Question

1. How does the effectiveness of voting with one’s feet depend on how taxes are assessed? Which type of taxation is most likely to generate socially optimal outcomes?

Answer 1

Introduction :

One potential factor influencing where people choose to live, work, and conduct business is how much they will be taxed in different places. But just how much of a factor are taxes, and how does their influence compare to the appeal of other considerations, like educational and employment opportunities and quality of life?

While federal taxes are consistent across the country, state and local taxes on income, purchases, and property vary considerably.

Tax Rates in U.S. States

Sales, Property, and Income Tax Rates in U.S. States

Sales tax rates differ significantly from state to state, from 0 to 7.5%, with Rhode Island’s at the high end of this range at 7%. In addition to statewide sales taxes, 37 states permit local sales taxes, which range from 0.13% to 8.5% across the country. (Rhode Island does not allow localities to impose their own sales taxes.) States’ average property tax rates, which vary by county, range from 0.25% to 1.97% of a home’s value, with Rhode Island’s slightly above average at 1.36%.^(a)Estate taxes, which are taxes on inherited income and property, are imposed in 15 states, including Rhode Island.

State income tax rates show the most variation: seven states do not impose any income tax, while residents in California’s top income bracket face a rate of 13.3%. Most states, including Rhode Island, have progressive tax structures, in which tax rates are higher on those with greater incomes. Nine states, however, have a flat tax, in which everyone across the income spectrum pays the same rate. Depending on the specific rates, states with flat tax systems can be more attractive to high-income workers because they often pay a lower dollar amount than in progressive tax systems. The reverse is true for low-income workers, who typically benefit more from progressive tax systems.

How Rhode Island Stacks up Against Its Neighbors

Rhode Island’s personal income tax is structured into three brackets: 3.75%, 4.75%, and 5.99%. The state previously had much higher rates for middle- and high-income earners, starting at 7% on people making more than $34,000 a year and maxing out at 9.9% for the highest earners. Rhode Island significantly lowered its rates beginning in the 2011 tax year to change its reputation as a high-tax state and to attract business and residents. After this policy change, Rhode Island went from imposing a much higher tax burden than its neighbor states to, in most cases, offering slightly lower tax rates.

Connecticut’s income tax schedule has six brackets, ranging from 3% to 6.7%. Its tax rates are generally the same as or higher than Rhode Island’s, except for people earning less than $10,000 a year. Massachusetts, on the other hand, imposes a flat tax rate of 5.25% on all residents regardless of income.^(c) Compared to RI’s progressive tax structure, low- and middle-income earners pay higher taxes in Massachusetts, but the highest earners (those making over $129,900) pay less.

2012 Personal Income Tax Rates By State

Do Taxes Affect Where People Choose To Live?

It is clear from the wide range of income, sales, and property tax rates across the country that people can significantly alter their tax bills by moving across state borders. There is no clear academic consensus, however, on how much tax rates actually affect where people choose to live.

Some studies find that state and local tax rates do influence domestic migration patterns. This aligns with a prominent model of migration known as the Tiebout hypothesis, which posits that people “vote with their feet” by moving to areas with the balance of public goods (benefits) and tax policies (costs) they find most optimal. A recent study of migration in New England, however, found that tax rates do not play a clear or important role in people’s decisions to move.

Research indicates that, in the U.S., migration tends to flow from states with higher state and local tax rates to states with lower tax rates, especially for people at higher income levels. These findings are complicated, however, by the fact that low-tax states may have lower costs of living, better employment opportunities, or lower housing prices, which are also attractive to individuals moving for economic reasons.U.S. Census data shows that most Americans move for reasons related to employment, housing, family, or quality of life.

Other studies examine what happens when a state changes its tax policies. Research on the 2004 implementation of a “millionaire’s tax” in New Jersey, for example, reached varied conclusions. One study found that the tax increase – which raised the tax rate on the top income bracket by 2.6 percentage points to 8.97% – drove out about 20,000 taxpayers,while a different study found little to no effect.

Are Taxes Driving Migration out of Rhode Island?

What about Rhode Island, which saw a net total of 10% of its population move away between 1991 and 2010? Is it possible that tax rates played a role in the net loss of 100,000 residents? One study concluded that estate taxes might be a significant force driving people to leave the state, “especially considering that the number one destination state for former Rhode Island residents is Florida, a state with no estate tax (or individual income tax).” Other research, however, disputed the conclusion that estate taxes caused people to leave Rhode Island or that they influence migration more generally.

A more relevant answer may lie in Rhode Island’s unemployment rate, which is currently the highest in the country. Research on migration in New England suggests that employment opportunities play a much more significant role in migration than taxes. Census data also shows that over a third of people who move report doing so for job-related reasons, making that the most common factor causing people to move.

When it comes to Rhode Island losing population and being competitive with other states on taxes, the issues are much more of a national than a regional concern. Net population flows between Rhode Island and its immediate neighbors are small, and the state is mostly losing population to southern states like Florida and North Carolina. In addition, the tax differences between Rhode Island and its neighbors are narrower than the gaps between Rhode Island and states in other regions of the country.

Taxes & Economic Competitiveness

While it is easy to imagine that taxes influence where people choose to live, a number of other factors play a role, and the exact impact of specific tax policy changes is difficult to ascertain. The question of how tax rates affect a state’s ability to attract and retain residents is still open for debate. What is clear is that states in some sense “compete” for residents – particularly wealthy and highly skilled ones – and should consider all the factors that may play a role in determining how they stack up against their neighbors and the rest of the country.