The United States exhibit vast geographical differences in the degree to which personal income, corporate income and wealth are taxed. There has been much debate in recent years on the costs and benefits of state and local governments imposing high taxes on their richest residents, especially in light of the potential for tax flight.
To add new empirical findings to the debate, a recent IZA discussion paper by Enrico Moretti and Daniel J. Wilson studies the effects of state-level estate taxes on the geographical location of the Forbes 400 richest Americans between 1981 and 2017 and the implications for tax policy.
Billionaires move away from estate tax states
The authors exploit the sudden change created by a 2001 federal tax reform. Before 2001, some states had an estate tax and others didn’t. However, there was also a federal credit against state estate taxes. For the ultra-wealthy, the credit amounted to a full offset. In practice, this meant that the estate tax liability for the ultra-wealthy was independent of their state of residence. As part of the Bush tax cuts of 2001, the credit was eliminated. The estate tax liability for the ultra-wealthy suddenly became highly dependent on state of residence.
The analysis shows that the number of Forbes 400 individuals in estate tax states fell by 35% (or 2.35 billionaires on average) after 2001 compared to non-estate tax states. The authors estimate that $80.7 billion of 2001 Forbes 400 wealth escaped estate taxation in the subsequent years due to billionaires moving away from estate tax states. Especially older billionaires’ geographical location appears to be highly sensitive to state estate taxes.
Estate tax revenues exceed foregone income tax revenue
States therefore face a trade-off in terms of tax revenues: On the one hand, an estate tax on billionaires implies a one-time estate tax revenue gain upon the death of a billionaire in the state. According to the estimates, estate tax revenues sharply increase – by $165 million on average – in the three years after a Forbes billionaire death. On the other hand, this comes at the cost of foregone income tax revenues if estate taxes induce some billionaires to move away.
Surprisingly, the authors find that for most states the benefit of additional revenues from adopting an estate tax significantly exceeds the cost of foregone income tax revenue due to tax-induced mobility. Overall, it is estimated that 28 of 29 states that currently do not have an estate tax and have at least one billionaire would experience revenue gains if they adopted an estate tax on billionaires. The only exception is California, where the personal income top tax rate is very high.
The authors caution, however, that their cost-benefit analysis does not include potential indirect effects on states if billionaire relocation causes relocation of firms and investments as well as a reduction of donations to local charities.