It is clearer than ever that the U.S. Tax Cuts and Jobs Act of 2017 made high-tax states less competitive with low-tax states. But instead of using this moment to reflect on how taxes influence behavior, politicians in places such as Connecticut, New York, New Jersey and Illinois are inexplicably doubling down by threatening to raise taxes on their citizens even more.

Until politicians start to understand the benefits of economic incentives and an equitable tax system, expect these high-tax states to continue down the road to financial depredation as taxpayers pick up and leave in greater numbers. This is why it’s worth keeping a close eye on recent developments in New Jersey, where the Democratic-controlled legislature last week approved a $38.7 billion budget that scraps Gov. Phil Murphy’s proposed millionaire’s tax, raising the risk of a government shutdown.

To review, up until a couple of years ago, individuals could deduct every dollar of state or local taxes paid from their federal return. This had the effect of shielding taxpayers from the full consequences of tax-and-spend policies in high-tax states. But under the new tax laws, the deductible amount is capped at $10,000. This change has been characterized as soaking the rich, but it soaks a lot of other people, too. It’s not hard to exceed the cap. Even middle-class families can do it in high-tax states.

I predicted in December 2017 that the cap on so-called SALT deductions would result in “a population migration so large that it could result in profound economic and social changes.” It’s happening. A Bloomberg News analysis last month of state-to-state moves based on data from the Internal Revenue Service and the U.S. Census Bureau found that Connecticut, New York and New Jersey faced some of the biggest financial drains.

Connecticut lost the equivalent of 1.6% of its annual adjusted gross income, as those who moved out of the state had an average income of $122,000, which was 26% higher than those migrating in. New York’s annual net loss was the highest, with a net $8.4 billion leaving the state. Exiting incomes of $19.1 billion were replaced by people who brought in $10.7 billion less in income. Illinois and New Jersey were next with net outflows of $4.8 billion and $3.4 billion.

In high-tax states, the combined federal, state, and local tax burden can approach or exceed 50%, even after taking into account lower marginal rates. There is something magic about the 50% number that causes people to rethink their finances. I would characterize a combined tax burden of over 50% as immoral, on the grounds that it is simply unfair to take more than half of what somebody makes. It is true that U.S. taxes overall are lower than in other countries as a percentage of GDP. It is also true that on a historical basis, marginal income tax rates are not especially high. This, however, does not provide a justification for ultra-high tax rates.

Rational economic actors seek to lower their tax bills. There are frictional costs associated with moving, but people will do the mental math and figure out if the long-term gain from a lower tax bill exceeds the short-term pain from moving. Blue state governors have mostly refused to acknowledge the migration. When they have, they attribute it to things like the weather.

Mostly, they have responded to complaints of high taxes with higher taxes. Which is also not irrational. If your state experiences out-migration and your tax base erodes, first-order thinking would lead you to believe that you can plug the hole with higher sales taxes and fees, as Connecticut is doing. Alternatively, a forward-thinking governor could instead drastically reduce the size and scope of government and lower the tax burden on, yes, even rich taxpayers.

Blue state Democrats are in a bit of a pickle. On one hand, they clamor for confiscatory tax rates of 70% to 90%, but on the other hand, they seek to lower taxes on the rich, by raising the cap on SALT deductions, to disincentivize them from leaving the state. One nice side effect of the SALT cap is that states that had been planning millionaire’s taxes (such as New Jersey) experienced a great deal of pressure to exercise restraint.

Despite overwhelming evidence that taxes influence behavior, there are plenty of tax-migration deniers. They say high taxes pay for top-notch services of the kind you get in wealthy blue states. I talk to the folks who move to Myrtle Beach, South Carolina, which is where I live and is the second-fastest-growing metropolitan area in the country. It has nice weather, yes, but more crucially, it has a low cost of living and an exceptionally low property tax burden that averages about $1,500 for a typical house. That is the selling point, and nothing else. The new arrivals are not much interested in the services.

Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of “Street Freak” and “All the Evil of This World.” He may have a stake in the areas he writes about.

(42) comments

stjohn42

This letter is just a rehash of the dated Reaganomics trope, that low taxes will "always" produce high growth. The problem being that it has *never* panned out that way, and you only need look as far as Kansas for an example of it failing.

TinaS

One more thing about the SALT cap. MFJ cap is 10K, MFS cap is 5 K. Filing single cap is 10K. That's a real hit to married people. But, in general, I don't really hate that. High (ish) income single people get taxed a lot in any case.

Comment deleted.
DickD

[thumbup][thumbup]

DickD

The tax cut was brutal on the high tax states. https://smartasset.com/taxes/trumps-plan-to-eliminate-the-state-and-local-tax-deduction-explained The state and local tax (SALT) deduction allows taxpayers of high-tax states to deduct local tax payments on their federal tax returns. The new tax plan signed by President Trump, called the Tax Cuts and Jobs Act, instituted a cap on the SALT deduction. Starting with the 2018 tax year, the maximum SALT deduction available is $10,000. Previously, there was no limit. Lets take a closer look at what the reduced deduction means for residents of high-tax states like California, New York and New Jersey.How State and Local Tax Deductions WorkTaxpayers who itemize their deductions (meaning they don’t take the standard deduction) can deduct what they’ve paid in certain state and local taxes. This SALT deduction includes property, income and sales taxes. More specifically, anyone who itemizes can deduct property taxes, but must choose between deducting their income taxes and sales taxes. Most choose to deduct their income taxes because those payments generally exceed sales tax payments. Residents of states with high income taxes (California, New York, New Jersey and Maryland, to name a few) generally opt to deduct their state and local income taxes if they itemize. Residents of states with high sales taxes (Louisiana, Texas and others) and low or nonexistent income taxes generally opt to deduct their sales taxes if they itemize. However, property taxes and income taxes – not sales taxes – are the primary drivers of the SALT deduction.Starting with the 2018 tax year, the maximum SALT deduction is $10,000. There was previously no limit. This will leave some high-income filers with a higher tax bill. The limit is also important to know because the 2018 standard deduction is $12,000 (for single filers). So you need to have another $2,000 of itemized deductions, beyond the SALT deduction, in order to itemize. This changes who should itemize their 2018 taxes.Since these tax matters can get complex, it’s useful to have guidance through tax season from an expert. Financial advisors can provide you with that guidance, and you can pair up with an advisor using SmartAsset’s matching tool.Who Uses the SALT Deduction?Not every American takes the state and local tax deduction. High-income filers are much more likely to itemize and therefore more likely to take the SALT deduction. The higher your income, the more valuable tax deductions are to you in general because you’re taxed at a higher rate.With the deduction for state and local taxes, the federal government is effectively subsidizing high earners in high-productivity states and cities. (Any deduction the federal government offers is a subsidy.) As you might expect, wealthy residents of wealthy states are most likely to pay state and local taxes. They also tend to have the highest average SALT deductions. According to the Tax Foundation, people with incomes over $100,000 receive more than 88% of SALT deduction benefits.Those who stand to gain from deducting their property taxes tend to be those who have expensive homes in prospering communities. Filers who deduct their state and local income taxes tend to be high earners in thriving states. States and cities with high income taxes also tend to be high-opportunity states like California and New York.Why the SALT Deduction MattersThe deduction for state and local taxes has been around since 1913, when the U.S. first instituted our federal income tax. Defenders of the SALT deduction, such as the National Governors Association, point out that state and local income, real estate and sales taxes are mandatory. Taxpayers can’t get out of them. For advocates of the deduction, eliminating it would therefore constitute double taxation.At the same time, the SALT deduction is one of the largest federal tax expenditures. Along with the mortgage interest deduction, the non-taxation of employer-sponsored health benefits and pension benefits, preferential tax rates on capital gains and the tax deferral of corporate profits earned abroad, the SALT deduction costs the federal government trillions in missed revenue opportunities. In fact, the Congressional Budget Office expects that those and other tax expenditures will add up to over 8% of GDP in 2017. That’s an amount equal to nearly half of all federal revenues projected 2017.So who will miss the SALT deduction the most? According to a 2016 report from the Tax Policy Center, “Taxpayers with incomes over $100,000 would have the largest tax increases both in dollars and as a percentage of income.” Eliminating the deduction entirely would raise taxes for about a quarter of taxpayers and reducing the deduction (as Congress is planning to do) would affect about half as of people.Filers with incomes over $500,000 are greatly affected, but their loss in deductions could also be offset by the decrease of the top federal income tax rate (from 39.6% to 37%), the doubling of the estate tax deduction and the cutting of the capital gains rate from 23.8% to 21%.Lower-income individuals would feel less direct impact from reducing the SALT deduction, but they would still be affected indirectly. That same report from the Tax Policy Center found that changing the SALT deduction could lead to a change in revenue for local and state governments. In response to the fact that people are paying more in federal taxes, those governments could choose to decrease their local tax rates. This would leave them with less to spend on government-sponsored programs and services.How the Reduced State and Local Tax Deduction Will Affect TaxpayersNew York, Connecticut, New Jersey, California, Massachusetts, Illinois, Maryland, Rhode Island and Vermont are the states (plus the District of Columbia) with the highest average deduction for state and local taxes. Here’s how those deductions break down:New York TaxpayersResidents of New York take the highest average deduction for state and local taxes, according to IRS data. In 2014, 34.14% of New York tax returns included a deduction for state and local taxes. The average size of those New York SALT deductions was $21,038.02. Residents of New York City will pay particularly high tax rates due to the local income taxes assessed there. Connecticut TaxpayersConnecticut residents take the second-highest average deduction for state and local taxes. 41.04% of Connecticut returns included a SALT deduction in 2014. The average size of Connecticut deductions for state and local taxes was $18,939.72.New Jersey TaxpayersNew Jersey residents pay famously high income and property taxes. It’s no surprise, then, that 41% of New Jersey tax returns claimed a deduction for state and local taxes. The average amount of that deduction was $17,183.33.California TaxpayersIn 2014, 33.86% of California returns included a deduction for state and local taxes. The average California SALT deduction was $17,148.35.D.C. TaxpayersBecause D.C. homes are so expensive, residents tend to pay a lot in property taxes. Income taxes in the District are high, too. It’s not surprising, therefore, that 39.19% of D.C. tax returns included deductions for state and local taxes. The average size of those deductions was $15,452.40.Massachusetts Taxpayers36.73% of Massachusetts returns took deductions for state and local taxes. The average size of Massachusetts SALT deductions was $14,760.99. Illinois Taxpayers32.34% of Illinois returns deducted state and local taxes paid in 2014. The average SALT deduction on those Illinois returns was $12,877.51.Maryland TaxpayersA whopping 45.04% of Maryland tax returns included a deduction for state and local taxes in 2014. That’s the highest percentage of returns claiming SALT deductions of any state. The average size of those deductions was $12,442.78.Rhode Island TaxpayersAlthough Rhode Island is a small state, its residents tend to have big incomes and big property tax bills. As a result, 32.83% of Rhode Island tax returns deducted state and local tax payments. The average size of Rhode Island SALT deductions was $12,138.75.Vermont TaxpayersFinally, rounding out our list of the top 10 states with the highest average deduction for state and local taxes is Vermont, where 27.41% of returns took SALT deductions. The average size of state and local tax deductions in Vermont was $11,843.95.  

MD1756

Dick, you lost me with the following statement "...At the same time, the SALT deduction is one of the largest federal tax expenditures...." You also state "...The higher your income, the more valuable tax deductions are to you in general because you’re taxed at a higher rate.With the deduction for state and local taxes, the federal government is effectively subsidizing high earners in high-productivity states and cities...." How is it a subsidy if the effect is to let you keep more of the money you earned? It's already been shown that rich people subsidize the rest of us where income tax is concerned. Lowering their income tax (and I'm not arguing that it should be lowered) is reducing their subsidizing everyone else. You also write "...According to the Tax Foundation, people with incomes over $100,000 receive more than 88% of SALT deduction benefits.Those who stand to gain from deducting their property taxes tend to be those who have expensive homes in prospering communities..." Well, it only makes sense since they pay over 80% of the income tax collected based on the AGI and doesn't count those who file a return and pay either no tax or actually get more money than they owe. You also wouldn't expect those at or below the poverty line to own property, so they clearly wouldn't get a deduction for real property taxes. You also write "...Along with the mortgage interest deduction, the non-taxation of employer-sponsored health benefits and pension benefits, preferential tax rates on capital gains and the tax deferral of corporate profits earned abroad, the SALT deduction costs the federal government trillions in missed revenue opportunities...." How much lost revenue do all the income tax deductions and credits people get for having children cost the government in lower revenues? Everyone who doesn't have children ends up subsidizing those who have children and those who can't afford their children get an even larger subsidy (some not only don't pay any tax, they actually get more money from the government when they file and take all eligble tax deductions and credits). How much does that cost the government? According to a 2013 article by the Committee for a Responsible Federal Budget (https://www.crfb.org/blogs/tax-break-down-child-tax-credit) The child tax credit is the sixth largest tax break today, according to the Joint Committee on Taxation (JCT). It costs $57 billion in revenue this year, $290 billion over 5 years, and an estimated $550 over ten years. Of that total, slightly more than half is spent on refunds to taxpayers who have no tax liability. "Lower-income individuals would feel less direct impact from reducing the SALT deduction, but they would still be affected indirectly...." They may have to pay higher rents to landlords who raise the rents to offset their higher taxes from lost deductions.

MD1756

I tried spacing out my response but the paragraphs didn't come out in the post.

DickD

We all have that problem, MD. Our differences, on the srticle, is how we view it. I know you don't like the fact people with children get more deductions. That is just the way the tax law is written. There's plenty in it I don't like too. My current beef is the State of Maryland not allowing you to itemize if you don't itemize on the federal tax return. Probably, because the State relies on the federal government for verification.

gary4books

Good point and one I never considered. Thanks DickD!

gary4books

The problem for me is that I must itemize my Federal taxes to itemize my State taxes and that means giving up my Federal standard deduction which means $500 more in Federal taxes to spend a thousand less on State taxes. So Maryland wants me to pay more Federal taxes? or just wants more state money without forcing its legislators to vote for the extra taxes?

DickD

When they made the ruling on giving everyone at least $12,000 and took away the personal exemption everyone that itemizes with more than the allowable amount lost, Because we have to itemize on both state and federal to get the state deductions, it only made it worse.

jerseygrl42

The States you mention along with CA. just love to tax and waste other peoples money so they can continue to buy votes and stay in office while punishing the working people

shiftless88

Supply and demand. Are you now against that philosophy?

matthewboh

Always love when jerseygrl142 does her dump and run. Wait, is she a Russian troll?

gary4books

Spending is not bad if the return is great.

gary4books

If we elect the right people our tax money is never wasted. It enhances our lives - as they should. Vote.

Comment deleted.
gabrielshorn2013

Nonsense. Why should the rest of the country be forced to subsidize high tax states by allowing SALT deductions.

shiftless88

I thought conservatives supported supply and demand? States like CA, WA, NY, CT and IL are in demand by people and by industry. So they can be taxed more. It is what the people who live there vote for. Not everyone wants a bare-bones economy with no services. Some people appreciate the things they get for their tax dollars. You could be like AL or MS and have low taxes resulting in inadequate public education, for example.

MD1756

Have you lived in NY? I've lived in NY, MD, VA and AL. Even upstate NY is expensive. Use zillow and look at the property taxes of those in Vestal, NY. For a much cheaper house than here, the taxes are much higher (example: assessed price of $181,900 the tax is $5,755). Sales tax is 8% (4% state and 4% Broome county). I can tell you from experience that service in Vestal NY were not any better than here (not really any worse either although I think the public k - 12 schools were a little better here). If I move in retirement it certainly wouldn't be back to NY because of the cost of living. I would move to PA or WV.

DickD

Lewis County New York was the same as Broome County, but our schools were better than here. I would never move to WV.

shiftless88

Clearly people think NY is worth it or they would have left long ago. Same with CA. There is a reason people stay in those places. Supply and demand.

MD1756

Many are leaving (just look at the numbers in the opinion piece from Jared Dillian, Bloomberg who certainly doesn't seem to be a conservative based on his background and the networks he appears on) and those without skills, where will they go when there is an abundance of unskilled laborers?

shiftless88

California is the most heavily populated state and New York is #4. For all this stuff I hear about people leaving those two states in droves they sure seem to maintain their status in population.

MD1756

Shiftless, look at the impact on state revenue which is more important than just the numbers of people. With the wealthy people leaving, there rest of the people will have to pay more to make up for it, and it is a more significant part of their income than it is for wealthy people. When MD raised their tax just 0.25% on income over $100k, I reduced my hours just on the principle of being penalized for doing the right thing. If MD was going to punish me for not having children, getting a good education and developing skills that commanded a good salary, I was going to reduce my income and thus their tax revenue and get more free time which I valued. I don't like subsidizing people who make irrational or ill advised life choices especially ones that just add to the problems of overpopulation by humans on this planet.

DickD

Inadequate is hardly the right word, how about terrible?

gabrielshorn2013

Very good fact-based article. The high tax states, by using the SALT deductions, were simply transferring their tax burden to the rest of the country. State and Federal taxes should be separate and independent. Those states that want high taxes can keep them. However, as the data shows, there has been a tax migration of the wealthy to states with a lower tax burden like SC.

DickD

And you would want to live in S. Carolina?

gabrielshorn2013

Have you been to the Charleston area Dick? If not, you really ought to go. Direct flights via SW. It is absolutely beautiful. Plenty of places to go and things to see. Lots of cultural opportunities, such as museums, music, etc. Beaches, golf, parkland too!

DickD

I did a lot of contract work for the state electrical company. They have their headquarters just a few miles outside of Charleston. .I agree it's a beautiful city, but that's not the same as living there.

gabrielshorn2013

I have friends and colleagues that live there, and they love it. I have visited several times, and it's a great historic old city.

gary4books

Sooner or later you will be able to fish at high tide. Just off your front porch. Perhaps.

hayduke2

Off the mark Gabe. Charleston is a beautiful city but doesn't support your argument. High cost of living. https://www.bestplaces.net/cost_of_living/city/south_carolina/charleston

gabrielshorn2013

The subject is taxation, not cost of living hay. In the city, yes, I would agree with you. However, outside the city in the Charleston area, no. Same as DC/Bethesda area and Frederick. The city is close enough for any cultural events, but far away enough so the cost of living is less. My point to Dick is that he appeared to make SC an undesirable place to live. The Charleston and Myrtle Beach areas are some of the fastest developing areas in the US, so apparently a lot of people find SC desirable.

hayduke2

Realize that Gabe but my point is that folks aren't moving solely for the tax reduction, they are moving for weather, age resistricted housing, beaches, etc.

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