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  • Dr. Mark Lee Levine, Professor

TAX RATES IMPACT DECISIONS



Do Tax Rates Encourage Decisions? You Bet!


Interestingly, I finished Arthur Laffer’s book, Taxes Have Consequences[1]. The book supported what I have been thinking for many years. Tax rates influence behavior. This work, published by Simon & Schuster, traces the development of taxes, especially income taxes, back to the inception of these taxes in the US.


This all sounds very, very boring, I know!

But, there were some very good stories and good data within the book.

The point of raising the issue in this Tip is to address the fundamental point that not only do taxes have impacts (consequences) on all taxpayers, but the nature of the impact, overall, is important.

One would normally assume that raising the tax rates for Federal income taxes would increase the gross revenue for the Federal coffers. But, contrary to this basic math position is the behavioral impact the change in rates induces as to action or inaction. What Laffer discovered, as others have, is, what might seem incongruous, viz., that an increase in tax rates lowers the gross revenue received by the governmental body.

Once this result was shown, Laffer spends a good deal of time developing and showing the history and behavior of very wealthy taxpayers (among others), who, when faced with very high tax rates, such as over 80% (even in to the 90%+ range), reduce their investments and income activity, often moving to tax exempt bonds. The reason is obvious, said Laffer: If the government is taking most of the profit you earn, yet you take the risk of investing, building a business, etc., then why take the risk? It makes more sense to move to the tax-exempt bonds (among other investments).

What Laffer concluded, as has been the position by many businesspeople and regulators, is the government should think “less logically” about raising tax rates to raise more taxes. That is, contrary to logical reasoning, tax revenue is not impacted solely by the rate that is being assessed against the taxable income. By making the incorrect assumption that higher rates yield more revenue, without weighing if the amount of net income will change, many tax collectors will be misled. If the income is not generated, there will be no revenue for the tax collector. A huge tax rate of 90%, for example, multiplied against noting is still nothing. Laffer made this point in his book.


When Laffer said “Taxes Have Consequences,” maybe it would have helped to say that “An Increase in Tax Rates Have Consequences.”

What we have seen over this history of the Federal Income Tax, as is also true to a degree with state income tax laws, is an increase in the rates causes taxpayers to change their planning.


Normally, we do not change our actions in shopping at one store or another, to save sales taxes on buying a hat. There will be differences in sales tax in some areas/cities as opposed to others. But the tax amount is not that significant in this setting. However, if the rate of tax was substantial, and the amount on which the rate would be assessed is a large number, taxpayers may modify their behavior. If it was a sales tax, for example, of 20% on a $100,000 vehicle as opposed to a 3% tax assessed against a $20,000 purchase, one might expect less planning or changes by the taxpayer in the instance with the smaller rate and smaller base to assess the tax.


As to State Income Taxes, the Tax Foundation recently presented data that illustrated the taxes paid in various states and the movement by taxpayers from one state to another. Of course, the rate of tax is not the only catalyst that would cause a taxpayer to move. Nevertheless, the rate of the state income tax was apparently an important consideration by residents of one state deciding to move to another state.

Here is the caption of the January 2023 article by the Tax Foundation[2], the same written by Janelle Fritts:

Americans Moved to Low-Tax States in 2022.”


Fritts’ lead in line on her article reads: “Americans were on the move in 2022 and chose low-tax states over high-tax ones. That’s the finding of recent U.S. Census Bureau population data and commercial datasets released this week by U-Haul and United Van Lines.”


Yes, there are many factors that help determine if a resident will move from one state to another. Family issues, health, jobs, opportunities, tax rates, and much more influence the decision to move. Still, the Fritts’ article noted:


“While international migration helped numbers on the national level, interstate migration was still a key driver of state population numbers. New York’s population shrunk by 0.9 percent between July 2021 and July 2022, Illinois lost 0.8 percent of its population, and Louisiana (also 0.8 percent), West Virginia (0.6 percent), and Hawaii (0.5 percent) rounded out the top five jurisdictions for population loss. At the same time, Florida gained 1.9 percent, while Idaho, South Carolina, Texas, South Dakota, Montana, Delaware, Arizona, North Carolina, Utah, Tennessee, Georgia, and Nevada all saw population gains of 1 percent or more.”


Here is the US Map showing the Population Changes in 2022:





Fritts concluded:

“This population shift paints a clear picture: people left high-tax, high-cost states for lower-tax, lower-cost alternatives.”


Conclusion

The decision to raise the rates for income taxes should be carefully weighed. The purpose for increasing the rates, in almost all instances in the US, has been to increase the net revenue to the taxing body. However, history has shown that at some point, revenue may decrease when rates are increased beyond a given level.


By

Dr. Mark Lee Levine

Professor/ University of Denver

[1]Taxes Have Consequences An Income Tax History of the United States, Arthur B. Laffer, Brian Domitrovic and Jeanne Cairns Sinquefield; foreword by Donald J. Trump, Simon and Shuster (2023) [2] https://taxfoundation.org/state-population-change-2022/?utm_medium=email&_hsmi=241077747&_hsenc=p2ANqtz-9LnNVCAfTI3uBrmZ9atkaELul8DtV5G_Xe5z0L44s3ZZAv8j7PWYuwg3qyvgAoFgy9j_gOykg70hMdXLezjwYvTBgA0g&utm_content=241077747&utm_source=hs_email


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