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Carolina Beat

Tax Flight Is No Myth

Sep. 1st, 2011
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RALEIGH -- As many states enact tax increases or consider them, various stakeholders rightly express concern that this may have a detrimental effect on the tax base. In other words, new taxes or higher tax rates will negatively impact the prosperity of residents and, in the long run, potentially reduce tax revenues.

Many mechanisms would account for such an outcome, including reduced in-state investment, reduced incentives for employment, increased gaming of the tax system, and outward migration. Whether these forces are strong enough to outweigh the higher tax burden will depend on the timeframe under consideration, the relative taxes elsewhere, and the costs associated with transferring assets and employment.

That people would leave a state when its officials seek to take more of their money, though, is hardly surprising, and it is consistent with findings from a Mercatus Center ranking of states in terms of personal and economic freedom.

The Center on Budget and Policy Priorities and the North Carolina Justice Center, however, contest that reality -- presumably because its implications go against their drive for an expanded government sector. So they're promoting a report, "Tax Flight is a Myth."

Logical rigor is sorely lacking from it, though, and from the outset they place an impossible burden on those who warn of blowback from higher taxes. They characterize these warnings as "unproven claim[s] that tax hikes will drive large numbers of households -- particularly the most affluent -- to other states."

Of course, one cannot prove a prediction before the policy goes into place. On the other hand, the evidence that economic freedom, including low and stable tax burdens, enables the rise of human prosperity is overwhelming. And the underlying policy disparities across borders do impact migration.

The Mercatus freedom ranking found that during the 2000 to 2009 period, the difference between a state ranked in the bottom third, such as Connecticut at No. 38, and a state in the top third, such as Iowa at No. 13, correlated with higher positive migration equal to 5.9 percent of population.

In other words, overgoverned states tend to have lost 3 percent of their population through domestic migration, while freer states tend to have added 3 percent to their population. (North Carolina ranked No. 18 and enjoyed net in-migration of 8.4 percent.)

So people are demonstrating their preferences with their feet, as predicted by basic economics, and they're demonstrating the tax rate trade-off known as the Laffer Curve. More recent research from Nathan Ashby in the Southern Economic Journal also has identified lower tax burdens as one of the key attractions for migration.

Even CBPP's own supposed counterexample showed outward migration after New Jersey raised its top income tax rate in 2004. The increase was on people earning more than $500,000 each year, but the authors point out that people earning $200,000 to $500,000 also began leaving the state. Apparently people with earnings just below the threshold should be impervious.

The report also asserts that interstate tax differentials typically equal just a few percentage points of income -- as though that bolsters their case. Given the costs associated with migration, that we see any relationship demonstrates how strongly people respond to tax incentives.

The authors do acknowledge that people move over housing costs, so why not for tax disparities? Evidently, the debate is a matter of degree, and they're simply seeking to downplay the role of migration on tax revenues.

In doing so, they draw on shaky and selective statistics. They claim that only 30 percent of those born in the United States change their state of residence in their entire lives. But that is based on past lifespans and is no doubt fluctuating as knowledge of distant opportunities spreads more rapidly and technology lowers the cost of migration. The statistic also ignores the presence of foreigners and their positive impact on tax revenues.

There also seems to be the assumption that if people cannot escape from a tax, it is a legitimate policy. Even if people do stay in-state and tax revenue increases, taxes are still wealth transfers that distort productivity incentives, dissuade investment, micromanage individuals, and generate compliance costs.

Fergus Hodgson is director of fiscal policy studies at the John Locke Foundation.