Taxes Matter 12: Tax Rates and Migration

Moving stacy and Brian.
Creative Commons License photo credit: akeg

A new study by Antony Davies and John Pulito, from the Mercatus Center, find that tax rates do influence the migration of people across state and county lines (pdf). They found that:

This paper explores the relationship between high-income tax rates and the interstate migration of high-income households. Controlling for property-tax rates, sales-tax rates, high-income tax brackets, unemployment, and state/county specific and time-specific effects, we find that higher state income-tax rates cause a net out-migration not only of higher-income residents, but of residents in general. We also find that changes in the income levels to which the tax rates apply similarly affect out-migration. For county-level data, we find that high-income households react to a lowering of income levels to which higher tax rates apply in the same way that they react to increases in the tax rates themselves. This behavior suggests that the tendency to lower the threshold for “high income” or “millionaire” households to capture households and flee to more tax-friendly environs. Finally, for state-level data, we find that the effect of property taxes on migration is significantly stronger than the effect of high-income tax rates on migration. For example, a one percentage point increase in the property-tax differential between two states has almost three times the effect on migration as does a one percentage point increase in the difference in high-income tax rates. All of these data suggest a recipe for population depletion. States lose households to more tax-friendly states by (1) lowering the “high-income” threshold so as to capture more households, (2) increasing high-income tax rates, and (3) increasing property-tax rates.

This is good stuff, however, I noticed two little issues in the study relating to their tax data:

  • First, the study only identifies Tennessee as taxing only dividends and interest. Yet, New Hampshire also only taxes dividends and interest. Also, it is unclear if they excluded Tennessee and New Hampshire or not from the study.
  • In footnote 3 they state that “. . . while North Dakota, Rhode Island, and Vermont now have a progressive income-tax system, this was not the case in 2000.  As of 2000, these states charges an income tax equal to a certain percentage of the federal income tax liability.” This is not true. Since the federal income tax code is progressive, then taking a fixed percentage of the  federal liability will “import” the progressiveness of the federal tax code to the state.

Was Quantitative Easing A Plot to Save the Federal Budget?

I’ve never been satisfied with Ben Bernanke’s rationale for Quantitative Easing as a way to save the economy.  Did he totally forget the 1970’s where economists had to invent a new term for recessionary inflation now known as stagflation.  To me, Quantitative Easing is a recipe for stagflation.

Drawing from my GMU/public choice roots, I’ve had this hypothesis that Ben Bernanke was under political pressure to keep interest rates low no matter the costs.  In particular,with these unprecedentedly large budget deficits, the federal budget is becoming extremely sensitive to the interest rate.  The chart below, from the Mercatus Center, shows how the interest costs on the debt will absolutely explode if interest rates rise.

Chart of Federal Interests Costs Under Different Interest Rates

But, what is the direct transmittal mechanism for higher interest rates leading to higher interest payments?  That would ultimately be determined by the term schedule on federal bonds, i.e., how much debt is short-term needing to immediately rolled-over versus debt that is long-term with no immediate need for roll-over.  The shorter the term schedule, then the more at-risk is the federal budget to a higher interest rate.

Unfortunately, I did not know where to find the data on the term schedule for federal bonds.  So today I found over at No Money, No Worries a blog post with the term schedule of federal bonds.  And here we find the smoking gun.  Nearly 38 percent of the $9 trillion in marketable federal debt must be rolled-over this year and the next year (2011 and 2012)!  If interest rates were to spike over the next 18 months, it could make the Mercatus chart look downright rosy.

So for all the folks wondering if there will be a QE III they should not be looking at the health of economy.  Rather, they should be looking at factors that would otherwise force the Federal Reserve to raise interest rates . . . like a plummeting dollar for instance.  Ironically, failure to get a grip on the ballooning federal deficit is exactly the kind of event that could trigger a falling dollar . . . which would then spark QE III to lower interest rates to keep interest costs from further ballooning the federal deficit.  Does anyone see anyway off this hamster wheel?  Argh!

Should States Be Allowed to Go Bankrupt?

Freedom Homes, Government Bailout Money
Creative Commons License photo credit: Alex E. Proimos

Veronique de Rugy, of Mercatus, has an article in Reason magazine dismissing the idea that states should be allowed to go bankrupt.  She states:

Bankruptcy may sound like a silver bullet that could solve budget woes, dismantle cronyism, fix pensions, and forestall a federal bailout. But it contains plenty of potentially counterproductive consequences. Restoring the states’ fiscal health requires fundamental changes to the way they do business. Until that happens, their balance sheets will be bleeding red ink, whether they are officially bankrupt or not.

More specifically, her concern is:

In many states, bankruptcy will be an option only if powerful unions and other entrenched interest groups see it as a way to force budget problems onto the state’s bondholders rather than public employees.

The problem I have with her argument is that bondholders would not let them get away with leaving them holding the bag.  Even without new issues of bonds, states are always in a state of roll-overs–issuing new bonds to pay off the old ones.  Any hint of default would send the price of issuing new bonds into the stratosphere.  This would then have an immediate impact on the budget either because the state would have to fund the roll-over out of tax revenue (pay-off the bond) or pay higher interest payments on the new bonds.

As such, bondholders do have an immediate way to punish a state that looks to default on their bonds.  The negative budget impact would likely result in tax increases since nearly every state has a balanced budget requirement.  That, in turn, may stoke voter backlash.  The bondholders can wait until maturity to be made whole . . . politicians don’t have that luxury.

I still can’t help but think that having the bankruptcy law on the table would change incentives in a positive direction by shaking bondholders out of their lethargy.  I agree that it isn’t a silver bullet that will work in all states, but bankruptcy may help save a few of those on the margin.  Those states that may fulfill Veronique’s prophecy may already be too far along to save anyway.

Fiscal Federalism VII: Texas to End Medicaid?

In a previous blog a new study by Mercatus found that federal grants often drive up state and local taxes because the federal funds dry up leaving them to pick-up the tab.  Another way this can happen is through programs with a federal match.  In the quest to get the federal dollars, state and local governments must raise some revenue of their own.  The largest of these is the Medicaid program–to see how various states are addicted to federal Medicaid money see this post.

Today the New York Times is reporting that Texas is planning to do something about this inversion of fiscal federalism–do away with the federal Medicaid program and put in place a state-run system.  Here’s why:

“With Obamacare mandates coming down, we have a situation where we cannot reduce benefits or change eligibility” to cut costs, said State Representative Warren Chisum, Republican of Pampa, the veteran conservative lawmaker who recently entered the race for speaker of the House. “This system is bankrupting our state,” he said. “We need to get out of it. And with the budget shortfall we’re anticipating, we may have to act this year.”

The Heritage Foundation, a conservative research organization, estimates Texas could save $60 billion from 2013 to 2019 by opting out of Medicaid and the Children’s Health Insurance Program, dropping coverage for acute care but continuing to finance long-term care services.

As the old saying goes, “Don’t Mess with Texas!”