How State Taxes and Migration Impact Inequality
Looking at Migration and Taxes Through the Job Search Process
I started my series by looking at general, nationwide trends in migration. Then I looked at variations among metro areas, then among the states. Along the way, I’ve also briefly touched on several policy questions. However, I’ve tried to stay clear of the most sensitive political issues. This week, I’m going to wade into some more political debates, and try to see what the best data and the best research can tell us about those debates. I’m going to start with the one everybody loves to hate: taxes.
There’s a pervasive debate about whether taxes cause migration. Commentators and economists like Travis Brown, Art Laffer, and others have prominently suggested (explicitly or implicitly) that one reason some states get more migration is because they have lower taxes. Obviously, plenty of other people disagree. If lowering taxes can draw thousands of new workers and consumers, then any state with higher taxes would be sabotaging its own economy and its peoples’ futures. Such a controversial idea obviously has its critics.
I’ve offered a review of the literature on taxes and migration in a methodological supplement to thus post. If you like that sort of thing, you can check it out. Here’s the short version: most academic evidence finds that higher taxes do reduce net migration, but the effect is generally small and varies across groups. But I’ll warn you: all the publications in the world won’t solve this debate. To really understand how taxes may impact migration, we need to get back to the basics. How do people make migration decisions?
One of the biggest reasons people move is for work. This is also likely the channel most impacted by taxes: people moving for family reasons may be influenced by taxes, but it’s probably a much more indirect effect.
I’ll analyze job-motivated migration in this post. To do that, I’m going to break the migration decision down into pieces. I’m going to explore and explain two main assertions: the basic structure of the job search has spillover effects on migration, and the possibility of migration alters the structure of the job search.
Job Search Networking: Opportunities, Information, and Bargaining Power
How do people find job opportunities? Obviously, there are a lot of options: classified ads, company websites, public job portals, proprietary job portals (such as those managed by universities), and other general sources. Another major pathway to a job is through personal connections, especially those formed through prior work experience or educational opportunities. Both formal job listings in various publications and personal connections can be lumped together as a job-seeker’s network. Job seekers can only apply to jobs they know exist, and they can only gain that knowledge through a network.
There are basically three channels through which variations in network size and quality impact a job seeker’s tax burdens and migration decisions: information about taxes, job opportunities, and altered negotiating power.
We’ll start with the simplest case: a bigger network gives the job seeker more opportunities in more places. This is an obvious fact. For someone who’s lived in the same small town in their entire life, with no ties beyond that town, losing their job can be devastating: there may be few similar jobs in the town, and they may not have any information about jobs elsewhere. This person has a “small network,” and thus is less likely to migrate. Even if the job seeker does find other jobs in the home-town, they’re likely all within the same jurisdiction, so taxes won’t vary much, if at all. This job-seeker’s choices are little affected by migration. But if she had a wider network that informed her of opportunities in other cities and states (possibly friends from university, former coworkers, past internship locations, trade connections), she could have had more job opportunities with more variation in taxes. With more job opportunities comes greater future employment security and greater ability to mitigate tax burdens.
In order to mitigate tax burdens, the job seeker needs information about the tax code in each potential job location. Having more opportunities may result in better managed tax liabilities, but, without information on tax codes in other locations, any such change in taxes would be accidental. For the job seeker to really manage taxes well, she needs a network that also gives information about tax burdens. The rise of the internet has made acquiring tax information far easier, especially for web-savvy individuals. But informal networks and perceptions still matter: if the job seeker’s network provides her information that a certain state has high taxes, she may trust that information even without formal evidence. Thus, “tax reputation” may matter as much as actual tax burdens. Migrants don’t usually have perfect information and a second degree as tax accountants, thus perceived tax burdens, meaning information about taxes made available through the job seeker’s network, matters more for in-migration.
Finally, a bigger network provides more job opportunities, which allows some workers to negotiate for better wages. When workers have multiple job offers and valuable skills (this doesn’t apply as much to minimum wage workers), they can haggle over their wages with employers. When a job seeker faces very different tax liabilities in different states, they may seek to negotiate extra compensation in the states with higher taxes. Thus a bigger network allows job seekers to use the threat of migration to increase their own wages and mitigate effective tax burdens.
The effect of taxes on migration will vary based on job seekers’ networks. Taxes may have the biggest impact on people with good information, lots of job opportunities, but who can’t easily negotiate for higher wages. For migrants with small networks, or who can get whatever wage they ask for from employers, taxes may matter less.
How Migration and Taxes Increase Inequality
Income inequality has become a major point of political contention over the last several years. Plenty of research has gone into quantifying it, and some research has tried to explain its “cause,” which mostly means providing descriptive characteristics of high-earners. However, less research has tried to quantify how high-migration societies may also be, by necessity, high-inequality societies. I’m going to take a stab at showing this relationship here. If you combine freedom of movement with decentralized taxing authority (like in the US), higher inequality is extremely likely.
Let’s start with a previous conclusion: the possibility of migration can give job seekers with big networks and valuable skills increased power in wage negotiations. On face value, this may seem like it creates a more competitive society, one where people have more tools to boost their wages. In reality, it does just the opposite.
Because workers can negotiate wages based on the threat of migration, states are able to shift wage tax burdens onto businesses, high-earners get excess wages, and “progressive” taxes are at least partly self-defeating. This is a pretty dire list, but is immediately obvious when we think about what happens in a wage negotiation.
Imagine a software programmer debating jobs in Texas or California. Assume the jobs are almost identical and the worker likes Austin just as much as San Francisco, in terms of quality of life. However, the job seeker currently lives in San Francisco so, all else being equal, would prefer not to have the hassle of moving. If both jobs pay the same amount, Texas is likely preferable, as it has no income tax. But maybe the worker, instead, goes back to the California employer and demands an extra $5,000 to compensate for the state’s higher taxes. Our worker is highly skilled and valuable, so the employer gives in and provides a raise.
The worker gets some of that raise, but it’s really just equivalent to pay in Texas. In reality, the employer bears the burden of the higher income tax rate. In this way, states with high income taxes drive negotiations for higher pre-tax wages, thus boosting labor costs for employers. While states should engage in a rational allocation of taxes and public services to appeal to mobile businesses and workers, wage negotiations allow workers to push “their” part of that tax allocation onto businesses. This reduces profits and investment, and incentivizes business relocation, which is far more costly and economically disruptive that worker relocation. It’s also more politically contention, and business threats of relocation often draw special tax credits (especially in states with high taxes), which pushes the tax burden off of mobile businesses onto immobile businesses: service-sector and locally-owned establishments.
But not all workers can negotiate. A minimum wage worker may just be replaced instead of getting a raise. In other words, only skilled workers benefit from this negotiation process. Low-skilled workers may have some spillover benefits, but far, far less. So a tax increase tends to fall on people whose wages are the most rigid: the poor.
If that’s true, then we might think that states should just have progressive taxes. But that’s not true either. If income taxes are progressive, high earners will just see even higher wage hikes, which will increase inequality. There’s a robust academic debate about how much this happens. The best answer is: some. Comparing inequality in a hypothetical flat-tax economy versus the same economy with a progressive tax, pre-tax inequality is probably higher in the progressive tax case, but after-tax inequality may be slightly lower.
Search Costs and Savings: High Income Simulates Big Networks
It gets worse. Not only does the combination of high or progressive regional taxes disfavor low-skilled people and boost inequality, but this process can forma vicious cycle. To see how, we need to introduce another concept: search costs. Being unemployed is not cheap. It takes time to apply to jobs, money to get to interviews and job fairs, and of course there’s still the normal cost of living to be paid while the unemployed person is without normal income. Unemployment insurance greatly softens this blow, but workers do face a very real timeline. The longer they go without work, the more they spend down their savings (and the bigger the hole on their resume, reducing prospects for future employment). For individuals with less savings, long job searches, or long-distance job searchs that require travel, are less viable.
In other words, having a pile of cash to fall back on makes it easier to bounce back, or to build the equivalent of a big network. These can be individual savings, or assistance from family members. Thus inherited wealth can enable a longer, more detailed, wider-ranging search.
The most likely people to have such savings are higher-income people, or people with high-income families. The results of such a “high cost” job search as similar to those of having a bigger, better network: more complete information, more job opportunities, and more negotiating strength. For the worker who needs a job now, “wage negotiations” essentially do not occur.
Who is most likely to have high skills and networks in other states? Quite simply, people with higher incomes and more education. In other words, the possibility of migration gives high-income people more negotiating power. This means that they are able to compensate for higher taxes with higher wages. This ultimately means that when states raise taxes on high earners, it is likely to increase inequality. This is a perverse effect, but is extremely important. Migration, taxes, and inequality all interact with each other such that the possibility of migration between areas with different tax policies leads to higher inequality in the high-tax areas. This is empirically the case, by the way, with higher tax cities and states tending to have higher pre-tax inequality (though there’s more to it than just taxes, of course). The academic literature on the subject suggests that income taxes definitely cause some pre-tax wage adjustments, but probably aren’t fully capitalized into wages.
The Cycle of Migration, Taxes, and Inequality: Does Federalism Favor the Skilled?
When these three models (networks, returns to skills, and search costs) are combined, the result is every inequality-fearing commentator’s nightmare: a self-perpetuating cycle of rising income for the rich and worsening tax burdens on the poor.
When everything is put together, it looks like high-skilled workers are able to hold employers and state (or city) governments hostage, demanding higher wages. We might think of New York City and the San Francisco-San Jose area as examples of this phenomenon. High earners succeed in both boosting wages and optimizing tax burdens (not least because of the highly regressive effects of the Federal income tax deduction for state and local taxes paid).
But is that really the whole story?
Economic Trade-Offs: Migration and Inequality as Opposites
The entire taxes-migration-inequality cycle makes one big assumption: the high-skilled worker doesn’t move. If the job seeker actually does migrate, then inequality doesn’t increase: it could actually fall. Thus, there’s a tradeoff between migration and inequality. If we imagine a state that hikes its taxes, low skilled workers may be unable to migrate, mid-skilled workers may be able to migrate and have little negotiating power, and high-skilled workers may be able to migrate, but have negotiating power. Thus low skilled workers stay and lose out, mid-skilled workers move, and the rich take a fatter paycheck.
Then there’s another key question: If high skilled workers become rooted, then they can use the threat of migration to negotiate for higher wages. But that threat only works if it is credible.
But why would an employer believe a worker about their threat of migration?
Obviously, because workers often migrate. As long as we live in a high-migration society where employers regularly lose workers to migration, then employers will remain concerned about migration, and take worker threats seriously. Put this way, declining migration could reduce the credibility of migration threats, reducing the bargaining power of high-skilled workers, reducing the link between migration and inequality.
But on the other hand, we already know that rich people move less. Most migration is by poorer people. That tells us something interesting: migration is associated with high inequality and high economic mobility. I’ve argued repeatedly that people move to “get ahead” in life.
The total effect is simple: the threat of migration increases inequality, but the experience of migration increases economic mobility.
There’s a second trade-off, then, between inequality and mobility.
As far as migration is concerned, we have a choice: live in a society of higher inequality and higher mobility, or live in a society of lower inequality and lower mobility.
The framework I’ve outlined here is justifiable from the economic literature and makes sense given the data I’ve presented previously, but is admittedly thin on hard data in several points. I’ll make some efforts at providing related data in the future. But for now, it’s enough to point out that while taxes do matter, the way they matter isn’t always straightforward.
Some people living close to state borders may “tax shop,” hopping over a state line for lower burdens, but most migrants aren’t doing anything so simple. Taxes are just one part of a very complicated process. For some migrants higher taxes may even be a good thing: low-income migrants with little hope for their own future economic advancement may prefer higher taxes on rich people, for example. People with high savings rates may prefer higher sales taxes than income taxes. In general, higher taxes discourage migrants, but every migrant is different, and every tax is different, so the “general case” can’t be directly and simply applied. Taxes matter, but they don’t matter in a simple way.
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Follow me on Twitter. Follow my Medium Collection at In a State of Migration. I’m a grad student in International Trade and Investment Policy at the George Washington University’s Elliott School. I like to write and tweet about migration, airplanes, trade, space, and other new and interesting research. Cover photo from Unsplash.
This post may have raised a lot of questions for you, like what specific effects certain taxes have, where you can find academic papers on this issue, how taxes impact economic growth, or what’s causing inequality. For answers to those questions (or explainations on why I’m not going to answer those questions), go to the technical notes post I’ve written. There were so many side-issues and perhaps excessively nerdy tangents when I originally wrote this that I’ve decided to exile them to a methodological post. Warning: only for truly brave souls. Here be dragons.
