline from the tax cuts to their advantage, and play on the endowment effect: if you want to keep this extra take-home pay, then push for lower spending delivered by members of Congress committed to smaller government.

December 11, 2017 4:00PM

SALT Deduction Changes Could Improve State Tax Systems Too

Thirteen law professors have written about how the GOP tax plan will provide incentives for tax planning and behavioral changes that might undermine current revenue estimates.

The document, “The Games They Will Play: Tax Games, Roadblocks, and Glitches,” is clearly written by professors skeptical of the overall tax package. But it provides useful examples of potential problems, such as ways new passthrough provisions could lead to complex battle lines between tax authorities and taxpayers.

It also assesses how the elimination of the state and local income and sales deduction (SALT) from the federal income tax code might encourage changes to state tax systems. Remember both House and Senate Bills would only retain a deduction of up to $10,000 for property taxes.

The restriction of the SALT deduction will, ceteris paribus, raise the cost of state and local government expenditures for affected taxpayers, particularly in higher-income, higher-tax jurisdictions. That might be expected to put pressure on states to reduce spending—a feature of this reform, rather than a bug.

But according to the professors, states may also seek to “reshape their tax systems so as to respond to this change and retain the benefit of the deduction for their taxpayers.” One means is to shift towards collecting more revenue from deductible taxes.

How might they do so?

One way for states to achieve this is by shifting to use of the property tax. The liquidity impact on taxpayers of a shift to property taxes can be mitigated by circuit breakers administered through a state’s income tax—essentially, reducing income tax liability in exchange for higher property taxes. Such responses would effectively allow taxpayers to deduct the full amount of state and local property and income taxes, up to the $10,000 cap.

Now, the professors paint this as a bad thing, because they believe it means federal revenue losses from tax reform will be greater than currently projected. From an economic perspective though, property taxes are broadly regarded as being less distortionary to economic decisions than income taxes. They also tend to encourage localism, and given they are widely disliked (particularly by elderly constituencies who turn out in elections), may be even more effective at bringing attention to the scale of state government spending than an increased income tax burden.

Whilst it would be better to have no SALT property deduction at all, if a consequence of tax reform is states using property taxes instead of income taxes, then that could be a good thing for the economy.

December 5, 2017 9:28AM

Kevin Hassett Updates Adam Smith

The chair of the White House Council of Economic Advisors, Kevin Hassett, visited Cato last week to talk about tax reform. Under Kevin’s leadership, the CEA has produced two reports discussing how corporate tax cuts can boost wages and growth.

The CEA explains the basic mechanism:

reductions in the corporate tax rate incentivize corporations to pursue additional capital investments as their cost declines. Complementarities between labor and capital then imply that the demand for labor rises under capital deepening and labor becomes more productive. Standard economic theory implies that the result of more productive and more sought-after labor is an increase in the price of labor, or worker wages.

And discusses how lower taxes attract investment from abroad:

One component of investment is foreign direct investment (FDI), and numerous empirical studies … have observed that FDI is highly responsive to cross-border differences in tax rates.

And describes how high corporate taxes hurt workers in the global economy:

The fact that capital can move relatively easily across borders while labor cannot serves to intensify the burden of the corporate tax on workers.

Essentially, the CEA studies update Adam Smith with new empirical data. Writing in his Wealth of Nations, Smith described how heavy taxes on mobile “stock,” or capital, in a world with open borders would cause losses to workers and the broader economy:

Secondly, land is a subject which cannot be removed, whereas stock easily may. The proprietor of land is necessarily a citizen of the particular country in which his estate lies. The proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax, and would remove his stock to some other country where he could either carry on his business, or enjoy his fortune more at his ease. By removing his stock he would put an end to all the industry which it had maintained in the country which he left. Stock cultivates land; stock employs labour. A tax which tended to drive away stock from any particular country, would so far tend to dry up every source of revenue, both to the sovereign and to the society. Not only the profits of stock, but the rent of land and the wages of labour, would necessarily be more or less diminished by its removal.

Today, people have much greater ability than in Smith’s time to move their capital across borders, and so taxes on capital are more damaging than ever.

Veronique de Rugy and I discussed these issues in a 2002 paper on international tax competition. Fifteen years later, it is gratifying that Congress may finally make reforms to attract capital rather than repel it.

December 4, 2017 1:02PM

Ryan Bourne: Corporate Tax Cut will Help Workers and Shareholders

By Cato Editors

In case you missed it over the weekend, Cato scholar Ryan Bourne wrote about the Republican tax reform plan in an op-ed featured in The Hill. He responds to the argument that corporations will use money saved from the reduction in the federal corporate tax rate to increase dividends, buy back shares, or other strategies that benefit their shareholders. 

Major companies, including Cisco Systems, Pfizer and Coca-Cola, have said they will use most of the gains from proposed corporate rate cuts to increase dividends to shareholders or buy back their own shares. This has been reported and shared on Twitter as a slam dunk against the Republican tax plan.

After all, a major claim of the administration has been that corporate rate cuts would benefit workers through wage rises, rather than flowing exclusively to capital owners.

Yet, the reaction of these companies is nothing unexpected, at least in the short term. Any substantial cut to the corporate rate provides an immediate windfall to so-called “old capital.”

But even though the initial beneficiaries of changes in the corporate tax rate will indeed be corporate shareholders, Bourne points out that those savings have to go somewhere. 

If existing firms have excess capital in the short-term, distributing it to shareholders in some way makes sense. This money is unlikely to sit dormant afterwards. In all likelihood, that money will be deployed elsewhere to find new value.

The market for growth industries through venture capital and angel investment is huge, and these windfalls can be invested in the start-ups and industries of the future.

The key point though is that the lower corporate rate improves the after-tax profitability of investment across the economy, and as such generates new activity. Other things given, domestic companies will have greater incentive to invest.

Foreign companies will be more likely to expand their investments in the U.S. — or even shift their operations here. U.S. companies will repatriate profits earned by their foreign subsidiaries rather than leaving them abroad, and more capital will flow from other less productive U.S. sectors into the U.S. corporate world. 

Read the op-ed here

November 30, 2017 8:54AM

A Tax Bill Provision Only Athletic Directors Could Hate

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It’s obviously too early to spike the football, but there is a provision in both the Senate and House tax bills that everyone should be able to endorse, except maybe colleges and their athletics departments: eliminating the 80 percent federal tax deduction college sports season ticket holders get when they pay “seat license” fees—often called “charitable gifts”—charged by schools. It’s an absurd deduction that I’ve complained about periodically, and it’s nice to see it targeted for elimination. And in case we need a reminder that this deduction has zilch to do with the “public good” that higher ed so often gives as its excuse for every special treatment it demands, USA Today has reported that this season 12 big football schools alone are on the hook for at least $70 million to buy out fired head coaches. Sounds like a lot of private good there.

These days it seems like we on Team America can’t agree on anything, but we all ought to agree on this: the seat license deduction must go.

November 29, 2017 11:00AM

Problems with a “Fiscal Trigger”

Fiscal rules can theoretically improve policy by eliminating “time inconsistency” among lawmakers. But the proposed fiscal trigger being discussed in the Senate tax reform bill would be a terrible fiscal rule.

You can see the thinking. Several senators worry about tax cuts blowing a big hole in the public finances. If they do not have the desired impact on economic growth, resulting in less revenue than expected, the budget deficit will grow and drive the national debt even higher. Concerned senators therefore seek a mechanism whereby if revenues are lower than expected, tax cuts will be partially reversed.

It’s welcome that some senators take the US federal government’s burgeoning national debt seriously. But there are obvious flaws with this plan (though we do not know details as yet), some of which have been discussed widely already.

First, how exactly will deviations in revenues be judged? An economy is a complex organism, and it is difficult to disentangle how much any change in revenue relative to forecasts is due to changes in tax rates as against other factors. Just look at the debate in the UK. Last week, the Daily Mail newspaper published a report that tax receipts following corporate tax cuts there had been much higher than expected. But experts from the Institute for Fiscal Studies pointed out that much of this was due to a faster recovery of corporate profits in the financial sector and the effects of Brexit, which had little to do with the changing rate. Under a trigger which merely judged revenues against forecasts, a host of things that affect revenues (both upwards and downwards) could be chalked up as the effects of tax policy, potentially resulting in damaging tax rises.

Then, as J.D. Foster notes, there are likely to be other tax policy changes and changes in growth forecasts in future years too. How will these be disentangled and the effects of this specific Act isolated? Will the trigger apply to just a particular revenue stream, such as corporate income tax revenues, or more broadly to capture all the spillovers of any investment boost? If the former, the probability that the trigger will be activated is highly dependent on the accuracy of any analysis of the incentives to incorporate versus operating as a passthrough. In other words, there are huge unknowns here.

Second, the inclusion of a trigger mechanism actually dampens the pro-growth effects of the tax plan, and risks lower-than-expected revenues becoming a self-fulfilling prophecy. Take corporate rates. On the margin, uncertainty about what the corporate rate might be in the long term deters investments today. Less investment today results in lower GDP and lower tax revenues elsewhere in the code. This lower-than-expected tax revenue then activates the trigger (if it applies across total revenues) which raises corporate taxes. There is good reason why economists say that tax policy should provide certainty and permanence in regard to rates. The GOP plan already has a lot of phase outs resulting from the Senate reconciliation rules. The last thing it needs is the risk of more.

Third, you do not need to be a Keynesian to recognize that an unforeseen recession, which would dampen revenues relative to forecast, would be a terrible time to worsen supply-side incentives by increasing the corporate income tax or marginal income tax rates. In truth, Congress would likely override the trigger in such circumstances. But if the trigger would simply be abandoned when it bound, then it suggests it is not a very well-designed trigger! Of course, there could be a recession escape clause, but similar logic applies more broadly if the economy grows more slowly than expected, due to reasons other than tax reform changes.

In short, a fiscal trigger that threatened higher taxes would introduce considerable uncertainty, risk tax hikes at the worst possible time, and could risk tax hikes when other factors resulted in lower revenue growth.