When You Wish Upon a Star, Taxes Matter

A new research study concludes state taxes affect the location decisions of high-end scientific talent. It also shows Minnesota has a lot at stake – and potentially a lot to lose.

Do people move in response to taxes? It’s a perpetual debate; pitting anecdotes from business, accountants, and financial planners against progressive interests backed by research that has generally found very modest – if any – causal relationships between taxes and migration. Now a new National Bureau of Economic Research working paper sheds some interesting new light on this timeless topic. It finds that relative state taxes do affect the location decisions of some of the most important players in state competitiveness: the best and brightest in the scientific community.

The paper, The Effect of State Taxes on the Geographic Location of Top Earners: Evidence from Star Scientists, is a joint investigation by two economists from the Federal Reserve Bank of San Francisco and the University of California, Berkeley. Noting that relatively little empirical work has been done on the “effects of taxation on the spatial mobility of individuals” the researchers sought to quantify the sensitivity of state-to-state migration by high skilled workers in response to personal and business tax differentials across the country.

The researchers focused their investigation on “star scientists,” defined as scientists in the private sector, academia, and government with patent counts in the top 5% of the distribution – in other words, the most productive scientific minds in the country. These individuals are a prime study target for two reasons. First, by definition, such highly productive and sought after individuals are likely to be among the highest groups of income earners. Second, in the words of the authors, “their locational decisions have potentially large consequences for local job creation.” Other studies have shown that the presence of “all star” scientists have implications for the establishment of research and development facilities and, in some cases, entire industries. Making this group even more interesting is that star scientists turn out to be a rather mobile bunch. According to the study, star scientists are almost four times as likely to migrate from one state to another as an average citizen and almost three times as likely to do so as someone with a professional or graduate degree.

The researchers created a unique data set combining information on top scientists based on patents issued between 1977 and 2010, their state of residence during those years, and changes in state-level individual and corporate taxation during this period. The result was over a quarter million “star-scientist year observations” which provided information on how many star scientists were “movers” and how many were “stayers.” Importantly, the study’s authors focused on state “pair effects” over time (e.g. the 30-plus-year history of star scientist migration between pairs of states, such as Minnesota and California). Incorporating this concept into the methodology controlled for “typical” migratory flow between states due to factors that are more or less permanent (e.g. nicer weather and the existence of Silicon Valley).

The result? In the words of the authors, “we uncover large, stable and precisely estimated effects of personal and corporate taxes on star scientists’ migration patterns.” Specifically, the investigators found that for taxpayers with incomes at the 99th percentile of their state, a one percentage point decline in a state’s marginal tax rate is associated with a 1.7 percentage point change over the long-run in the out-migration and in-migration rates of star scientists. To illustrate, their estimates imply that the effect of New York’s reduction in its marginal tax rate at the 99th percentile from 7.5% to 6.85% in 2006 (0.65 percentage points) was 12 fewer star scientists moving away and 12 additional star scientists moving into the state for a net increase of 24 stars. Overall, the researchers conclude, “state taxes have significant effect on the geographical location of star scientists and possibly other high skilled workers. While there are many other factors that drive when innovative individual and innovative companies decide to locate, there are enough firms and workers on the margin that relative taxes matter.”

Corporate income tax changes also impacted star mobility. The reason: star scientists’ salaries and those of R&D personnel associated with the star can influence corporate tax liability. The investigators found that corporate tax rate changes affected mobility only among private sector star scientists; academic and government star movements were unaffected. Moreover, corporate taxes only demonstrated a mobility effect in states where wages were included in the apportionment formula for multi-state income. Corporate taxes had no effect on migration where labor’s location had little or no impact on the corporate tax bill.

Tests for validity and related topics offered other tidbits. For example:

• Are star scientists really among the top earners in a state? The study found star scientists’ movements were sensitive to changes in the 99th percentile marginal tax rate (MTR) but insensitive to changes to state tax rates affecting the 50th percentile MTR (i.e., middle incomes).

• What is the timing of these effects? The researchers found no evidence of pre trends – changes in mobility followed changes in taxes and did not precede them. In addition, mobility effects were small in the short run but grew over time, presumably because it takes time for firms and people to relocate.

• Should we understand the cause and effect relationship the other way around – i.e. do states raise and lower marginal tax rates in response to the economic situations faced by stars and their employers? The study found no evidence that changes in state taxes were correlated with the fortunes of the employers operating in the state.

Minnesota: Land of 600 Stars

What might this all mean for Minnesota? First, we have a lot at stake and potentially a lot to lose. According to the study, Minnesota was home to 593 star scientists in 2006, placing us 6th in the nation and trailing only states with far larger economies like California, Texas and New York. In fact, on a per capita basis, Minnesota has more star scientists than any of its high performing peers. It seems likely that these highly coveted individuals, with their rich professional networks and business relationships and their magnet-like ability to attract capital, are one of the unheralded factors of Minnesota’s economic success.

The study also provides information on the bilateral relationship Minnesota has with nine of our primary competitor states. Looking more closely at that data, from 1997 to 2006 Minnesota was a net star scientist “exporter”; 32 stars left Minnesota to reside in one of these nine competitor states while 26 stars from those states came here. This was prior to the 4th tier creation which increased the state’s top income tax rate from 7.85% to 9.85%. Increasing the marginal tax rate on top earners would seem to place Minnesota at even higher risk of being a net star scientist “exporter”, with economic consequences that are not insubstantial given the jobs and other economic activity associated with these individuals.

With respect to corporate income taxes, this study casts additional light on how important single sales factor apportionment likely is to Minnesota’s competitiveness. Economists generally regard state corporate income taxes as bad tax policy to begin with, and Minnesota’s competitiveness is certainly not enhanced by having the third highest rate in the nation. Experts have long recognized that single sales apportionment takes out some of the sting of this tax – particularly for our larger domiciled headquartered companies with a lot of physical presence in the state. This study finds an added benefit – by ensuring labor’s location has no impact on the corporate tax bill, single sales apportionment also reduces any incentive corporate taxation might have on star scientists to migrate from Minnesota.

Perhaps most importantly, the study suggests that any negative impact from the fourth income tax tier will materialize very gradually over time. Rather than triggering “I told you so,” headline-grabbing headquarters closures or mass relocations, any tax-induced effects will be hidden in the slow, imperceptible leakage of high-end talent over a period of many years. And even more hidden, but no less significant, is the potential in-migration of star talent that never materializes.

This lack of highly visible cause and effect relationships makes any push to reconsider past tax policy decisions much more difficult. This is especially true for Minnesota, which has one of best performing state economies in the nation by most any measure and which seems impervious to new tax burdens. Yet if these findings are true, Minnesota policymakers have some new things to think about with respect to the state’s long-term economic interests.

Minnesota policymakers are keenly attuned to the vital importance of growing and developing a high quality workforce to ensure our future economic success. But the mobility of the workforce is another important factor to consider when developing policies to improve state competitiveness. Creating star scientists is a fantastic public policy objective. Retaining the ones we create and attracting more of them is no less important.