High earners are flocking to low-tax states

Do people really move because they think their state income taxes are too high? It's been a longstanding debate. Finally, a recent report from the Tax Foundation provides some compelling evidence that yes, they do. 

The right-leaning group analyzed data from the Internal Revenue Service that compares the addresses for tax returns filed for tax years 2018 and 2019. These are returns that were sent to the IRS starting in 2019 up until July 15, 2020 (because taxpayers were granted a three-month extension during the pandemic for their 2019 returns).

It's among the most comprehensive data I've seen covering relatively recent moves — encompassing some 150 million taxpayers who filed a return, along with their adjusted gross incomes. 

The Tax Foundation focused on three categories: Top marginal individual income tax rates, tax code structure, and state and local tax collections per capita — in other words, a state's total tax coffer (income tax plus other taxes like property tax and sales tax collected) divided by population.

By all three measures, the states experiencing the largest net inflows of taxpayers were lower-tax states. They had among the lowest top marginal rates, below-average state and local tax collections, and what the foundation deems "well-structured" tax codes. While many factors can spur a person to move, taxes seem to be part of the decision for many, with no- or low-tax states consistently the biggest winners.

Notably, seven of the 10 states that experienced the largest gains in taxpayers either had zero income tax or top rates below the national median during the time period. Now, nine of those states either have no income tax, a flat income tax, or plan to move to one. Likewise, the states that saw the biggest net losses of taxpayers were all states with relatively high tax burdens: New York, California, Illinois, Massachusetts and New Jersey. I wouldn't do this myself, but hey, I live in one of those high-tax states.

Zeroing in on higher-earning taxpayers, or those with taxable incomes of at least $200,000, shows that the top three favored spots to move to were Florida, Texas and Arizona. Florida and Texas don't have state income taxes, and Arizona plans to move to a flat-rate individual income tax next year.

Are these moves short-sighted? After all, when other taxes are taken into account, such as property, sales and excise taxes, Texas and Arizona are more middle-of-the-pack. And salaries in New York, California, Massachusetts and New Jersey tend to be higher than incomes in the lower-tax states.

Katherine Loughead, a senior policy analyst at the Tax Foundation who wrote the report, agrees that the state income tax seems to be driving the decision for movers more than any other tax. Even if taxpayers grumble about property taxes, they're more likely to feel the benefit directly of paying higher property taxes, say for good public schools, than they are with high income tax rates.

Still, there are outliers. South Carolina was No. 5 for attracting wealthy taxpayers, yet it still imposes a graduated individual income tax rate topping out at 7%. Virginia lost high earners despite having a relatively run-of-the-mill top marginal rate of 5.75%.

No one likes to feel like they're getting a raw deal, especially when it comes to the taxman, but focusing too narrowly on avoiding income taxes can backfire. Just ask New York transplants in Florida dealing with the costly Hurricane Ian aftermath.