Connecting state and local government leaders
COMMENTARY | States and cities struggling through the pandemic recession are wondering if higher taxes will raise revenue, or cause a mass exodus.
Cities and states across the country are facing a conundrum: They are desperate for cash because of the ravages of the Covid-19 recession. Rich people are pretty much the only ones who have any, because of both the recession and the yawning inequality that long predated it. But if cities and states raise taxes on the 1 percent, they worry that rich families might simply leave, no longer bound to their offices or their children’s schools. The conundrum is real, and the solution is easy enough: Let the federal government help states and cities circumvent the whole issue.
The pandemic recession has battered local coffers, causing revenue losses of an estimated $155 billion in 2020 and $167 billion in 2021, about 6 percent of local revenue. New York alone is projecting a $59 billion shortfall through 2022. The federal government could easily finance those kinds of deficits by issuing bonds. But doing so is harder for local governments, which generally have to keep their budgets balanced and often have limits on their borrowing. When big recessions hit, and the Covid-19 recession is a huge one, many of them have no choice but to raise revenue or cut services.
The latter is already happening, despite the fact that schools, child-care operators, and health systems need more money, not less. States and localities have laid off 1 million workers and engaged in extensive furloughs. Connecticut’s governor, Ned Lamont, has asked agencies to identify cuts worth at least 10 percent. For Wyoming, the total is 30 percent; the state is dealing with a collapse in income related to oil-and-gas extraction too. “The cuts we’ve talked about here are getting close to the bone,” Wyoming Governor Mark Gordon told reporters earlier this year. “In some cases, we really are talking about the bone.” (The situation in Wyoming, by the way, proves that this is not simply a blue-state problem, as Republicans in the Senate like to claim.)
If cutting to the bone sounds a bit much, the alternative is raising revenue. State and city income-tax takings have held up surprisingly well because job losses and lost hours have been concentrated among low-wage workers unlikely to pay much local income tax to begin with. Rich folks have rebounded and, in some cases, thrived during this recession: Employment is up among high-wage workers, property values are climbing, and the stock market has fully recovered. If anyone’s coffers are getting raided, why not the 1 percent’s?
States soaking the rich, or considering it, include New Jersey, which passed a “millionaire’s tax” this summer, taking an additional two percent of any earnings that exceed $1 million. California is contemplating a retroactive measure that would take an additional 3.5 percent of earnings more than $5 million. New York, both state and city, is considering new measures that would hit the wealthiest of the wealthy to pay for schools, homeless shelters, and frontline medical services. Lawmakers in Hawaii, Illinois, Massachusetts, Maryland, Oklahoma, Vermont, and Wisconsin have also proposed tax hikes on high earners.
In response, the wealthiest of the wealthy have broadcast a message: Pass the tax hikes and we’ll leave. The billionaire hedge-funder Ken Griffin has spent nearly $50 million—yes, you read that right—fighting Governor J. B. Pritzker’s progressive income-tax proposal in Illinois. If passed, it would mean “the continued exodus of families and businesses,” Griffin said in a statement. Any number of Silicon Valley investor types have threatened to flee to Nevada or Texas if California passes a wealth tax. President Donald Trump claimed recently that he relocated from New York to Florida because of high taxes. Some tax analysts are warning that raising taxes would not raise any additional revenue, precisely because the hikes would cause so many wealthy people to leave.
In normal times, legislatures should set such fears aside. Local tax increases can cause high-net-worth individuals to move, tax experts said; tax avoidance and tax arbitrage are multitrillion-dollar affairs, and rich people are sensitive to tax rates. But many of the people who move when their home state raises taxes are close to retirement anyway. Social networks, professional networks, offices, and schools help keep high earners in place. And revenue still tends to rise overall. “There are always a few, sometimes very few, taxpayers who move because of the tax rate, but in general, that’s not really the determining factor,” Lucy Dadayan, a senior research associate at the Tax Policy Center, told me. After the Trump administration’s Tax Cuts and Jobs Act raised rates on high earners by capping the state- and local-tax deduction, the number of ultrarich New Yorkers continued to rise: The city counted 3,528 filers earning more than $5 million in 2016, and 4,412 in 2018.
Covid-19 could change the calculus: Social networks have moved online, professional networks have splintered, offices are shut for months to come, and school campuses are closed. Rich workers might feel better about taking off for the Hamptons, Miami, or Tahoe under those circumstances, particularly considering how high the cost of living is in the country’s winner-take-all cities, such as San Francisco, Palo Alto, and New York. But nobody knows when life will normalize post-COVID-19. “How is life going to be in a year?” Dadayan asked. “It’s not easy to make a hasty decision about where to live, and relocation might be temporary.”
Legislatures might want to hold off on making big decisions until next year too. The election may determine whether states and cities need to raise additional revenue at all: Democrats and Republicans have been squabbling for months over whether Uncle Sam should keep filling local budget gaps. If Joe Biden wins and Democrats take the Senate, a large bailout is likely.
Given that the federal government can borrow limitlessly, for cheap, and given states’ and cities’ desperate need to funnel more money into constituent services, a bailout is a great idea. “States have balanced-budget requirements, so absent federal aid, they need extra taxes for short-run revenue purposes,” Gabriel Zucman, an economist at UC Berkeley, told me. The federal government “has no short-run revenue need in the current low-rate environment,” as Uncle Sam functionally borrows cash for free.
In the long run, lawmakers should keep in mind that tax rates are far from the only reason a rich person might consider flight: Decaying infrastructure and degrading public services are surely just as important. Both the federal government and the states should go ahead and soak the rich to reduce inequality and raise money for health care, child care, infrastructure investment, education, decarbonization, and a thousand other priorities. Zucman noted that the 91 percent top tax bracket in place from World War II to 1963 reduced inequality without reducing innovation or growth. And, I’d add, without causing many greedy, unpatriotic rich people to flee the country.
Annie Lowrey is a staff writer at The Atlantic, where she covers economic policy.