Wall Street Journal editorial, The Blue State Blues: Taxing the Rich, Except in My District:
One irony of the tax increase that arrives on January 1 is that the it will hit residents of high-income, Democratic-leaning states like California, Connecticut, New Jersey and New York the hardest. This is a problem for pro-tax Democrats.
Enter New York Representative Jerrold Nadler, who wants to exempt his own six-figure constituents from the tax hike he supports. Mr. Nadler's bill would "require the IRS to adjust tax brackets proportionally in regions where the average cost of living is higher than the national average."
In other words, the various tax brackets would apply to residents in certain regions at higher income levels versus other parts of the country. A family with an income of $50,000 or even $1 million in Manhattan would pay less federal income tax than a family with the same earnings in Omaha. The bill is called the Tax Equity Act, but a more accurate title would be the Blue State Tax Preference Act. …
Why should someone in Spokane or Knoxville or Topeka be penalized because New York and California impose destructive policies? Mr. Nadler also conveniently forgets that the federal tax code already subsidizes high-cost states through the deductibility of state and local income and property taxes. …
So welcome to the brave new world of "tax equity." If you live in a state that voted for Barack Obama, you get a tax cut.
- Louis Kaplow (Harvard), Regional Cost-of-Living Adjustments In Tax/Transfer Schemes, 51 Tax L. Rev. 175 (1996)
- Michael S. Knoll (Penn) & Thomas D. Griffith (USC), Taxing Sunny Days: Adjusting Taxes for Regional Living Costs and Amenities, 116 Harv. L. Rev. 987 (2003)
- Dave Rifkin (Georgetown), Substantive Tax Equity and Adjusting the Income Tax for Regional Cost of Living Differences
18 responses to “WSJ: The Blue State Blues — Taxing the Rich, Except in My District”
The adjustment of tax brackets to take into account regional differences in the cost of living would violate the uniformity clause and therefore be unconstitutional.
High cost areas have high cost because they are desirable. People choose to live there despite the higher cost. They aren’t just assigned to high cost neighborhoods at birth.
Adjusting tax rates by zip code would be the same as charging a lower sales tax rate on a Lexus than on a Kia. The higher cost was incurred by choice, so the tax rate should be neutral with respect to that choice.
This objection seems so simple. How could the brainiac authors have overlooked it?
Furthermore, market-clearing income levels adjust for taxation. Therefore the argument also fails as a matter of basic economics. Providing a tax break after the market has set income levels in the absence of such a break confers a windfall. I’m not an economist and even I can see that.
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
New York Congresscritter: tax the rich, just not my rich
TaxProf has the details….
Well, this is a bad idea, just because it will result in more people pretending to live where they don’t than an open U.S. Senate seat.
That said, the most recent data available at http://www.taxfoundation.org/research/show/22685.html in a report entitled “Federal Taxes Paid vs. Federal Spending Received by State, 1981-2005” demonstrates that red states are blood sucking parasites getting subsidized by hard working people in the blue states (OK, the actual picture is a bit more nuanced than that, for example, Texas is getting screwed just like California and New York). So, the inequity is real.
The fallacy of JeffreyK is that he breaks down “blood sucking parasites” (bsp’s) by state rather than demographics. One should note that “bsp’s” are the supporters of Obama/Pelosi/Reid’s wealth redistribution programs no matter where they live. It happens that a disproportionate number of the bsp’s are found in poorer red states, like those of the Deep South, which do not support socialism. And, while the majority of people in red states generally oppose passing new government handouts, they’re not so stupid as to turn them down once everyone else is taking them. If you don’t like people from all states taking goverment money, quit passing so many welfare programs.
As for Rep. Nadler, I suggest that he march right into Harlem and tell those folks to their faces that they are costing his Upper East Side taxpayers too much and that they need to quit asking for so many government handouts.
Also, would Rep. Nadler agree that people in states where people earn less and the dollar buys more should be able to pay less to the IRS, as those people had to work harder for those dollars and as those dollars represent greater purchasing power to them?
I have to agree with AMTBuff. Noone is forced to live in California or New York. As it is, there is already a high cost of living break built into the tax code. The itemized deduction on mortgage interest only pencils out when you spend coast prices for housing — it rarely exceeds the standard if you purchase a modest house in the Mid-West or Deep South and stay out of debt.
I have a hard time imagining that the idea would gain a lot of traction politically either in an election year.
This happens to be my field of expertise. It was my dissertation topic, which I published in the the August 2009 Journal of Political Economy, “The Unequal Geographic Distibution of Federal Taxation” (it’s also posted on my website). It follows up on the works you cited and irons out most of the remaining issues.
The economically efficient proposal is to index taxes to local wage levels, controlling for the characteristics of individuals. Cost of living is high where the jobs pay well (e.g. Chicago) and the amenities are high (Hawaii): the first deserves adjustment, as it leads to higher tax payments, while the second does not (AMT Buff’s argument). You shouldn’t get penalized for taking a job in high-wage area, where the wages ultimately compensate for the higher cost-of-living.
Furthermore, if we take the general equilibrium model seriously, inefficient local public services or regulation drive out labor, and may lead to slightly higher wages and tax payments for those remaining. Whatever the case, the sufficient statisitic is wage levels if we can ever measure them correctly.
My calculations also show that the deductibility of interest and local taxes can be efficiency improving as they offset the effects of over-taxation in productive cities. But they also subsidize life in Hawaii, which is not an efficient policy.
Plus, Nadler first proposed this act in 1993 and many times since, and it never goes anywhere — low cost-of-living areas get disproportionate representation in Congress. Nothing new to get outraged about. The outrage should come from the big cities, where regular people pay too much in taxes, while similar people in the countryside pay far less and find it easier to qualify for means-tested benefits. A corrective policy would make rural areas less desirable and increase the population of our cities (Historically, Detroit has over-paid federal taxes for a very long time). But, as Malcolm Gladwell said, it might be the best kept secret in American politics.
Sorry for responding so late. I just moved yesterday: to Nadler’s district of all places!
David, you say that “wages ultimately compensate for the higher cost-of-living”, but income taxes are part of the higher cost of living too! Therefore wages should already have adjusted for the effects of progressive taxation. Do you agree?
If you agree, then wages would re-adjust to counteract whatever location-dependent changes were made in the tax rate. The only difference would be a temporary windfall to those whose tax rates were reduced, lasting only until wages fully adjusted.
I really don’t see the point of such an exercise. Please enlighten me.
AMT Buff:
I accounted for the wage feedback effects in the model in my article.
The wage effect is only partial: with perfect mobility, higher taxes are compensated partly by higher wages (~25%) and by a lower cost of livng (~75%). The distributional effects occur only to land owners, but there are efficiency losses as too few people live and work in productive places.
With imperfect mobility/heterogeneity, the adjustment is incomplete, and people with stronger tastes for city life (or city jobs) lose, while country-lovers are made better off.
The Rifkin paper is defective. On pages 5-6 it mistakenly assumes that a 2x difference in cost of living implies a 2x difference in PRETAX wages. This is simply incorrect. A 2x difference in cost of living implies a 2x difference in AFTER TAX wages. Otherwise the employment market would favor the low cost region. The rest of the paper traces the logical conclusions of this faulty step, so it’s all garbage.
As to the Albouy paper, I don’t have the patience to follow the math. However let’s step back to Rifkin’s simplied example of two otherwise identical areas with a factor of 2 difference in all costs of living. I fail to see how the employment market will not reach equilibrium with the after-tax wages for a given job differing by a factor of 2 between the two areas. Any other result would not be stable. David, please tell me what I’m missing here.
How would this work in a state with both high and low cost of living areas? Would persons in Palm Beach Florida pay a much lower marginal tax rate than folks in West Palm Beach, since there is a significant difference in costs of living between the two cities? Would a successful business owner in East LA pay a higher tax rate than a movie star in Beverly Hills, simply because the latter lived in a higher cost “region”?
AMT Buff,
1. If you are going to rip me apart, at least have the decency to not hide behind the anonymity of a nom de plume.
2. You are wrong, and you reasoning proves it. The 2x difference is on PRE-TAX wages, because, as you say in arguing that the 2x difference is AFTER TAX wages: “Otherwise the employment market would favor the low cost region.”
Where is everything purchased in the United States made? In expense labor markets like Detroit (well, at least it used to be) or in China and other locations with low costs.
By your own reasoning, you prove the truth of my conclusion, as the employment market, as you suggest, does favor low cost regions.
Pardon me for not brushing up on a paper I wrote over 15 years ago, which is no where near as sophisticated as David Albouy’s (and I haven’t had a chance to look at the other two), but I feel rather fine about casting my lot with the likes of Kaplow, Knoll & Griffith, and Albouy.
Mr. Rifkin, please accept my apologies for using a handle. I try to be nice to everyone, and I could have worded that post a lot more gently.
Let’s explore the pretax vs. aftertax issue. If you are right, I will retract my earlier statement.
On mathematical questions, it often helps to consider a limiting or extreme case. So let’s consider the case in which the tax rate is zero up to $X and 100% above $X. That is to say, everyone’s after-tax income is capped at $X regardless of pre-tax income. Now suppose that the pre-tax wage in the low-cost area is $X.
Unless I read it wrong, your paper claims that that the pre-tax wage in the high cost area will be $2X. Yet the after-tax wage will be $X, the same as in the low-cost area.
In this situation, I claim that no workers will choose the high-cost area. Workers will demand an after-tax wage commensurate with the local cost, so they will choose the low-cost area.
I realize that the example I chose is the most progressive possible tax, but progressivity is the reason for your result, so I pushed it to the limit. A complete and correct analysis should apply to all cases, including extreme ones. Please point out my error here. If I missed something, I genuinely want to know about it.
AMT Buff,
You logic is unsound as you contrive a system of taxation that is politically untenable. If you can cite to me an instance where, in the history of man (yeah, I’m willing to go that far), when at some amount ($X, X sheep, or X corn) the tax rate becomes 100% I would appreciate being enlightened.
At tax rates of 0% and 100% there is neither horizontal nor vertical equity to be had. You system is Marxian in premise as each worker only is entitled to the amount the State decrees that the worker needs, and those who do not reach X will be supplied it by the State as their abilities are unable to reach X, but all pigs are equal. Sadly, we know some pigs are more equal than others. And even sadder, those with with equal real income, not nominal income, are taxed inequitably if they choose to earn real and nominal $100x in NYC or LA or wherever vs. $25x nominal, but $100 real, income.
I fail to see why you would defend the proposition that a person with $50x nominal income but $200x real income should pay less tax than a person with $100x real and nominal income.
If you inject the temporal element into this you can see the equity issue involved to an even greater degree. Inflation at 7% every 10 years (easy 7/10 rule) means that $1 in year 1 equals $2 in year 11, $4 in year 21, and $8 in year 31. Theoretically, $1 in year 31 should be taxed less than $8 in year 31. All income increases according to the rules of 7/10. However some people, located in 25 states (A states), are subject to a static tax system and other people in the other 25 states (B states) the tax system was adjusted for inflation annually per the 7/10 rule. (I realize this is equally ludicrous as an 100% tax system, but if we are going to play hypothetical here, all is fair game).
State A residents in the static system pay substantially higher taxes in year 31 than those in state B. As inflation causes bracket creep, and AMT creep, for State A residents, State B residents are insulated from AMT and bracket creep because the income tax rate on $1 in year 1 is 1x, on $2 in year 11 is 0.5x, on $4 in year 21 is 0.25x, and on $8 in year 31 is 0.125x. Set x to 1, and State B residents pay $1 of tax (nominally) every year for 30 years. Whereas for State A residences are subject to bracket and AMT creep because the income tax rate on $1 in year 1 is 1x, on $2 in year 11 is 1x, on $4 in year 21 is 1x, and on $8 in year 31 is 1x, paying $1, $2, $4, $8 dollars (nominally) over the course of time resulting State B residents paying $11 (nominally) more tax than State A residents.
Amusing to me is that fact that someone with AMT in the moniker would argue so steadfastly against the idea that geographical cost of living differences do not exist. Given the state of the AMT (needing a “patch” year after year because of bracket creep), and given who is affected most by AMT creep, those in the states with the highest cost of living (rendering their nominal income meaningless), it is amusing that someone fascinated by the AMT not only would not have thought about this but would oppose such measures.
Accordingly, if adjusting the income tax for regional cost of differences is wrong, I suggest that patching the AMT, and perhaps indexing any amount for inflation is equally incorrect.
I questioned your paper’s assumption that pretax (rather than after-tax) incomes will always be equal after adjustment for local cost of living.
As I stated, my example is an extreme case, chosen for its ability to illustrate a problem with the assumption. I fully agree with your contention that this example tax system is confiscatory, Marxist, and suffers from bracket creep. It’s politically untenable, economically unwise, and generally a terrible idea. I didn’t chose this example because I liked it, but because it stresses the assumption of pre-tax purchasing power parity.
My example shows that the assumption of pre-tax purchasing power parity does not hold up under extremely progressive tax rates. Therefore the assumption also needs to be questioned at less progressive tax rates. Presumably the degradation is accuracy is gradual as you move from a completely flat tax to a completely non-flat tax such as my extreme example.
The fact that the example tax rate schedule is unrealistic does invalidate this argument. Think about it: Travel near the speed of light is impractical, but we still believe special relativity. It’s just a combination of thought experiment and some math.
If the model is correct, the math will work even for extreme cases. That’s part of the scientific method, and it’s a major reason why we use equations rather than words to make sure of our arguments when a problem gets tricky.
As to fixing the AMT, I’ve long favored eliminating it, along with all the hidden rate increases such as phase-outs. I’m no fan of a bait and switch tax code.
On a personal note, I live in a high cost area. I will be very sympathetic to this argument if somebody can prove it to me. I’m not an economist, and I would like to know if there is some deep economic principle involved that counteracts my belief from basic economics that after-tax wages settle at purchasing power parity, hedonic factors being equal.
Third times a charm. So say what you will, as this is my last post on this matter.
Your physics example is flawed in that it ignores well established principles that Einstein’s “macro” physics breakdown on a subatomic (“micro”) level. Although we adhere to special relativity although we know that it has no application, and is in fact incorrect, on a smaller scale. (I chose “adhere to” rather than “believe in” as belief implies an element of faith that cannot be accounted for or proven, and from your post it appears that you used the word “believe” colloquially.)
The scientific method that I set out briefly in my last post was testing geographical cost of living differences vs. temporal cost of living differences. When the theory is applied to temporal cost of living differences, the result is not just inequity, but the same inequity in the same quantity as geographic cost of living differences. Thus, the temporal “proof” (in the mathematical sense of the word) validates the soundness of the geographical cost of living differences analysis and conclusion.
If you want more detailed mathematical proof, I suggest reading David Albouy’s paper. With a lot more math he details this conclusion.