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Joel Slemrod
  Joel Slemrod

Wealthy Retirees Opt for Fun in the Sun - and Low State Taxes

6/21/2005 --
The elderly rich tend to leave states that impose heavy taxes on estates and inheritance, as well as purchases, to resettle in states with relatively low tax rates.

ANN ARBOR, Mich.—Well-heeled retirees often relocate to warmer climes in search of sunny skies and year-round golfing, but they also do it to avoid paying higher taxes, says a University of Michigan economist.

A new study by Joel Slemrod of Michigan's Stephen M. Ross School of Business and colleague Jon Bakija of Williams College suggests that wealthy elderly people change their real (or reported) state of residence to avoid paying high state taxes, particularly those that target estates and inheritance, as well as purchases.

High personal income taxes and property taxes levied by states also give upper-bracket taxpayers additional incentives to pack up their bags and head for fun-in-the-sun places with lower, less progressive tax rates.

"The wealthy elderly are now almost exclusively the ones impacted by state estate and inheritance (EI) taxes, and their behavior may have special implications for the optimal progressivity of a state tax system," said Slemrod, professor of business economics and director of the Ross School's Office of Tax Policy Research.

Slemrod and Bakija examined how wealthy elderly people in all 50 states respond to state tax policy by the decisions they make on where to reside. They utilized data on the number of federal estate tax returns filed in each of five wealth categories for 18 different years between 1965 and 1998.

The researchers found that the number of federal estate tax return filers reported as residing in each state is negatively influenced by the level of taxes imposed on high-income and high-wealth people in that state—suggesting that taxes act as a deterrent to location.

Generally speaking, a one-percentage-point increase in the effective state EI average tax rate targeted specifically at the wealth classes is associated with a 1.4 percent to 2.7 percent decline in the number of federal estate tax returns filed in the state. Individuals who have estates over $5 million are particularly sensitive to the EI tax, declining by nearly 4 percent in response to a one-percentage-point rate increase.

In addition, Slemrod and Bakija report that sales tax, income tax and property tax rates also have similar and sometimes larger negative effects on the number of federal estate tax returns filed in a state, because, other things being equal, the rich prefer not to live in a state that taxes them heavily.

"Our results support the idea that state governments face a trade-off between raising revenue in a progressive fashion and the efficiency costs of that approach, and should take tax-induced migration and related avoidance activities into account when setting tax policy," Slemrod said. "Out-migration by high-income people and in-migration by low-income individuals may have undesirable effects on other state tax revenues, as well as policies and programs."

The researchers say their findings take on added significance as states "decouple" from the federal estate tax cut. The 2001 federal tax legislation includes a phase-out of the federal estate tax, resulting in full repeal by 2010. Over the next several years, the 2001 tax bill also repeals the federal estate tax credit, to which state EI taxes are tied.

Consequently, many states face either a full or partial loss of EI tax revenue. Individual states can avert this revenue loss by "decoupling," which enables them to protect the relevant parts of their tax code from the changes in the federal tax code—in most cases by remaining linked to federal law as it existed prior to the 2001 change.

Decoupling has negative implications for the elderly rich, who tend to flee from states where their EI tax rates are high, Slemrod and Bakija say. Currently, the District of Columbia and the following states are decoupled from the federal changes: Kansas, Illinois, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, North Carolina, Ohio, Oregon, Rhode Island, Vermont, Virginia, Washington and Wisconsin.

"Our results imply that in the case of a decoupled estate tax, revenue loss and deadweight loss from these particular forms of behavioral response are unlikely to be large relative to revenues collected," Slemrod said. "The deadweight loss of a tax is the additional time and money taxpayers lose in documenting, computing and avoiding taxes over and above the actual taxes they pay."

For more information, contact:
Bernie DeGroat
Phone:(734) 936-1015 or 647-1847