Monday, January 9, 2017

Raise Taxes, Watch People Leave

The headline of this blog article may be trivial: we all know taxes reduce private-sector economic activity. We also know that when taxes get unbearably high, we do everything we can to avoid them (which is legal; evading taxes is illegal and never acceptable). One way to avoid high taxes is to move to some place where taxes are lower.

Again, few people would dispute that lower taxes are preferable to higher taxes. Yet the first occasion our elected legislators here in Cheyenne get a chance to present their ideas for how to deal with the state's budget deficit, they immediately propose tax increases

This is not the first time we are being told that a tax increase will solve our problems. 

Five years ago the legislature tried to raise the gasoline tax by a dime. They met enough resistance to back off - only to come back a year later with greater success. 

However, the minute the governor had signed the bill to raise the gasoline tax by a dime, we began hearing from the executive branch that the tax hike was nowhere near adequate to keep our roads in good condition. They wanted even more tax revenue.

There is no doubt that there are government functions that are essential for a society to be functional, peaceful and prosperous. However, those functions are limited to the protection of life, liberty and property, and - it can be argued - the production of public goods.* The sum total of what government would provide under this definition is a fraction of what our governments, from the federal down to the local township, has gotten itself involved in. 

Unfortunately, rather than striving for smaller government, the gut reaction of many elected officials is to want to continue to grow government. Therefore, in fiscal crises, such as the one we are in right now here in Wyoming, the first legislative reaction tends to be to raise taxes. 

In addition to habitual statism, there is another reason why this idea arises here: the general perception that we are a low-tax state. However, just because we have no personal or corporate income tax, no death tax or tax on wealth, does not mean that our taxes are low. To begin with, the average private-sector job outside of the minerals industry does not pay more than $36,000 per year. This is low enough to make any tax feel like someone is nibbling away at your paycheck. 

Furthermore, the conventional wisdom on taxes is that individuals and businesses are only hurt by the taxes that they themselves are responsible for paying. But a family is not just harmed by sales, use, excise and property taxes - they also pay the taxes that their employers pay. For example, when a retail business pays property taxes, it takes the money out of what it would otherwise pay its employees. 

The same principle applies to severance taxes that minerals companies have to pay, and any other tax imposed on business activities. Not to mention the owner of a small business lowers or forfeits his own paycheck to make sure his firm is up to date with all its tax payments. 

In short: one way or the other, every tax hits the personal income of a business owner or a business employee. 

When we compare the state and local taxes here in Wyoming to the income of average Wyomingites, our state no longer looks so good. In fact, we end up among unlikely peers: in 2010, state and local taxes were 14.2 percent of personal income, ranking us as the third-heaviest taxed state. Alaska was first, again despite the absence of a personal income tax (though their corporate income tax is pretty burdensome). Second place went to New York.

In 2013, the latest year for which tax-burden data is available, we had fallen to 9th place, partly due to a growth spurt in the minerals industry in 2011. However, our taxes were still high enough to have a negative impact on interstate migration: since 2010, Wyoming has had a net migration outflow - in other words lost more residents than we have gained - every year except 2015. (I explained the anomaly of 2015 in this blog article.) 

There is no doubt that taxes have a major impact on people's decisions on staying or leaving Wyoming. If we take a step back and look at the nation as a whole, we find that states with a tax burden on personal income in excess of ten percent generally lose more residents than they gain; by contrast, states with a tax burden below ten percent tend to see more U-Hauls coming into the state than leaving. The following chart reports observations of net migration as a percentage of state population, and state and local taxes as share of personal income. The observations are from all 50 states over a period of four years; the 200 observations are divided into deciles with the lowest observed tax burdens in the first decile and the highest burdens in the last: 

Figure 1
Sources: Key Policy Data (tax burden) and Bureau of the Census (net migration)

Again, when states have a tax burden below ten percent they tend to be migration magnets (blue columns) while a tax burden in excess of ten percent drives people out of the state (red columns).

With an average tax burden for 2010-2013 of 12.7 percent, Wyoming is already in the "red" zone. That number places us 2.3 percentage points above the national average. Alas, it is no surprise that we, during this period, lost a total of 3,100 residents more than we attracted from other states. 

It will not take much to push our tax burden higher, and thus cause a major migration outflow. In the figure above, the tenth decile exhibits the strongest correlation between migration and the tax burden: with an average tax burden of 14.7 percent of personal income, states in this decile suffered a net loss of 1.6 percent of their population each year. That is about three times the annual net loss we suffered in 2010-2013.

I have no indication as of today that the legislature is going to propose tax increases that would take Wyoming up from its current disadvantageous tax burden to the 14+ percent level. However, it is a fact that personal income is falling in our state; it is also a fact that the decline in private-sector economic activity continues with no end in sight. This means that even if we maintain the current level of taxation, we will see our tax burden rise over time. 

With this in mind, it would be a very bad idea for our lawmakers to raise taxes - and take the risk of driving more people to leave our state. 

*) The term "public goods" refers to products where it is impossible to discriminate between two people's consumption of the product. The classical example is a street light: one person's consumption of the light does not prohibit another person's consumption. By contrast, when I buy a truck you cannot have the same truck (and I dare you touch it...) but have to hope that Ram will build another one. There is a small set of products that fall into the category of public goods, one of them being highways, which is why it can be argued that government should provide infrastructure. However, the exact demarcation line between public and private commodities is sometimes hard to draw and open for debate.

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