Lawmakers in at least eight states are considering raising income tax rates on a small percentage of top income-earners in order to shore up their state budgets. But this is a risky way of raising revenue, especially during a recession.
Relying on such a small percentage of the population creates larger boom-and-bust periods for budgets, and it also drives away capital and jobs to lower-tax states. Economists Arthur Laffer and Stephen Moore found that from 1998 to 2007, “the no-income tax states created 89% more jobs and had 32% faster personal income growth than their high-tax counterparts.”
Just in the past year, Hawaii, Maryland, and New York implemented so-called “millionaire” taxes, aiming tax hikes at the top 1 to 5 percent of their taxpayers. Supporters of those tax hikes say these taxpayers have more money and thus can more easily afford paying higher rates. But heavily taxing a small minority of a state’s most successful residents is dangerous public policy, for the following reasons.
1. High taxes encourage the wealthy to move to lower-taxed states, bringing much of their income, capital, and ultimately tax revenues with them. Successful businessman and billionaire Tom Golisano recently announced he will move from high-tax New York to income tax-less Florida. He said his move was caused by New York’s strangling tax-and-spend policies, which have created an environment where many successful businessmen have virtually no choice but to leave. The state is expected to lose more than $4 million in tax revenue from his move alone.
2. High taxes discourage capital from flowing into a state, thereby preventing more jobs from being created. According to Chris Edwards, tax policy director at the Cato Institute, “In the United States, half of all business income is reported on individual returns, not corporate returns, and a lot of that business income is reported by people at the top end. If you raise individual income taxes at the top end, you hit a large amount of small business income. And empirical research has shown that small businesses are sensitive to income tax changes.”
3. High taxes make it more difficult to attract high-income people to a state. In Maryland, according to the comptroller’s office, the creation of a new 6.25 percent tax bracket for those with $1 million in taxable income resulted in one-third fewer millionaires in the state. While the faltering economy certainly played a role in the decline, some Maryland millionaires moved out of the state due to the tax hike. California’s experience shows that even before the housing market collapse, high-income citizens were already fleeing high-tax states in droves.
4. Relying on a small number of taxpayers for a large portion of tax revenue can lead to larger budget deficits than experienced by states with broader and flatter tax systems. In Rich States, Poor States, Laffer and Moore explain how California helped create its own budget mess. “When California faced a $14 billion deficit in 2003, a major cause of this was ‘millionaire migration’ due to the high top income tax rate (9.3 percent). Out of the 25,000 or so seven-figure-income families, more than 5,000 left in the early 2000s, and the loss of their tax payments accounted for about half the budget hole.”
The income tax hikes themselves are not the only reason successful residents leave or choose not to locate in these states. As important is the high tax rate compared to other states or countries. The gap between low- and high-tax states can mean a difference in take-home pay of as much as 10 percent.
Lower taxes and reduced spending are a better, more sustainable solution to budget deficits than tax increases on a state’s most productive citizens. As the documents cited below explain, raising taxes on high-income earners is a treacherous way to shore up state budgets.
Ten Principles of State Fiscal Policy
http://heartland.org/policybot/results/19354/
This booklet provides policymakers and civic and business leaders with a highly condensed yet easy-to-read guide to state fiscal policy matters. It presents the 10 most important principles of sound fiscal policy, from “Above all else: Keep taxes low” to “Protect state employees from politics.”
State Budget Shortfalls Present a Tax Reform Opportunity
http://www.taxfoundation.org/publications/show/24321.html
This special report by the Tax Foundation outlines how states with tax codes relying on small tax bases are more susceptible to large budget deficits. It points out that eliminating tax favors, lowering tax rates, and broadening tax bases can lead to a more sustainable and economically appealing tax code.
Soak the Rich, Lose the Rich
http://online.wsj.com/article/SB124260067214828295.html
Arthur Laffer and Stephen Moore take to task the various states considering income tax hikes on their most productive citizens. They note that Texas—a state with no income tax and very pro-growth tax policy—”created more new jobs in 2008 than all other 49 states combined.”
Md. Millionaires Hit by Tax Bracket for Wealthy
http://heartland.org/publications/budget%20tax/article/23325/
This article from Budget & Tax News looks at Maryland becoming the first state to implement a tax bracket for those earning more than $1 million per year. It interviews experts who criticize the plan, including some who accurately predict that some of these residents will abandon the state, leaving a new budget deficit to be dealt with.
It’s Not Just Millionaires Fleeing Maryland Taxes
http://www.washingtonexaminer.com/opinion/columns/marta-mossburg/Its-not-just-millionaires-fleeing-Maryland-taxes-45349682.html
Washington Examiner columnist Marta Mossburg looks at how the Maryland “millionaire tax” flopped and what it means to the state. She warns that without tax reform Maryland will continue to see successful residents leave the state for lower-tax states.
Millionaires Go Missing
http://online.wsj.com/article/SB124329282377252471.html
The Wall Street Journal offers a quick “two-minute drill in soak-the-rich economics.” It notes that budgets relying on a few rich individuals are more susceptible to larger boom-and-bust revenue periods.
Rich States, Poor States
http://www.alec.org/am/pdf/tax/09RSPS/26969_REPORT_full.pdf
http://www.alec.org/am/pdf/tax/09RSPS/09RSPS_exec_summ.pdf
The second edition of this policy study by Arthur Laffer, Stephen Moore, and Jonathan Williams analyzes how state fiscal policy contributes to state fiscal health. This paper provides “an in-depth analysis of policies, some of which foster economic growth and prosperity in states like Utah, Arizona and Texas, others of which cause economic malaise in states like California, New York and Michigan.”
The Price of Paradise: Hawaii Becomes Fifth State to Adopt New Income Tax Brackets on High-Earners
http://www.taxfoundation.org/publications/show/24693.html
This Tax Foundation study takes a look at what Hawaii’s various tax hikes—including the creation of a new tax bracket for high-income earners—would do to the state’s budget, economy, and taxpayers. The authors note, “state budget shortfalls are a result of trying to keep spending commitments based on naïve assumptions about tax revenue growth from the boom.”
Resenting the Rich
http://www.cato.org/pub_display.php?pub_id=10123
Chris Edwards, director of tax policy at the Cato Institute, participated in a debate about taxing the rich, published in the Economist. These are his closing remarks, where he notes, “Higher taxes at the top end would severely damage savings and investment.”
