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Monday, Nov 28, 2022

High Tax States Lose Income as Well

The fact that more people are moving out than moving into California for other states is nothing new.

Net domestic migration has been negative every year since 2011.

What’s different was 2021 marks the first year that California’s net outflow was large enough to offset the natural increase in its population growth (births minus deaths) and its foreign immigration.

As a result, the total population in California declined by 173,000 in 2021. That first-time annual loss in California’s population represents a decrease of almost half a percent in the state’s population growth.

Although many socioeconomic factors explain this population exodus, our research points to California’s high state and local taxes as the major culprit.

The Tax Foundation’s 2021 State Business Tax Climate ranks California as the second highest in the nation, below New Jersey and just above New York.

When we arranged all 50 states in groups of 10 based on their state and local tax rank, we found that the 10 states that ranked lowest in taxes gained, on average, about a half percent in net domestic migration in 2019. On the other side of the tax continuum, the 10 states that ranked highest in state and local taxes (including California) lost, on average, 0.34% in net domestic migration.

These people flows, however, don’t tell us anything about the income levels of these people who have decided to leave one state and enter another. While lower taxes appear to attract people and higher taxes push them away, little is known about the incomes of these migrants. But now, with the release of the Internal Revenue Service 2019-20 income tax returns for state-to-state migration, we can address that issue.

The IRS data, for example, tell us that the average adjusted gross income (AGI) of tax filers leaving California in 2019 was $105,000 versus a significantly lower $83,000 for those entering the state.

Those numbers compare to an average AGI of $85,000 for all California filers. The fact that people leaving California have, on average, higher average AGI than the statewide average while new entrants have lower average AGI suggests that people are not only fleeing the state but there is income flight as well.

These findings for California are consistent with what the IRS data tell us about income flows in the rest of the nation. Chart 1 shows the 10 states that ranked lowest in state and local taxes had an average AGI inflow per filer of $88,000 as compared to an outflow of $66,000.

States that ranked 11-20 and 21-30 in state and local taxes also attracted tax filers with higher AGI while losing those with lower AGI.

The average AGI of inflows and outflows for those states that ranked 31-40 were the same at $73,000. The tables turned, however, for the 10 states that ranked highest in taxes. For those states, the AGI inflow per filer of $81,000 was less than the outflow of $86,000.
Combining AGI inflows and outflows per filer with the total number of filers results in the total AGI moving into and out of states.

For example, the total AGI for those leaving California was $39 billion versus $21 billion for those entering the state. California’s net loss in total AGI in California, therefore, was $18 billion.

That net loss of AGI represents 1.1% of the state’s total AGI in 2019 of $1.6 trillion. Since we know that net domestic migration in 2021 has turned even more negative, the net loss in California’s AGI has undoubtedly increased since 2019.

Chart 2 shows the inflows and outflows for total AGI arranged from the lowest 10 states in taxes to the highest.

As in the case of Chart 1, states that ranked lower in taxes had higher inflows than outflows in total AGI, especially for the 10 states that ranked lowest in taxes.

In contrast, the 10 states that ranked highest in taxes had total AGI inflows of $67 billion. Those inflows, however, were far surpassed by outflows of $110 billion, resulting in a net loss of $43 billion in total AGI for these ten states.

Chart 3 shows a 10-state moving average of the net difference between inflows and outflows in total AGI.

Notice the 10 states that ranked lowest in taxes experienced net increases in total AGI of about $40 billion.

As each state that ranked higher in taxes was added to the moving average while the state that ranked lower was lopped off, the moving average of net changes in total AGI resulting from state-to-state migration generally declined. That decline started from a positive $40 billion for the 10 states that ranked lowest in taxes and ended with a negative $40 billion for those that ranked highest in taxes. The decline was particularly pronounced for those states that ranked in the highest 41-50 in state and local taxes.

We added a trendline in Chart 3 to show that the net AGI declined, on average, about $1 billion as each state moved up one place to a higher tax rank. Clearly, not only do states with higher relative state and local taxes lose people to states with lower taxes, they lose income as well. n­­­

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