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Tax Competition Works

In my February 23, 2022, TaxBytes, “Tax Competition Between States: How Low Will Tax Rates Go?,” I pointed out some good news at the state level: State governments are competing for residents from high-tax states by cutting tax rates.
New evidence shows that cutting tax rates or keeping them low attracts residents, especially high-income earners, from high-tax states.
Economist Chris Edwards, an expert on taxes and budgets at the Cato Institute, has garnered the evidence. In a September 25 article in the Washington Examiner, Edwards writes:
“The IRS data confirm the news stories about top earners moving to low‐​tax states. For households with incomes above $200,000, California is losing two households for each one it gains, and New York is losing three households for each one it gains.
"On the flip side, Florida is gaining more than two top‐​earning households for each it loses. Eight of the nine states that do not have income taxes enjoy net in‐​migration of top earners.”
Edwards also points out that although top-earning households—those with $200,000 or more of income—were only 7 percent of interstate movers, they “accounted for 41% of all movers’ income.”
Why should state governments care about losing high-income people? One main reason is they pay way more than their pro-rata share of state income taxes. In 2012, shortly after California’s electorate voted to raise the top marginal state income tax rate from the already-high 9.3 percent to a whopping 13.3 percent, I did a back-of-the-envelope calculation for someone making $1 million annually in California. I wrote:
"He now pays approximately $88,000 in state income taxes. With the new higher tax rates, the California State government is planning to collect approximately an extra $19,500 from him, for a total of about $107,500 in tax revenue. But if he moves to another state, it collects a big fat zero. Revenue falls by $88,000. What if one out of every ten people making one million dollars a year leaves California and the rest don’t change their behavior in response to the higher rates? Then the tax rates, which were estimated to extract an extra $195,000 from these people, instead extract $175,500 from the nine who stay ($19,500 x 9) but lose $88,000 from the guy who leaves. Net revenue increase: not the planned $195,000 but, instead, $107,000, or only 55% of the amount the government planned on." 
Why should the rest of us care? Two reasons. First, simple fairness: People who pay high state taxes don’t get much more from government services than people who pay low taxes. So why is it fair to tax high-income earners so heavily?  Second, high-income people tend to bring some dynamism to a state economy: starting businesses, hiring employees, and adding to economic well-being.