It’s a taxing decision. When states hike income and other taxes on high earners, do these taxpayers beat a hasty retreat, leading to a drain on state tax revenues?
Higher state taxes do push taxpayers to uproot and move, often both their residences and businesses, according to recent research.
The domino effect is a critical loss to state coffers since higher-income taxpayers account for a higher proportion of both federal and state revenues, Andrey Yushkov, a senior policy analyst with the Center for State Tax Policy at the Tax Foundation said in a new blog.
“The consensus is that high-income individuals are very sensitive to tax increases. ... The behavioral responses of top earners are particularly important since they generate a significant share of both federal and state tax revenues,” Yushkov said.
Many high earners happen to be concentrated in high-tax states. For years, it was generally believed that their jobs, and the case of business owners, their companies' location made moving an arduous tax. But that appears to have changed in recent years, likely because of the work-from-home phenomenon and the propensity of certain states to keep raising income taxes
In tax year 2021 alone, taxpayers with adjusted gross income of $200,000 or above—just 7% of tax returns—generated $1.5 trillion in federal income tax payments, constituting 68% of total federal income tax collections, according to the most recent IRS data, Yushkov found.
Taxpayers with adjusted gross income of $1 million or above, just 0.5% of tax returns, paid $824 billion or 37% of total federal income tax receipts, he said.
We know that Americans were on the move in 2023, and many chose low-tax states over high-tax ones, according to recent U.S. Census Bureau interstate migration data and commercial datasets released in January by U-Haul and United Van Lines.
High-tax states like California, New York and Hawaii lost between 1.1% and 0.9% of their taxpayers between 2022 and 2023, the data found.
That’s important in states like California which are running a budget deficit of $79 billion. Taxpayers there with taxable income of $1 million or above contribute about 40% to state income tax receipts.
California’s state income tax, which has a top marginal rate of 13.3% and was passed in 2012 as part of the state’s infamous Proposition 13, is one of the highest in the nation.
“We get questions all the time from clients who want to know how much they’ll save if they move their residence and business out of state,” Daren Blonski, co-founder and managing principal of Sonoma Wealth Advisors, Sonoma, Calif. said.
“Where clients live has really become part and parcel of the tax planning we do for clients, many of whom own business. A move can make good sense in some circumstances, especially if a client wants to sell a business down the road and can live elsewhere in the meantime,” Blonski added.
But new research published in the January issue of the American Economic Journal: Economic Policy found that in response to the increase in California’s top marginal state income tax rate, high earners reported $321,000 to $436,000 less in taxable income during 2012-2014, reducing the income tax they reported by 10%, Yushkov said.
“The likely reasons were shifting income-generating activities to other countries, or other forms of tax avoidance,” he added.
Even golf pros, who are often taxed as nonresidents for tournaments that they compete in, are getting savvy and avoiding tournaments in high-tax states, research in the January edition of the journal found.
Taxpayers who have the opportunity to work in multiple states can and do “vote with their feet,” and often decide not to work where there are high income tax rates, Yuskhov said.
“That this is true of professional golfers, who only have a limited number of tournaments to enter (even if the amount at stake is quite high), may indicate an even greater impact for those who have a wider range of employment options,” he said.
One of the most striking findings comes from a new paper, “The Introduction of the Income Tax, Fiscal Capacity, and Migration: Evidence from US States,” which found that states that introduced higher income taxes after World War I, lost more than 16% of their population within 20 to 30 years after the reform.
“In other words, outmigration in the long run outweighed fiscal capacity gains when new state income taxes were introduced,” Yushov said.
After lawmakers’ success in passing a wealth tax in Massachusetts last year, 10 additional states are pushing wealth taxes in 2024. Massachusetts voters approved its 4% tax hike on earners with annual income above $1 million, on top of the state’s 5% flat income tax, which went into effect in 2023.
Currently, lawmakers in California, Connecticut, Hawaii, Maryland, Minnesota, New York, Nevada, Pennsylvania and Washington and Vermont are working on wealth tax bills—some mirroring Massachusetts Senator Elizabeth Warren’s 2020 presidential platform, which proposed a 2% annual tax on taxpayers with assets of $50 million or more and 3% on assets over $1 billion, according to research from the State Revenue Alliance.
Vermont Democrats, for example, have introduced a bill that would tax the unrealized gains of Vermonters with over $10 million in assets and impose a 3% tax on individuals with incomes of $500,000 or more.
But have voters, at least in some states, had enough? Texas voters overwhelmingly passed a constitutional amendment in November that would preemptively bar all future efforts by the state to tax wealth or net worth.
Even Californians in 2023 rejected the idea of plugging the state's $37.9 billion budget deficit with additional wealth taxes.
“When considering new sources of revenue, lawmakers need to think beyond the short-term logic of taxation and account for the long-term implications of increased tax burdens, especially in an increasingly mobile economy,” Yushkov said.