Taxing the dynastic wealth of billionaire families can sometimes backfire, particularly in states like New York that already have high income-tax rates.

Estate taxes prompt many super-rich residents to move to states without the levies, especially as they get older, according to a new study from economists Enrico Moretti and Daniel Wilson. However, because most billionaires stick around, the majority of states can impose an estate tax and still bring in more revenue than they lose.

The study, published in the May issue of the American Economic Journal: Economic Policy, offers ammunition to both sides of a policy battle raging in capitals across the US. States controlled by Democrats have been raising taxes on the wealthy, arguing that it spreads wealth and funds services like education that boost growth and innovation over the long term. Those run by Republicans have been cutting levies on the rich, betting that low rates can attract people, businesses and investment.

The findings suggest estate taxes don’t pay off everywhere, particularly in Democratic-led states with above-average income-tax rates. For traditionally Republican-run states with low or non-existent income taxes on the wealthy, however, “there is virtually no cost to adopting an estate tax,” Moretti said in an interview.

“What we’re saying is you can either be progressive on income tax or be progressive on adopting an estate tax, but if you do both it’s going to backfire,” said Moretti, an economics professor at the University of California, Berkeley, who conducted the research with Wilson, of the Federal Reserve Bank of San Francisco.

The duo analyzed the behavior of hundreds of prominent billionaires after 2001, when a change in US law made state-imposed estate taxes more costly by repealing a federal credit. By 2010, in the dozen states with estate taxes, more than 21% of billionaires had fled to somewhere without the levy. Hardly any billionaires moved in the other direction.

The researchers then tried to measure the direct effects of migration of billionaires on income and estate tax collections. For the average state, they estimated, the boost from an estate levy still exceeds any lost income tax revenue by 53%.

Most of the states with an estate tax place a 16% levy on large fortunes at death, on top of the 40% federal gift-and-estate tax rate. Advisers to the super-wealthy have come up with a variety of ways to legally avoid the estate tax, however. Moretti and Wilson calculate that, by using these techniques and loopholes, estates of the wealthy end up paying only about half the statutory rate.

The new study is a “very careful analysis,” said Cornell University sociology professor Cristobal Young, one of the only other researchers who has studied the effects of taxes on the migration of the wealthy in the US. But its conclusions “don’t fit into a simple narrative.”

Washington Wins
Of the dozen states with an estate tax, the most cost-effective is Washington, which created one in 2005 with the highest rate in the nation, of 20%. Even if it prompts some billionaires to move away, Washington wouldn’t lose much revenue because the state has no tax on regular income. Taxing the wealth of remaining billionaires would more than make up for any revenue lost.

Other states without income taxes, like Florida and Texas, could nab the same windfall if they were to impose an estate tax, the authors found.

The calculus changes when income taxes on the wealthy reach California-style levels. The Golden State’s 13.3% rate on millionaires is the highest in the US, but it has no estate tax. Moretti and Wilson estimate that imposing one would backfire spectacularly, prompting billionaires to flee and take years of future income tax bills with them.

Despite heavily taxing the rich, California and New York have more than twice as many of the top billionaires as Texas and Florida. Of the world’s 500 richest people on the Bloomberg Billionaires Index, 44 live in California, 30 in New York, 24 in Texas and eight in Florida.

New York’s estate tax used to bring in more revenue than it lost, the study finds, but its analysis ends in 2017. Since then, lawmakers have boosted taxes on the wealthy substantially. In 2021, the state’s top rate, on income of more than $25 million, jumped to 10.9%. Add in New York City’s local income tax of almost 4%, and some New Yorkers are paying even more than Californians.

The higher rates suggest New York’s estate tax is probably backfiring now, Moretti said.

Research from Cornell’s Young has found income taxes historically had little impact on where people lived. And rich taxpayers — who can afford to live anywhere — tend to be less likely to move than other Americans.

Still, terms of the tax competition between states have changed since the pandemic, which popularized remote work, and since federal tax changes widened gaps in effective rates between states by capping the state and local tax, or SALT, deduction.

Several high-profile billionaires have relocated their businesses to states without income taxes, including Elon Musk, who went from California to Texas, hedge fund founder Ken Griffin, who left Illinois for Florida, and investor Carl Icahn, who moved to Florida from New York.

--With assistance from Jack Witzig.

This article was provided by Bloomberg News.