Commentary

Tax Reform Forces States to Compete with Each Other

The Republicans passed the Tax Cuts and Jobs Act last year, but the battle over the legislation is not over. Some high-tax states, such as New York, have passed schemes to try to get around a centerpiece of the law, the cap on federal deductions for state and local taxes. New York governor Andrew Cuomo called the cap “repugnant to this state, repugnant to the Constitution and the values of the American people.”

The governor is wrong about that, but why is he so outraged?

The cap and other changes under the law have subjected 25 million mainly higher-income households to the full bite of state and local income, sales, and property taxes. This is a painful change for high-tax states, and it will magnify the difference between, say, New York City’s top income-tax rate of 12.7 percent and Florida’s of 0 percent.

As Cuomo has recognized, higher-income taxpayers will increasingly “vote with their feet” and move out, which will hammer some state budgets. The top 1 percent of earners pays 41 percent of state income taxes in New York and a huge 50 percent in high-tax California.

They no longer can hike taxes and expect federal deductions to make up part of the difference.

We don’t know how many people the law will prompt to move, but we can look at past trends to get an idea. Internal Revenue Service migration data show that 2.8 percent of households moved between states in 2016, with some states losing residents and others gaining, on net. The largest loser states were generally high-tax places such as New York, Illinois, New Jersey, California, and Connecticut. The largest gainer states were low- and medium-tax places such as Florida, Texas, Washington, North Carolina, and Colorado.

Overall, the IRS data show that almost 600,000 people moved, on net, from the 25 highest-tax states to the 25 lowest-tax states in that single year. This migration pattern has been ongoing for years, even before the new tax law intensified the relative pain of living in high-tax states.

Based on the IRS data, we can calculate the ratio of migration inflows to outflows for each state. In 2016, New York’s ratio was 0.65, meaning for every 100 households that left, only 65 moved in. Florida’s ratio was 1.45, meaning that 145 households moved in for every 100 that left.

Where are people leaving and where are they going? Of the 25 highest-tax states, 24 of them had net out-migration. Of the 25 lowest-tax states, 17 had net in-migration. Taxes appear to be steering interstate movers.

High earners are the hardest hit by the new tax cap, and the IRS data show that they were already moving to low-tax states. For the 25 highest-tax states, the average migration ratio for those earning more than $200,000 was 0.84, meaning large net out-migration. For the 25 lowest-tax states, the average ratio was 1.37, meaning large net in-migration.

New York had the lowest ratio for high earners at 0.49, while Florida had the highest at 2.62. High earners love Florida’s lack of income and estate taxes, and there has been a steady stream of high-paying financial firms moving to Florida from the Northeast for that reason.

The effort by New York and other states to fight the deduction cap is a dead end, and the IRS has already ruled against some of the state workaround schemes.

The stark reality for high-tax states is that they need to improve the efficiency of their public services and give taxpayers more value for their money.

In 2015, New York’s total state and local tax burden was 14.9 percent of personal income, which was almost twice Florida’s burden of 7.6 percent. Unless you think that New York’s public services are twice as good as Florida’s, the higher tax costs in the Empire State are simply a rip-off. For a family making, say, $100,000 a year, that 7.3-point difference means $7,300 in tax savings by moving to Florida.

Such tax differences are enough for some families to pack their bags and move, especially when low-tax states such as Florida and Texas also offer warmer weather and lower housing costs.

Cuomo and leaders of other high-tax states need to accept that the GOP tax law has ushered in a new era of state tax competition. The smart way forward for chronic migration losers such as New York is to up their game and deliver better services at lower costs.

Chris Edwards is the editor of www.DownsizingGovernment.org at the Cato Institute.