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Fixed-Income Insights

After a tax reform provision placed limits on deductions for wealthy individuals living in high income tax states, some feared an exodus to lower-tax states. Here’s a closer look at what really happened.

(This article is from the forthcoming third-quarter 2019 edition of The Muni Quarterly.)

The December 2017 tax reform provision limiting state and local tax deduction to $10,000, known as “SALT,” meant an increased tax burden for wealthy individuals in high income tax states. Some feared that, along with a population shift to lower-income tax states, there would be a transfer of wealth, resulting in a loss of tax base for the high tax states. Is this more rhetoric than truth?

The most affluent now pay combined marginal taxes of 39.4% in Texas and Florida, versus 51.8% in New York City and 53.4% in California, a spread of 14% between the zero-tax and highest-taxed states. So, the question is, “Will the wealthy in these states move and take their tax revenue with them, resulting in a deterioration of the credit quality of their home states?”. Although there have been studies that show that there has in fact been out-migration from high tax states to lower tax states, there is much evidence that it is not the wealthiest who move.

Demographic Data and Out-Migration Rates
A recent Moody’s Investors Service report, citing U.S. Census Bureau and IRS data, found that the five states with the highest state and local tax deductions as a percentage of adjusted gross income—New York, New Jersey, Connecticut, California and Maryland—were not among those with the highest out-migration rates in 2017. California, which ranked fourth in state and local tax deductions among the 50 states, ranked 49th in out-migration during 2017. New York, ranked highest in state and local tax deductions, ranked 38th in out-migration. “Job opportunities and demographic trends, more so than tax rates, influence relocation from one state to another,” said Marcia Van Wagner, a vice president and senior credit officer at Moody’s. Those states with the highest out-migration in 2017—Delaware, Alaska, North Dakota, Hawaii and Wyoming—were among the lowest for state and local tax deductions. In addition, the report cited that those who left high-tax states in 2017 tended to move to another of the five states with the highest state and local tax deductions. Moody’s noted that the most popular destination for people leaving New Jersey and Connecticut is New York.

The New York Times reported that half of all venture capital investment migrates to California alone, even though the state has the highest marginal tax rates.  The article quoted Cristobal Young, a Cornell University sociology professor, who stated “Substantially more rich people are moving into California than moving out. “There’s more opportunity in California. There are a lot of ways to make a lot of money in California, more than other places. A lot of that is tech, but it’s a diverse economy…. “. Next 10, a public policy think tank, found that “the main driver for net out-migration appears to be high housing costs since migration rates are highest for those at lower-wage levels…. The vast majority of people who moved out of California were concentrated in lower-skilled, lower-paying fields.” The state Legislative Analyst’s Office reported: “Although California has had net out-migration among most demographic groups, it has gained among those with higher incomes ($110,000 per year or more) and higher levels of education (graduate degrees).”

Along with California, the state of Connecticut has been the focus of millionaire migration. Although accounts of wealthy residents fleeing Connecticut are prevalent, empirical evidence does not support this. "People move because of professional opportunities," said University of Connecticut economist Fred Carstensen, who heads the Connecticut Center for Economic Analysis. "They retire and choose a lifestyle, which leads some to move. Taxes have ranked as a particularly strong driver. It's not that important. But it's a convenient thing to talk about."

Tax Flight, “Embedded Elites” and “Transitory Millionaires”
A 2016 American Sociological Review article stated that the wealthy are "embedded elites" and not "transitory millionaires." "We find that millionaire tax flight is occurring, but only at the margins of statistical and socioeconomic significance," wrote the panel of Stanford University sociologists and U.S. Treasury Department economists, who reviewed census data and 45 million tax records dating back 13 years. Wealthy households "are embedded in the regions where they achieve success, and they have limited interest in moving to procure tax advantages," researchers wrote. The reason, as concluded from the study: the more affluent own their own homes and businesses, are married and have children," thus anchoring these individuals to their communities. The study found the migration rate nationally of households reporting more than $1 million in income per year was 2.4 percent—which is lower than the 2.9 percent rate for the general population.

In Illinois, IRS data shows that during a recent four-year period when income tax rates increased, about 55% of those that left the state were younger than 35 years of age, and over 60% had incomes of less than $50,000. According to the data, taxpayers departed Illinois for other states, and this has been occurring for decades, well before there were discussions regarding comparative tax burdens.

Minnesota, which already had one of the highest overall tax burdens in the region, imposed a surcharge for individuals earning more than $150,000 in 2013. From 2013 to 2016, the number of Minnesota tax filers reporting income of $200,000 and more increased by 28%. In addition, Minnesota’s population grew 2%, a modest increase but one that exceeded all its Midwestern neighbors.

Tax Flight Trends and Municipal Bond Investing
It seems that the need for employment is still one of the main reasons people move while home and business ownership—most common among high-income households—promote stability. Prudent investing requires parsing impactful credit factors from the rhetoric, particularly when buying municipal bonds. While we are cognizant that higher taxes may drive migration patterns and tax base changes, it is clear to us that the cause and effect is not straightforward. Therefore, our credit analysts look beyond conventional thought, with the goal of identifying meaningful trends.

 

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice.  You should consult your own legal or tax advisor for guidance on regulatory compliance matters.  Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client.

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