Rising inequality and budget deficits brought about by the novel coronavirus have some clients asking PIMCO whether high-tax states will consider raising taxes further, and whether higher taxes will trigger a longer-term trend of outmigration.
On the issue of whether taxes will rise, there is little doubt.
Here are just a few examples:
- California suspended the use of net-operating-loss carryforwards, which allow businesses to reduce future tax liabilities. California has also temporarily limited business tax credits.
- New Jersey recently implemented a 20% increase in the state’s personal income tax for residents earning more than $1 million annually.
- Voters in the Land of Lincoln will consider a ballot initiative this November to change Illinois’ long-standing flat personal income tax to a progressive tax structure.
We remind clients that following the global financial crisis, most states enacted some form of a tax hike, including temporary (California, Illinois) and permanent (New York) increases in personal income taxes.
Will higher personal income taxes accelerate population outmigration?
We believe higher personal income taxes could, on the margin, accelerate some outmigration from high-tax states, but the academic research on the subject is inconclusive. Studies focused primarily on California and New Jersey find limited migration to lower-tax states, especially among wealthy residents. Studies have also concluded that overall migration among millionaires is relatively muted and has had minimal impact on the tax base of higher-tax states. According to researchers, this is due in part because high earners are more likely than the general population to be married, with resulting family commitments that lead to greater residential stability. Footnote 1
Indeed, individual mobility is often overstated, as lifecycle constraints, such as reluctance to pull children from schools, leave a job, or abandon social and cultural institutions, limit interstate tax migration. Each year, approximately 1%–2% of Americans move across state borders; the majority cite employment and family as their primary motivation – not higher income taxes.
Nevertheless, the risk of future outmigration from higher-tax states still exists. Federal taxes have become less progressive over the decades, while state income tax regimes have become more progressive. In addition, higher corporate income tax rates can have negative effects on economic growth, leading to loss of employment. Continued inequality and a large shift in urban-to-suburban migration has the potential to change human behavior in a manner that may result in higher interstate tax migration.
Will the pandemic lead to material urban outmigration?
There has also been considerable conjecture that the pandemic will spell doom for cities as residents flee for suburbia. In the suburbs surrounding New York City, fierce bidding wars have broken out – largely fueled by New Yorkers who are able to work remotely and are now seeking more space for their families. Footnote 2 Nonetheless, we believe the jury is still out on how pronounced this outmigration will be and whether it will prove ephemeral or longer-lasting. Geography may also play a role. Some early data suggest that move rates may have actually slowed in many parts of the nation during the pandemic. Footnote 3
It’s important to note that cities such as New York and San Francisco, which are often cited as epicenters of population loss, are still heavily reliant on property tax revenues. Because tax assessments do not typically occur annually, there is a considerable lag between migration trends that affect property valuations and diminished property tax revenues. This lag, coupled with direct federal support, would mean that cities have time to recover.
Additionally, what migration we do see out of large urban cores won’t necessarily harm the municipal markets in aggregate – particularly if pandemic-fueled migration benefits surrounding suburbs through increased housing prices and assessed valuations.
Could there come a tipping point at which urban outmigration accelerates, leading to credit downgrades that undermine investor confidence in the muni markets as a whole? It’s possible, and investors should be aware that the risk of longer-term demographic shifts may not be reflected in the price of some bonds today.
Nonetheless, with so many COVID-19 vaccines in the pipeline and the potential for additional federal support to state and local governments following the November elections, we don’t see urban outmigration leading to immediate credit stress.
Credit fundamentals are key
Demographics and migration trends in general, and tax flight in particular, are always part of our forward-looking credit analysis for all obligors, especially those that we believe could be experiencing tax fatigue. However, we balance these trends against an obligor’s overall credit profile. In our view outmigration does not always equate to credit risk, and how an obligor manages its finances and debt profile against demographic realities is far more predictive of credit quality.
It’s likely the pandemic will result in higher taxes for many Americans, while potentially influencing national migration trends. What effect these changes ultimately have on the municipal markets, however, remains to be seen.
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1 Source: American Sociological Association, 2016
2 Source: New York Times as of 30 August 2020
3 Source: Bloomberg CityLab as of 16 September 2020