Income Taxes, the TCJA, and Taxpayer Migration

SALT Cap Confounds Doomsayers as Fears of Exodus Prove Overblown      

Bloomberg News, June 1, 2021

As this recent headline indicates, there is new fodder in the never-ending debate over the role state income taxes play on taxpayer relocation.  Newly-released Statistics of Income data from the Internal Revenue Service indicates the Tax Cuts and Jobs Act (TCJA) caps on state and local tax deductibility so far has had a negligible initial impact on the nation’s domestic migration patterns.

Such a finding shouldn’t be surprising.  Nobody should really have been expecting an Oklahoma land rush-type exodus out of states due to the cap on state and local tax deductibility.  For starters, the amount of interstate migration that occurs in any year – for any reason let alone taxes – is small, about 2% according to the latest Census Bureau estimates on a population basis, less on a tax filer basis.  Moreover, research on taxes and migration have generally found taxes matter on the margin, but they’re just one of many factors.  That appears to be true even for taxpayers who are most affected by high state income taxes and are the most economically mobile.  One study of administrative tax returns over 13 years (45 million tax records), tracked the states from which millionaires file their taxes.  It concluded “millionaire tax flight is occurring, but only at the margins of statistical and socioeconomic significance.”[1] 

But the underlying economics of state and local taxes (SALT) did change with the passage of the TCJA.   The $10,000 limit on state and local tax deductibility made SALT more economically relevant because of the potentially large impact on federal tax burdens.  That is especially true for Minnesota’s higher income filers who disproportionately benefitted from SALT deductibility.  As a result, the math underlying taxes and residency decision-making has changed for many to some degree.  We take a closer look at the influence of the SALT cap on effective tax rates, what the new IRS Statistics of Income releases are communicating about Minnesota taxpayer migration, and conclude with some thoughts on the implications for Minnesota’s income tax debates.

Low Sodium ETRs

Taxpayer returns change from year to year in part due to ordinary fluctuations and changes in the makeup of taxpayer income.  This can present a challenge in quantifying the before and after impact of any policy change, even when comparing an “average” tax filer in different states.  For example, in our latest national individual income tax comparison study the income make-up of our post-TCJA $1 million married joint filer featured 3.1% more taxable income (or conversely 37% less non-taxable income) than our pre-TCJA $1 million filer.  That alone results in a federal tax increase independent of any policy influence not just for Minnesota but all states when imputing that profile change onto the rest of the country.  Layering complex policy changes like the TCJA that affect both adjusted gross income and taxable income in multiple ways makes the isolation of the effects of particular provisions even more problematic. 

Perhaps the best perspective of how the SALT cap can affect filers in different states differently can be gained from looking at “before and after” aggregate effective tax rates (ETR) of millionaire income filers - whose tax burdens are most likely impacted by the SALT cap -- and comparing the results in states with and without a state income tax (Table 1).     

As the national column shows, federal adjusted gross income grew 7.3% but the net effect of TCJA changes and rate reductions resulted in a more modest 3.0% increase in federal taxes paid yielding a reduction in the effective tax rate of millionaire filers of 4%.  States without an income tax had lower AGI growth than the national average but experienced a 6.7% reduction in federal taxes paid on income resulting in effective tax rate decline of 8.1%.  

In stark contrast, even though year-on-year AGI growth in the top 10 most progressive income tax states[2] was more anemic, federal taxes paid increased by 5% resulting in an effective tax rate increase of 4.7%.  Of these 10 states, three -- New York, California, and Connecticut - constitute 82% of the total AGI for this group meaning their experience is largely driving these results.  All three of these states experienced 2017-2018 effective tax rate increases indicating the loss of SALT deductibility more than offset TCJA rate reductions in the aggregate.  It is not at all surprising that the push for restoring SALT deductibility resides in their congressional delegations.  

Table 2 presents Minnesota’s results.  Growth in federal adjusted gross income among these filers was above the national average.  SALT deductions fell by a whopping 97.4% exposing more income to federal taxation.  Yet, rate reductions and other TCJA tax cut benefits offset the loss of SALT deductibility resulting in a slight decrease in the federal effective tax rate paid in the aggregate by Minnesota millionaire filers.  The implications relevant to location decision-making is how Minnesota high income filers might evaluate and weigh any smaller absolute benefits obtained through the TCJA in Minnesota compared to potentially larger tax benefits now available elsewhere.

A Closer Look at Minnesota Migration Findings

New IRS Statistics of Income information on state migration[3] is based on year-to-year address changes reported on individual income tax returns filed with the IRS.  It captures both inflows (the number of new residents who moved to a state and where they migrated from) and outflows (the number of residents leaving a state and where they went.) as well as the adjusted gross income each flow represents.  Tax returns are matched for two consecutive calendar years based on the filer’s taxpayer identification number. 

Migration statistics from the IRS have long been a bit of a Venus fly trap for reporters and policy commentators -- attracting them with seemingly straightforward, intriguing data linking migration with income flows only to find themselves caught reporting on erroneous data uses and interpretations.  The most common mistake is that the reported adjusted gross income (AGI) associated with migration does not necessarily move.  A lot of reported AGI change is actually “location bound” -- the migrant may leave but whether or not the AGI leaves depends on the nature and source of the income.  Most labor income stays with an employment position.  AGI on a “moved” return may represent income that was in the other state already but is now received by a new taxpayer.  Intangible income (e.g. interest and dividends) do leave, but business income is highly ambiguous.  As a result, contrary to how it is often represented, outmigration of AGI is not the same as “lost money.”  In addition, simply comparing net AGI inflows to outflows in a particular year fails to take into account AGI was earned prior to departure.  Together this has often led to migration-related reporting that is both faulty and overstated.

However, IRS migration data can still provide useful insights and perspective on interstate taxpayer migration.  That is truer now with recent IRS data reporting improvements allowing users to see pre- as well as post-migration income (addressing the latter problem above) as well as enabling an examination of the average impact of migration for each state broken down by age and income.  Looking at the most recent release (and some previous releases for trend purposes) here are three findings we found interesting relevant to high income filers specifically and Minnesota migration generally.

1. Taxpayer net out-migration in the most recent reported year exceeded taxpayer in-migration by almost 2 to 1, but Minnesota continues to hold its own in gaining taxpayers from many states from around the country.    

As Table 3 shows the number of states that were net “providers” and net “receivers” of Minnesota taxpayers is nearly equal.  More specifically:  

• Minnesota is contributing to the national migration trend to the south and west.  Just five states – Florida, Arizona, Texas, Colorado, and Washington – comprised over 70% of all Minnesota tax filer out-migration.   However, the most recent data show Minnesota as a net “winner” from a perhaps surprising diversity of states around the country.    

• These findings often continue a trend that has existed for many years.  Since 2012-13 Minnesota’s net migration status has not changed with 27 states.  That includes continuing net in-migration from several populous states in the Upper Midwest.  IRS reports Minnesota has experienced positive net migration with Iowa, Illinois, Indiana and Michigan every year and been a net recipient from Wisconsin - by far our largest “trading partner” -- in every year but one.  

2.  Migration of higher-income taxpayers is a lot more complicated than rich retirees moving to low tax states.

As Table 4 shows, among filers with incomes in excess of $200,000 [4] there was 35% (790 filers) more Minnesota out-migration than in-migration in the most recent reported year.  But the data also reveals a much more complex story surrounding migration of higher income households than the common debate over wealthy retired taxpayers and their greater mobility:

• Of all the age groups, the over 65 cohort had the smallest average income change from those moving out of Minnesota.  Moreover, although 161 more fliers left the state than entered in this cohort, those who migrated into Minnesota featured an average income increase nearly $10,000 higher than those who left.
• 60% of all of Minnesota’s highest-income migration occurred in the “prime working years” -- ages 26-54.   Within this age and income combination, 18% more filers out-migrated than came to Minnesota.   However, some good news can be found within the youngest high income, prime working cohort (26-35), Minnesota experienced net positive migration featuring an average income change for arrivals 22% higher than those who left the state.
• Passage of the TCJA does not seem to have had any significant immediate impact on high income taxpayer migration.  Outmigration of $200,000 and above filers is largely consistent before and after enactment of the TCJA (3,053 in the year after enactment versus a 3,018 average in three years prior to enactment.)

3. Looking more broadly at taxpayer migration in working years, Minnesota’s appearance of “migration equilibrium” masks a net outmigration trend of moderate to higher income filers.

As economic geographers note, the primary economic impact of migration is in shrinking or growing the productive and consumptive base of the economy through the movement of labor.   For this reason, it’s worth taking a look at migration trends within the full workforce age demographic.

At first glance it appears Minnesota general workforce migration trends are remarkably stable.   Over the last four years 2,039 more working age (under 65) tax fliers migrated to Minnesota than left -- a difference of only 1%.  Out-migration and in-migration of Minnesota’s prime workforce ages 26-54 is largely balanced.  Both the number of returns and the average change in income per return are almost identical.  Since 2015-16, prime workforce in-migration has exceeded out-migration by 5.9% (7,285 filers) and the average change in AGI among those who came to the state is a rather miniscule $60 less than those who left it.

However, when cross referencing workforce age returns by AGI income levels (Table 5), a different trend emerges:

• For each year, net migration for working age filers with $75,000 or more income was negative, even in the two years when the net migration of all working age filers was decidedly positive.
• For the last four reporting years, the out-migration of working age filers over $75,000 comprised between 82.9% and 87.4% of all state outmigration with incomes over $75,000.

Are We Discussing the “Right” Migration Concerns?

Even with the IRS’s data improvements, tax migration information is far from perfect.  For example, the IRS uses return addresses in assembling this data, not the actual residence of the taxpayer.  Therefore, migration findings could be affected by any filer whose return address isn’t their residential address (out of state tax preparer, using a P.O. Box, business address if they have pass-through income, etc.).   Foreign filer migration is not included in these figures.  Various timing issues regarding income, taxpayer movement and filing are another potential complication.  And, of course, any single year can be an outlier.  Care needs to be given in reading too much into the findings.  

However, there are some results and recent trends that merit observation and continued monitoring:

• By far most taxpayer migration – in and out -- occurs among younger taxpayers in the workforce, not retirees.  
• More high-income migration occurs within the workforce, rather than among those in, or near, retirement.
• Overall net migration trends in the workforce “mask” net outmigration trends among some important workforce demographic cohorts.

Given this, it’s fair to call into question lawmakers’ continuing focus on the movement of seniors with respect to state income tax policy.  Some of that is due to the fact that older and wealthier taxpayers contribute to the economy through their own consumption, philanthropy, volunteerism, and local investment as well as their tax dollars.  (We suspect the fact that they vote in disproportionately larger numbers might have a little something to do with this emphasis too.)

But the foundation for long-run economic growth resides in the earning potential and productivity of the workforce, and net workforce out-migration can be an indicator that something is out of whack.  As one scholar has stated it, “net out-migration can be a signal that a state’s economy is not providing sufficient opportunities for some residents to use their skills fully and to improve their standard of living.  Out-migration can damage a state’s long-term growth prospects if the people leaving tend to be working-age adults with critical job skills, high levels of education, and strong entrepreneurial drive.”[5]   

At the same time, workforce in-migration trends demand equal attention since they reflect the intersection of capital mobility, workforce location, and business decision making.  Cost of labor and the need for geographic pay adjustments have long been recognized as one of many influences in business siting decisions.  The individual income tax can be part of this calculus.  As one research study has described it, the effect of the personal income tax on economic growth is a potential “double edged sword.”[6]  All else equal, higher individual income taxes create an incentive for individuals to apply their talents elsewhere. But if employers must compensate employees for the higher burden with higher pre-tax wages to level the playing field, their labor costs go up and the case for expanding and growing business within Minnesota becomes that much more challenging.  According to a recent study of cost-of-living adjusted salaries, the Minneapolis/St. Paul/Bloomington metropolitan statistical area trails 17 of its 20 peer metropolitan areas.[7]  This finding does not include individual income tax considerations.

It’s in this context that IRS migration data deserve consideration.   To be sure, in the grand scheme of the Minnesota workforce, the amounts of net-outmigration reflected in this data may appear to be nothing more than decimal dust.   Yet any steady “drip, drip, drip” of continuing net outflow among moderate-to-high-income filers in the workforce is worth reflecting on -- especially as interest in increasing our reliance on the individual income tax even more is not going away.