STATE TAX AND FLEEING RESIDENTS 

Haskel (Ben) Benishay*

       Increasing state tax rates brings about some out migration of residents and businesses of the state.

Some economic phenomena apply equally to companies and the price of their products, and to states and their taxes.

          Economic theory and empirical data indicate that when company product becomes more expensive, less of the product is bought. Consumers’ response to an increase in product price, by buying less, thus lowering revenue emanating from reduced product sales. The company either is not affected at all by the increase in product price, which is seldom true, or in most cases, an increase causes a decrease in revenue generated from reduced sales of the more expensive product. This relationship is well known to marketers of products.

          A similar response occurs when a state, one of the United States of America, imposes or increases state tax rates. The state is the provider of various services, which those who live and function in the state receive. An increase in state tax rates is tantamount to an increase in the price of living and functioning in the state. In response some of the state’s residents and businesses leave for another state where tax rates are lower. Thus, an increase in state’s tax rates brings about, in the longer run, a movement of residents and businesses out of the state to other states whose taxes are lower. Relatedly, high or higher, state taxes cause, in the long run, a decline in state’s tax revenues. If a state’s leadership wishes to raise tax revenue, increasing state tax rates is not the way to proceed. A better way may well be to lower tax rates. However, this is easier said than done.

          Most people and politicians have a simple intuitive but wrong way of viewing the effect of taxes on tax revenues. Conventional wisdom, which is most people’s wisdom, asserts that when tax rates are raised, tax revenues also rise. Some refer to this conventional wisdom as STATIC short run wisdom. When one acknowledges that a decrease in tax rates may yield, in the longer run, more tax revenues and visa versa, one is said to engage in DYNAMIC long run analysis. Generally, the long run dynamic analysis is the more valid and realistic. The conclusion for purposes of a state decision-making: “Do not increase tax rates in order to increase tax revenues and reduce state budget deficit.” In the long run the reverse will happen. However, sadly, the leadership of most states does not heed such advice. Most states’ leaders and constituents wrongly view raising tax rates as a way to increase revenue and lower the state’s deficit in the short and long run. However, the short run increase in revenue is temporary and reverses in the longer run.

          Prime examples of states with high tax rates causing people and businesses to leave are New York and California. In both states tax rates including income, sales, and real estate tax rates, are higher than in other states. Result: people and businesses migrate out of these two states to other states with lower tax rates.

          In both states, New York and California, the consequences over the long run are fewer businesses and fewer people who are able to pay taxes. Those remaining, tend to be poorer than those who leave. More of those who remain need state assistance, or even worse, become wards of the state. There are other factors which affect in and out migration between states. California is blessed with a moderate climate and comparatively milder winters than in many other states of the union. This causes people to migrate to California, which counteracts to some extent the out migration due to high taxes. Good weather moderates the out migration. But the effect of higher taxes dominates.

          New York State is not blessed with moderate weather. It has been losing businesses and individuals to other states with lower taxes and better weather. People and businesses leave predominantly because of high taxes. Inclement weather adds to the effect of high taxes. In the long run, New York State will lose population, and southern and western states with lower tax rates, will gain.

          The advice to state governors and legislatures across America: Do not raise taxes! If you do, then in the short run tax revenue will increase and deficits decrease. However, in the long run, revenue will decrease and deficits increase. Thus, it is not a good idea to raise taxes. In the long run it boomerangs. But despite the bad long run consequences of raising taxes, politicians often do raise taxes. Why do they? One reason, and the most likely one, is that the length of time politicians stay in office is shorter than the long run delay period necessary to bring about several bad consequences: out migration of people and businesses, the shrinkage in tax revenue, and the increase in state deficit. Another reason for politicians who stay in office for a long time, is that when tax revenues decrease and deficits increase, in the long run as a result of tax increase, these politicians argue for additional increases in tax rates to improve the state’s situation in the new short run. And the cycle continues.

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          *Professor Emeritus at Kellogg School of Management of Northwestern University, and president of ABEMINFO.