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Blue states fear exodus of rich taxpayers, but study finds no sign – yet

The new federal tax law's cap on deducting state and local income taxes has caused much hand-wringing in high-tax states like California that rely heavily on their richest taxpayers. But a study this week found no sign – yet – that its making the wealthy flee to lower-tax states like Nevada.

The Moody's Investors Service report, citing U.S. Census Bureau and IRS data, found that out-migration from the five states, including California, where the state and local tax deduction represented the largest share of federal adjusted gross income was in line with national trends. And it was less than from 2005 to 2007, before the last economic downturn.

"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. But she added that the $10,000 deduction cap "will be widely felt for the first time this tax season, and could spur some out-migration from high-tax states."

The "Tax Cuts and Jobs Act" approved in December 2017 was the biggest federal tax overhaul since the 1980s and the signature legislative accomplishment of the Republican Congress and Trump administration.

Republicans argued the state and local tax deduction effectively forced lower tax, GOP-led states to subsidize the Democrat-run states that impose higher taxes on their citizens. Reductions in rates and other changes would offset impacts of the deduction cap, they said.

Democrats in turn sharply criticized the tax law's across-the-board rate reduction as a giveaway to the rich, while bemoaning the limits on deductions for state and local taxes as a Republican tax hike on residents in blue states.

Because the law was passed in late 2017, most taxpayers didn't feel any pinch from its cap on deductions until they filed their income taxes for 2018, which are due by Monday.

New York Gov. Andrew Cuomo earlier this year said the law already was inflicting pain on his state budget, as withholding and estimated tax receipts for late December and January came in "worse than we had anticipated." The deduction cap, he said, was chasing wealthy New Yorkers to Florida and would end up costing the state more than $14 billion.

Cuomo said other high-tax states, including California were seeing similar impacts, though Golden State officials told this news organization they expected the dip in tax receipts from December and January to be made up later this year.

In February, New Jersey Sen. Bob Menendez, a Democrat, introduced legislation to restore the full state and local tax deduction and replace the lost revenue by restoring the highest tax bracket rate for those earning more than $500,000 a year from 37 percent to 39.6 percent. He called it the "Stop the Attack on Local Taxpayers Act."

Moody's took an interest in the issue as one of the leading agencies that assesses the credit-worthiness of state-issued bonds. A reduction in taxpayers that trims a state's revenues also hurts its credit quality.

The deduction cap primarily affects just "households in the top 1 percent of taxpayers," Moody's noted, as even those earning "mid-to-high six figures" are likely to see their overall tax burden lower under the new tax law even with the cap on state and local tax deductions.

But those 1-percenters are key to California's overall finances, accounting for nearly half (45.8 percent in 2016) of personal income tax receipts, the single largest source of state revenue.

The Moody's report 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, for example, 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.

Those states with the highest out-migration in 2017 – Delaware, Alaska, North Dakota, Hawaii and Wyoming – tended to be far down the list for state and local tax deductions. Alaska, ranked second in out-migration rate, was dead last in state and local tax deductions.

Moody's also found 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. Nearly 30 percent of those who left New York in 2017 moved to another high-tax state, about twice the 14 percent who went to Florida.

Moody's noted that "researchers have found a correlation between millionaires' moves to Florida and the tax differential between Florida and their home state." But Moody's said "Florida has net in-migration from virtually every other state in the nation," while "the wealthy are not drawn to other low-tax states disproportionately, suggesting that low taxes alone are not sufficient to attract wealthy domestic movers."

The report also noted that California and New York had the seventh and 17th strongest employment growth rates since 2010, and have below-average rates of out-migration.

Steve Sandberg, press secretary for Senator Menendez, said the legislation to restore the full state and local tax deduction was motivated more by concerns about fairness than about losing wealthy taxpayers. But he predicted that more rich residents in high-tax states will be motivated to leave after seeing for the first time this year how they are affected.

"It's a little early, people are just now paying their taxes," Sandberg said. "Now what we're seeing is sort of sticker shock – people are filing their taxes and they're rightfully angry, because they realize they're paying more than in previous years and largely because they can't deduct state and local taxes."

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