Finance

Taxing the Rich Isn’t Always a Moneymaker

Several states increased taxes on the wealthy in recent years. The move brought in extra revenue but didn’t solve all of states’ budget problems.
by | December 2011
 

A key part of President Obama’s fiscal plan is his proposal to raise the tax rate on the nation’s highest earners, the Warren Buffett-backed “millionaire’s tax.” Yet states that have boosted taxes on the wealthy in recent years have largely been left disappointed by their take.

After Oregon voters approved an increase last year on those earning more than $125,000, the state estimated it would collect an additional $180 million in revenues. But Oregon fell $50 million short. A similar shortfall in Maryland was even worse, and other states, such as Connecticut, have been disappointed as well.

There may be any number of reasons for this. Opponents of tax hikes targeting the rich point out that this is a highly mobile group that can easily pack up and move. “Over the last few years, there have been massive reductions of half-millionaires and millionaires in the year immediately following the tax hike,” says David Logan, an economist at the conservative Tax Foundation.

Academic studies argue both ways. Some say there does appear to be out-migration as a result; others dispute the idea. But timing almost certainly has something to do with the disappointing numbers. After all, states are most likely to raise rates just when an economic downturn starts eating into incomes and capital gains. “We raised the tax rate right before the heart of the recession, so we didn’t necessarily hit the initial estimates,” says Joseph Shapiro, a spokesman for Maryland Comptroller Peter Franchot.

The more progressive the income tax rates, the greater the volatility is going to be. That’s one reason why states such as California and New York have posted some of the worst budget shortfalls in recent years. Things could get worse in the coming months. Kim Rueben, an analyst with the Urban Institute, says that a lot of people cashed out their stocks in 2010 because the market was fairly high and there was a great deal of uncertainty about federal capital gains rates. Neither of those situations is the case today, so collections might look a little worse next April.

No tax system is ever going to be recession-proof, says Jon Shure of the Center on Budget and Policy Priorities, a liberal think tank. Estimates are bound to be missed when the economy is tanking. But he says that shouldn’t be used, as it often is, as an argument that tax increases on the rich have backfired. States may not collect as much as they’d hoped, but “every state that raised taxes on the very wealthy got more revenue than they would have if they hadn’t raised the taxes,” Shure says.

Raising taxes on the wealthy has been popular in cash-starved states because it’s a relatively palatable idea politically. But there aren’t enough wealthy people around to make up most deficits through a 2 or 3 percentage point hike on a limited pool of individuals. “I believe income taxes should stay progressive,” says Scott Pattison, executive director of the National Association of State Budget Officers, “but folks should be careful about thinking this is a panacea to solve your issues structurally.”

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