War Between the States

States tax people differently.  People and businesses can move.  Game on.

States are in competition with one another for businesses and prosperous people.  The new tax law raises the stakes.

A retired businessman and blog reader asked:  "Peter, I hear the sad-sad complaints now coming from all the BIG Blue State people in Congress.  Buy why should people in high income tax and higher property tax states get these huge federal tax deductions to reduce their share of the Federal Income tax.  If you want to live in a state and vote in all kinds of costly programs for people that end up driving up taxes in hour state why is it not fair for residents of those states to pay their full share of Federal taxes?"

High Income Tax States

He has a point.  State and local income taxes are currently deductible from federal taxable income, as are property taxes.   Sales taxes are deductible either using a standard formula based on your zip code, or if a taxpayer keeps the actual receipts for purchases.  And one is only allowed to choose between income tax or sales tax.  Keeping sales tax receipts is tedious, yet the calculator for the federal government estimates a very low deductible sales tax balance.  The figures created by the calculator are very small compared to the deductions one gets from a simple deduction of withheld state income tax.

Example:  The Federal calculator for the deduction for a taxpayer in Cambridge, Massachusetts, with a 6.25% tax on retail sales, reports that a professor or physician earring between $270,000 and $300,000 could deduct $1,336.   A clerk in the DMV office earning between $60,000 and $70,000 has a calculation of $596.

In Oregon, the physician with a $300,000 income would pay--and deduct--about $27,000, and the clerk earning $70,000 would deduct about $600, same as in Massachusetts.

Net-net bottom line:  The rule that allows federal deduction of state income taxes reduces the federal tax burden on upper income tax payers--your physician, e.g.--and therefore shifts the burden to people in other states.  My businessman-reader was right. 

My Oregon friends and readers may well find this unwelcome information. I certainly do.  I want to pay lower taxes and I want to be fair.  Choose one.

Still, Oregonians should acknowledge the simple reality of it.  The federal tax code today benefits states that use an income tax to the detriment of states that use a sales tax or states that have moderate levels of both.

States compete for businesses and prosperous people with their tax policies.  High income taxes are a negative for high income earners.  High income people usually do not spend all their income.  They are savers and investors.  They spend money on untaxed tuition rather than on taxable necessities like toilet paper.  They do better with a sales tax and no income tax.  The current tax code ameliorates some of that penalty.

Click Here: Bloomberg article

The tax law in front of Trump ends that, putting a low cap on those deductions.  The financial press is noticing this, and an example is the article from Bloomberg.  New York and California's loss is the gain of Texas and Florida.

Yet people want to crowd into California and New York to do business.  Why?

California got to tech early and well.  They had Stanford and a superior public higher education system in 1970.  They had the Xerox Palo Alto Research Center (PARC) where they invented the semiconductor, Graphical User Interface, the foundation for the internet.   They created a node of culture and expertise that makes it possible for new ideas to do business.  The San Francisco/Silicon Valley area is a hive of businesses with the employees, experienced venture capital, vendors, educational institutions, and legal framework that nurture an industry.  People pay high taxes and sky high real estate prices, and yet it is apparently still worth it to crowd into a very expensive place like the Bay Area to build a technology business.  It is where the action is.

Same with New York.  Industry culture still requires proximity.  That may change as more work becomes "virtual" and more employees interact electronically.

State laws affect business culture.  It is subtle, but powerful. California essentially makes non-compete employment agreements unenforceable.  This is a business asset for the Bay Area tech industry, because employees know their skills are transferable.  It is a beehive of activity, not a place where people are stuck in place.  That creates a culture of innovation and flexibility, which helps the industry even if it inconveniences businesses who want to stifle competition.  Important is what we do not see: temporary restraining orders forbidding an employee to move.

The competition for Amazon's secondary headquarters is on.  They would pay high salaries and the employee taxpayers would be net plusses.   Cities and states are fighting to attract Amazon.  (Businesses that pay low wages (Walmart) cost a state money, because the employees, working 29 hours a week at near minimum wage, are eligible for public benefits like food stamps and health care subsidies.)

Taxes will be a consideration and the upcoming cap on State and Local Taxes is a particular challenge for Oregon.   Oregon's population center, greater Portland, is just across the Columbia River from Washington State.  Portland's metropolitan area includes Clark County, Washington.  Washington has no income tax, but a high sales tax.  Oregon has a high income tax and no sales tax.  Prosperous people notice the obvious opportunity for tax arbitrage.  Live in Washington, shop in Oregon.  People in Clark County do game the system.  They buy their furniture and electronics in Oregon to avoid the tax.  

Hillary Counties are 64% of the Country's GDP

The blue states with high taxes are the economic engine for the country.  It is where the jobs are, which is good.  It is also where the taxes are highest and the real estate is the most expensive.  

Newcomers get sticker shock.

A low income tax many not be dispositive for new businesses choosing a location, but tax incentives were a stated priority for Amazon as the encourage a bidding war between cities.  Tax considerations are most certainly a factor for that most attractive of new residents--the very prosperous retiree.  Their demands on public services are low, and better yet, perhaps they live as empty nesters in a nice house with high property taxes, and their kids are long gone from school.  They get their income every month as pension and dividend checks via on-the-books investment accounts, where they are easy to tax as income.  Those people have every reason to move to a low tax state.

But my observation and experience here is that people mostly move to live near where their grandchildren are.