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WALL STREET JOURNAL
Soak the Rich, Lose the Rich
Americans know how to use the moving van to
escape high taxes
By ARTHUR LAFFER and STEPHEN MOORE
May 18, 2009
With states facing nearly $100 billion in combined
budget deficits this year, we're seeing more
governors than ever proposing the Barack Obama
solution to balancing the budget: Soak the rich.
Lawmakers in California, Connecticut, Delaware,
Illinois, Minnesota, New Jersey, New York and Oregon
want to raise income tax rates on the top 1% or 2%
or 5% of their citizens. New Illinois Gov. Patrick
Quinn wants a 50% increase in the income tax rate on
the wealthy because this is the "fair" way to close
his state's gaping deficit.
Mr. Quinn and other tax-raising governors have been
emboldened by recent studies by left-wing groups
like the Center for Budget and Policy Priorities
that suggest that "tax increases, particularly tax
increases on higher-income families, may be the best
available option." A recent letter to New York Gov.
David Paterson signed by 100 economists advises the
Empire State to "raise tax rates for high income
families right away."
Here's the problem for states that want to pry more
money out of the wallets of rich people. It never
works because people, investment capital and
businesses are mobile: They can leave tax-unfriendly
states and move to tax-friendly states.
And the evidence that we discovered in our
new study for the American Legislative Exchange
Council, "Rich States, Poor States," published in
March, shows that Americans are more sensitive to
high taxes than ever before. The tax differential
between low-tax and high-tax states is widening,
meaning that a relocation from high-tax California
or Ohio, to no-income tax Texas or Tennessee, is all
the more financially profitable both in terms of
lower tax bills and more job opportunities.
Updating some research from Richard Vedder of Ohio
University, we found that from 1998 to 2007, more
than 1,100 people every day including Sundays and
holidays moved from the nine highest income-tax
states such as California, New Jersey, New York and
Ohio and relocated mostly to the nine tax-haven
states with no income tax, including Florida,
Nevada, New Hampshire and Texas. We also found that
over these same years the no-income tax states
created 89% more jobs and had 32% faster personal
income growth than their high-tax counterparts.
Did the greater prosperity in low-tax states happen
by chance? Is it coincidence that the two highest
tax-rate states in the nation, California and New
York, have the biggest fiscal holes to repair? No.
Dozens of academic studies -- old and new -- have
found clear and irrefutable statistical evidence
that high state and local taxes repel jobs and
businesses.
Martin Feldstein, Harvard economist and former
president of the National Bureau of Economic
Research, co-authored a famous study in 1998 called
"Can State Taxes Redistribute Income?" This should
be required reading for today's state legislators.
It concludes: "Since individuals can avoid
unfavorable taxes by migrating to jurisdictions that
offer more favorable tax conditions, a relatively
unfavorable tax will cause gross wages to adjust. .
. . A more progressive tax thus induces firms to
hire fewer high skilled employees and to hire more
low skilled employees."
More recently, Barry W. Poulson of the University of
Colorado last year examined many factors that
explain why some states grew richer than others from
1964 to 2004 and found "a significant negative
impact of higher marginal tax rates on state
economic growth." In other words, soaking the rich
doesn't work. To the contrary, middle-class workers
end up taking the hit.
Finally, there is the issue of whether high-income
people move away from states that have high
income-tax rates. Examining IRS tax return data by
state, E.J. McMahon, a fiscal expert at the
Manhattan Institute, measured the impact of large
income-tax rate increases on the rich ($200,000
income or more) in Connecticut, which raised its tax
rate in 2003 to 5% from 4.5%; in New Jersey, which
raised its rate in 2004 to 8.97% from 6.35%; and in
New York, which raised its tax rate in 2003 to 7.7%
from 6.85%. Over the period 2002-2005, in each of
these states the "soak the rich" tax hike was
followed by a significant reduction in the number of
rich people paying taxes in these states relative to
the national average. Amazingly, these three states
ranked 46th, 49th and 50th among all states in the
percentage increase in wealthy tax filers in the
years after they tried to soak the rich.
This result was all the more remarkable given that
these were years when the stock market boomed and
Wall Street gains were in the trillions of dollars.
Examining data from a 2008 Princeton study on the
New Jersey tax hike on the wealthy, we found that
there were 4,000 missing half-millionaires in New
Jersey after that tax took effect. New Jersey now
has one of the largest budget deficits in the
nation.
We believe there are three unintended consequences
from states raising tax rates on the rich. First,
some rich residents sell their homes and leave the
state; second, those who stay in the state report
less taxable income on their tax returns; and third,
some rich people choose not to locate in a high-tax
state. Since many rich people also tend to be
successful business owners, jobs leave with them or
they never arrive in the first place. This is why
high income-tax states have such a tough time
creating net new jobs for low-income residents and
college graduates.
Those who disapprove of tax competition complain
that lower state taxes only create a zero-sum
competition where states "race to the bottom" and
cut services to the poor as taxes fall to zero. They
say that tax cutting inevitably means lower quality
schools and police protection as lower tax rates
mean starvation of public services.
They're wrong, and New Hampshire is our favorite
illustration. The Live Free or Die State has no
income or sales tax, yet it has high-quality schools
and excellent public services. Students in New
Hampshire public schools achieve the fourth-highest
test scores in the nation -- even though the state
spends about $1,000 a year less per resident on
state and local government than the average state
and, incredibly, $5,000 less per person than New
York. And on the other side of the ledger,
California in 2007 had the highest-paid classroom
teachers in the nation, and yet the Golden State had
the second-lowest test scores.
Or consider the fiasco of New Jersey. In the early
1960s, the state had no state income tax and no
state sales tax. It was a rapidly growing state
attracting people from everywhere and running budget
surpluses. Today its income and sales taxes are
among the highest in the nation yet it suffers from
perpetual deficits and its schools rank among the
worst in the nation -- much worse than those in New
Hampshire. Most of the massive infusion of tax
dollars over the past 40 years has simply enriched
the public-employee unions in the Garden State.
People are fleeing the state in droves.
One last point: States aren't simply
competing with each other. As Texas Gov. Rick Perry
recently told us, "Our state is competing with
Germany, France, Japan and China for business. We'd
better have a pro-growth tax system or those
American jobs will be out-sourced." Gov. Perry and
Texas have the jobs and prosperity model exactly
right. Texas created more new jobs in 2008 than all
other 49 states combined. And Texas is the only
state other than Georgia and North Dakota that is
cutting taxes this year.
The Texas economic model makes a whole lot more
sense than the New Jersey model, and we hope the
politicians in California, Delaware, Illinois,
Minnesota and New York realize this before it's too
late.
Mr. Laffer is president of Laffer Associates.
Mr. Moore is senior economics writer for the Wall
Street Journal. They are co-authors of �Rich States,
Poor States?(American Legislative Exchange Council,
2009). See
Laffer Curve
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