In the 2018 midterms, my congressional district in southern Orange County elected a Democrat named Katie Porter. Although she is quite progressive, she strongly opposes the new cap on deductions state and local taxes (SALT). Southern Orange County is mostly upper middle class, and this tax change hits our area harder than many other parts of the US.
Nonetheless, the cap on SALT deductions is a progressive provision in the tax code, with the higher tax burden falling overwhelmingly on the top quintile. It also makes the tax code more efficient. As an aside, this was part of a GOP bill that also cut tax rates for affluent taxpayers. So the net effect of the tax bill was probably positive for my district. It was certainly positive for me, and I’m a fairly typical resident.
At the national level, the Democrats are moving in a “soak the rich” direction, with both Sanders and (frontrunner) Warren proposing wealth taxes for the rich. But how do the blue states feel about these ideas?
It’s worth noting that of the 16 states with the fewest millionaires per capita, all but New Mexico voted for Trump. Of the 14 states with the most millionaires per capita, only Alaska and New Hampshire voted for Trump. Rich states tend to be blue states. So one might expect even Democrats to be reluctant to soak the rich if it means soaking their constituents.
[And even these figures may understate the pattern, as my source excludes real estate wealth. Many of the rich blue states have very expensive homes.]
On the other hand, the $10,000 SALT cap hits a substantial number of voters, whereas some of the recent wealth tax proposals would impact only a small number of individuals. Might the Democrats be willing to support taxes that hit their states disproportionately, but impact only a tiny number of voters?
Actually, even progressive politicians can become quite protective of the super-rich when they look at things from a local perspective. Wealthy residents in places like Manhattan and Silicon Valley provide a hugely disproportionate share of revenues to state governments. These governments may have progressive instincts, but they don’t want to “kill the goose that lays the golden eggs”.
Assume that you are a progressive that wants to set an revenue maximizing income tax rate on people making over $1,000,000/year. You seek the “top of the Laffer Curve” tax rate. Now suppose that you estimate 8% to be the optimal rate. You believe that at higher rates the tax becomes counterproductive. In that case, as long as state and local taxes are fully deductible, you might set the top rate at about 13%, as California did a few years ago. At that rate, the effective rate on the rich was roughly 8%. But with the recent $10,000 cap on SALT deductions the marginal rate on the rich in California effectively jumped from about 8% to 13%.
It might seem odd to suggest that a rate as low as 8% is the revenue maximizing rate for a state government. But you need to consider several factors:
1. Laffer Curve effects are much more powerful at the state level than at the national level, as people can easily move between states. Yes, the maximizing rate will be higher in states like California, New York and Hawaii, which have amenities that tend to hold the rich in place. But there is still a limit.
2. The state tax is added to the federal income tax rate, which maxes out in the low 40s. (It’s complicated)
3. You need to also think about indirect effects. The loss of a single extremely rich taxpayer may have indirect effects as well, if the owner of a company brings their firm with them when they relocate from Silicon Valley to Austin, or New York to Miami.
4. And of course you need to consider long run effects. People don’t move immediately, but fewer new businesses may be set up in your state.
I’m certainly not claiming that I know for certain that California’s 13% tax rate is now counterproductive. But wherever the revenue maximizing rate is, it’s substantially lower after the SALT cap was imposed. Thus if it were 20% before, then it’s closer to 13% now. Blue state reps have a strong incentive to prevent the federal government from encroaching on their state’s tax base.
I tend to doubt that a blue state dominated political party will be able to get a “soak the rich” tax regime through Congress, even in the unlikely event the Democrats take control of the Senate.
“All politics is local”.
READER COMMENTS
Robert R
Oct 21 2019 at 11:50pm
I love to better understand why you think that the current rates are close to the revenue-maximizing rates. Not that I disagree, I just don’t have any framework for deciding whether you are right or not. I certainly don’t think that the California government is clever enough to deliberately set things at the sweet spot. In fact, it’s not clear to me whether they are too high or too low for that goal. So, if you can spare the time, I’d love to understand your logic better.
Mark Z
Oct 22 2019 at 7:18am
States with the most millionaires and millionaires themselves don’t necessarily vote the same way, so a California Democrat likely doesn’t see himself as answering to California millionaires, and many supporters of a wealth tax (e.g. Gabriel Zucman) are open about the fact that it’s not primarily about revenue, it’s about reducing the wealth of its targets. And I don’t think policy makers can be reliably trusted not to kill their own golden geese (Queens politicians preventing Amazon from setting up comes to mind, or the Seattle government’s attitude toward Microsoft).
Alan Goldhammer
Oct 22 2019 at 8:27am
Over at Marginal Revolution, Alex posted a video clip of a conference on the wealth tax topic with Zucman, Summers, and Mankiw. It was interesting watching it and Summers skewered Zucman for using inexact data and creating a tax that is way too complicated to enforce even though it ‘sounds good’ (e.g., ‘soak the rich’). Sanders’s proposals from 2016 were loony and now Warren is running close behind.
Warren’s ‘I have a plan for everyting’ is very reminiscent of Clinton’s approach and likely doomed to failure as well.
BB
Oct 22 2019 at 10:41am
Scott,
I’m not sold on these arguments. Amazon did a nation wide search for new headquarters and chose Arlington VA and NYC. The wealthiest individuals tend to live in blue states, although they may pay taxes in red states. And the super wealthy support republican politicians but choose to spend most of their time in blue states.I’m skeptical of a wealth tax because it seams to fail everywhere else. However, bringing back the inheritance tax makes sense to me. And adding another marginal rate for the super wealthy seems like it would work as well. I agree that capping the SALT deduction is the correct answer, although it offset most of the benefits I received from the tax cut. I think some form of soak the rich has a good chance of succeeding.
Thaomas
Oct 24 2019 at 2:06pm
@ BB
What is the dead-weight loss of the SLG deduction? To me the SLG deduction looks like a (very tiny) move toward consumption taxation as a tax paid to a SLG is not part of individuals’ consumption and is not distorting their choice between present and future consumption.
Scott Sumner
Oct 22 2019 at 11:27am
Robert, I never suggested that the current rate is at the top of the Laffer Curve. I merely did a thought experiment considering how SALT caps would affect things if it were.
Mark, I think you’ll find many Democratic politicians in New York who support the interests of Wall Street because the industry brings them so much money. Ditto for Massachusetts politicians and the biotech industry.
Alan, Yes, Summers just destroyed Saez; it was brutal.
Daniel Kahn
Oct 22 2019 at 11:53am
Correction: New Hampshire (narrowly) voted for Clinton in 2016, so that leaves only one exception in the top 14 millionaire per capita states.
Scott Sumner
Oct 22 2019 at 3:18pm
Thanks, my mistake.
IVV
Oct 22 2019 at 1:01pm
It also definitely depends on the tax structure.
I live in New Jersey, and the Trump tax changes resulted in a significant net increase in taxes on my household. The state income tax is relatively low, but the local property tax is famously exorbitant–and that’s not going to change. Basically the best thing I can do for my bottom line is to stop donating anything to charity. It’s not a good feeling.
Scott Sumner
Oct 22 2019 at 3:18pm
IVV, That may be so, but don’t forget that Trump cut income tax rates for the upper middle class, and also cut the corporate tax rate, which benefits the upper middle class.
IVV
Oct 23 2019 at 1:14pm
The cuts to the corporate tax aren’t directly seen by the upper middle class, as a class of well-paid laborers. It is not a given that an upper middle class member is a significant owner of a corporation (owner of a stock portfolio, sure, but not necessarily a controlling owner of a business, even a small one).
Also, the cuts to the percentage do not offset the lack of deductions from SALT in my particular case, so on net the tax is higher regardless.
Mark Brady
Oct 22 2019 at 8:28pm
“Basically the best thing I can do for my bottom line is to stop donating anything to charity. It’s not a good feeling.”
1. Wouldn’t you feel even better if you were to donate to charity at a greater financial cost to yourself?
2. It’s not clear that “society” is better off with more charitable contributions and fewer personal consumption expenditures.
IVV
Oct 23 2019 at 1:17pm
No, of course not. Do you think I’m donating to charity to feel financial pain? I’m doing it out of an interest in influence. The cost to me has increased to have the same effect.
Absolutely correct. But are either of us interested in improving “society”? Or are we interested in exerting influence on the world we experience personally?
Mark Brady
Oct 24 2019 at 12:17am
“No, of course not. Do you think I’m donating to charity to feel financial pain? I’m doing it out of an interest in influence. The cost to me has increased to have the same effect.”
Good answer. It’s just that many people donate to charity to feel good. Hence my question.
“Absolutely correct. But are either of us interested in improving “society”? Or are we interested in exerting influence on the world we experience personally?”
Indeed. And I suggest that this is a reason for particular expenditures (e.g., donations to non-profits) not to be tax-deductible so that tax rates can be lower. (I understand that governments are prone to remove tax deductibility without lowering the tax rates.)
Matthias Görgens
Oct 23 2019 at 8:24am
If it makes you feel any better, if you bought your property after the ‘exorbitant’ property tax was known, it’s essentially free for you.
Lower property tax just means higher mortgage payments, as California demonstrates.
IVV
Oct 23 2019 at 1:09pm
Property taxes have not decreased and will not decrease.
Fred_in_PA
Oct 22 2019 at 3:57pm
“. . . even progressive politicians can become quite protective of the super-rich . . . . Wealthy residents in places like Manhattan and Silicon Valley provide a hugely disproportionate share of revenues to state governments.”
They probably also provide a hugely disproportionate share of campaign donations — especially, early / “seed”campaign donations.
Phil H
Oct 23 2019 at 2:46am
“It’s worth noting that of the 16 states with the fewest millionaires per capita, all but New Mexico voted for Trump. Of the 14 states with the most millionaires per capita, only Alaska and New Hampshire voted for Trump. Rich states tend to be blue states.”
I feel like a reality check is needed on this paragraph. Despite the well-documented Democratic leanings of many celebrity rich people, last I checked it was still true that the rich vote more Republican and the poor vote more Democrat. Any analysis that tries to invert this basic relationship is going to run into trouble, isn’t it?
Scott Sumner
Oct 23 2019 at 12:56pm
I addressed that in the post.
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