High taxes are a massive cause of capital flight

Taxing the rich is one of the central policy debates in this time of rising inequality. Elite taxation can change the distribution of income in society, support equitable growth, and finance public goods and services that improve the quality of life for everyone. None of these goals are well served, however, if taxes lead to high levels of tax flight among U.S. millionaires. Progressive taxation, especially at the state level, ultimately depends on the embeddedness of the tax base. In other words, are the rich “mobile millionaires,” readily drawn to places with lower tax rates? Or are they “embedded elites,” who are reluctant to migrate away from places where they have been highly successful?

Supply-side economics has long argued that taxes on the rich cause avoidance behavior and reduce the incentive to work, invest, and innovate. Amid the growing red state/blue state rivalry in the United States, tax incentives for migration have become a new focus of debate. Why would rich people continue to live in New York, New Jersey, or California when they could save large sums in taxes by moving to places such as Florida, Texas, or Nevada? Of course, taxes also fund public goods that the rich consume—not even the richest city dweller can get to work without public infrastructure—but top earners have greater ability to opt out of many public services such as schools and social services. From this view, the rich seem motivated and mobile—sensitive to taxation and readily capable of exit.

Yet there are myriad social dimensions that rich households face when migrating to avoid taxes. Top earners are often the “working rich,” with many roots in the places where they built their careers. Others are business owners with complex ties between customers, suppliers, and workers that are not easily relocated. Top earners are often married, have school-aged children, and have lived in their state for many years—social factors that tie people to places. These ties represent place-specific social capital, a form of embeddedness that makes migration costly.

Our new working paper, “Taxing the Rich: How Incentives and Embeddedness Shape Millionaire Tax Flight,” examines the joint effect of incentives and embeddedness on the mobility of the rich in the United States. Drawing on administrative tax data from IRS tax returns of top income earners, we study two large-scale “natural experiments,” which are contrasting real-life situations that social scientists investigate to determine cause-and-effect relationships. The first is the federal Tax Cuts and Jobs Act of 2017, which changed tax incentives to favor low-tax states. The second is the COVID-19 pandemic, which began in early 2020 in the United States and which deeply disrupted people’s socioeconomic attachments to places.

The 2017 federal tax bill championed by then-President Donald Trump cut the top income tax rate but also raised taxes on some top earners by capping a deduction used most heavily in so-called blue states: the state and local tax deduction. This made the tax reform highly polarizing, actually raising taxes on millionaires in many blue states, such as New York and California, while cutting taxes in red states, such as Florida and Texas. Many predicted dramatic migration flows of top earners from high-tax to low-tax states. President Trump himself soon moved his permanent residence from New York to Florida.

To study the 2017 tax reform, we used administrative data from IRS tax returns, drawing on more than 12 million observations. We employed so-called difference-in-differences models, which compare the changes in outcomes over time between a population affected by the tax cuts and the pandemic (the treatment group) and a population not affected (the comparison group). Tax-induced migration can occur along two different margins: the decision of whether to move at all and, conditional on moving, what destination to select. We examine each margin in detail.

In a typical year, a small number of millionaires circulate between states: Roughly 2.7 percent of the millionaire population moves across state lines, exchanging one state for another. How much did the 2017 tax reform influence this migration? In our working paper, we examined migration rates for every income group, starting from those with the lowest incomes to those making $5 million a year or more. We also examined migration rates for those living in low-tax states, who were incentivized to stay, and high-tax states, who were incentivized to move. Migration patterns before and after the tax reform law passed were essentially identical. (See Figure 1.)

In a 2018 opinion piece published in The Wall Street Journal, “So Long, California. Sayonara, New York,” economists Arthur Laffer and Stephen Moore predicted that “based on the historical relationship between tax rates and migration patterns, both California and New York will lose on net about 800,000 residents over the next three years—roughly twice the number that left from 2014-16.” Then-New York Gov. Andrew Cuomo (D) likewise feared that his state’s millionaires would flee to a better tax environment. Yet our estimate of this migration, as shown in Figure 1, is zero.

Indeed, millionaires generally have low rates of migration—lower than that of the poor—because they are rooted in place by socioeconomic ties, such as employment, marriage, children at home, and business ownership. There is a subset of millionaires with high migration rates and who fit the image of the mobile millionaire. They are relatively young, unmarried, childless, and earn their money from capital rather than work. We term these individuals the “anomic elite,” who are unencumbered by place-based attachments. They move more frequently but are a small minority of the millionaire population.

After the decision to move, a second element of tax migration is the choice of destinations that movers select. To analyze this, we focus only on those millionaires who actually move. Among movers, did lower-tax states become more attractive after federal tax reform?

It is perhaps surprisingly common to see millionaires move into states that charge them higher tax rates. Basketball star LeBron James, for example, made a series of moves from Florida (no income tax) to Ohio (5 percent top rate) to California (13 percent top rate). Many millionaire moves are also between states that have roughly the same tax rate. There are many idiosyncratic and personal reasons why millionaires move, and most migrations do not come with a net tax advantage. Nevertheless, there is a systematic pattern in which low-tax states are favored as migration destinations. The effect is modest, but millionaire migration tends to flow from high-tax to low-tax states.

In our database on cross-border migration flows, the elasticity of the millionaire population with respect to the top tax rate is 0.14. For the average state, if top tax rates rise by 1 percent, this causes roughly 13 more out-migrations and 12 fewer in-migrations, from a base population of more than 9,000 millionaires—amounting to a population loss among millionaires of one-third of 1 percent.

We also see that when the tax reform changed the relative tax rates between states, low-tax states increased their share of millionaire destinations while high-tax states lost shares. For California, the Tax Cuts and Jobs Act produced a loss of roughly 380 millionaires from a base population of 81,000, or 0.5 percent of the millionaire population. Similarly, we calculate that Texas gained 140 millionaires due to the 2017 tax law, a 0.4 percent increase on its base population of 39,000 millionaires.