Blue States Will Pay Obama Tax Bill

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Much has been made in the current presidential campaign about the way that Barack Obama’s tax plans would redistribute money among income groups. But changes in tax policy also redistribute income geographically, because states and regions have different concentrations of wealth. Obama’s tax plan might produce one of the most radical geographic redistributions of income propelled by the tax code since….well, since President Bush’s tax cuts. And, ironically, some of the biggest losers would be states where Obama has the greatest support.

To get a glimpse of how this redistribution might work, I took a look at a study done by E.J. McMahon at the Manhattan Institute’s Empire Center for New York State Policy. Crunching data from the Internal Revenue Service, the Congressional Budget Office and the New York State Department of Taxation and Finance, where he was once deputy commissioner of tax policy, McMahon compares the flow of tax dollars from New York to Washington under changes in the income tax code proposed by both candidates. Other states with higher-than-average family income could expect similar patterns.

McMahon estimates that McCain’s tax plans would be a modest win for New York, allowing its citizens to keep about $1 billion of income in the next two years that they might otherwise send to Washington. Those gains would come largely because of the impact of his plan to increase the exemption that married couples earn for each dependent to $7,000, from $3000.

This would be in addition to the impact of the tax cuts of 2001 and 2003, which proved a huge boon for New York. According to McMahon’s study, by 2004, when the full effect of those tax cuts were in place, New Yorkers were saving nearly $14 billion a year in federal income taxes, boosting after-tax income of the state’s residents by 2.7 percent on average. As that great New Yorker Damon Runyon might have put it, that’s a lot of cucumbers.

Obama’s plan would have quite a different effect, largely because it would roll back the tax cuts of 2001 and 2003 on the top tax brackets and raise capital gains and dividend tax rates for those earners. While Obama would also cut taxes for lower income households, largely through a series of tax credits, those reductions wouldn’t be enough to offset the tax increases, so that New Yorkers would probably send about $3 billion more to Washington in the next two years than if the tax code were left unchanged. All told, the difference in the two tax plans represents a swing of $4 billion for the New York State economy.

The impact wouldn’t be limited to individuals, however. Obviously, taking money out of a private economy also influences state and local tax collections. McMahon’s study estimates that the net reduction in taxable income among New Yorkers under Obama’s plan would cut state taxes by about $800 million over two years, and New York City tax collections by $144 million. Considering that New York State has a projected two-year budget deficit of $14 billion, I supposed that the $800 million wouldn’t qualify as much more than a little bit of loose scratch, as Runyon would have described it.

Obviously, there are a lot of variables that could change these figures including the rapidly slowing economy, where incomes and investment portfolios are changing so quickly that many of us may be sending less to Washington no matter who’s in charge.

Still, it’s a pretty good bet that changes in tax policy would have roughly the kind of impacts outlined in McMahon’s study, and obviously not just for New York. Other states with higher-than average incomes and with concentrations of high-income earners would be similarly affected, most especially Connecticut, New Jersey, Maryland, Massachusetts, Rhode Island, Maryland, New Hampshire, New York, and California. My handy online RealClearPolitics electoral map tells me each of those states will go fairly easily for Obama. This shouldn’t be surprising. Each of those states voted for John Kerry in 2004 even though they probably all realized a big benefit from the Bush tax cuts.

There are several explanations for this. An obvious one is that although these states have more higher-income earners than the country in general, those who might benefit from an Obama tax plan still outnumber those likely to pay his tax increases.

But that doesn’t completely explain the electoral map. There’s something else going on, as Columbia University political scientist and statistician Andrew Gelman notes in his new book Red State, Blue State, Rich State, Poor State. Gelman observes that while lower-income voters are more likely to vote Democratic everywhere, voters in moderate and high income households are more likely to vote Republican in red, or conservative states, and equally as likely to vote Democratic as Republican in blue, or liberal, states. What accounts for this? Looking at the differences among wealthier voters in these states, Gelman finds one distinction that is compelling to him: In blue states, wealthier voters tend to be more secular, and in red states they are more likely to be religious. Simply put, many higher-income citizens may be voting according to their cultural or religious values, not their pocketbooks.

Of course, just because people vote their cultural values doesn’t mean they don’t act in their own economic interest. If Obama does raise taxes on high income earners it is almost certain, based on prior tax increases, that some of those affected would do what they can to minimize the additional tax bite. One common strategy is to load up on tax-free investments, for instance. It’s no coincidence that New York City is one of the largest issuers of triple-tax free muni bonds in the country. The city’s high-earners have a big incentive to shelter income by snapping up munis, and they do so in record numbers regardless of how they vote.

Another strategy is to become less productive, something that’s easy for most high-income families to do by simply working less. According to Census figures, 76 percent of all families in the top income quintile contain at least two adults working full time—more than in any other income quintile (this is actually how people become rich in America today). In some of these families with children it will make more economic sense for one parent to stay home with the kids and save money on day-care than subject a family’s second income to a 45 percent-to-50 percent combined federal, state and local tax bite. You can’t argue with those family values.

Of course, Obama’s supporters in blue states, which include most of the major political figures in these places, will argue that his presidency will redress the flow of tax dollars to Washington through policies that send more federal spending their way. But don’t believe for a moment that this will make a big difference. Back when Bill Clinton was elected president, New York Democrats were among the first to put their hands out. Then-New York City Mayor David Dinkins waited a mere 12 hours after Clinton was declared victor to release a 20-page wish-list for the city. But Gotham got little of what it asked for.

One person who understood why this strategy never worked was the late Sen. Daniel Patrick Moynihan. For nearly 25 years Moynihan sponsored a study which charted how much each state sent to Washington in taxes and how much it got back in spending. States like New York, New Jersey, Connecticut, California, and Massachusetts were losers. Toward the end of his life, Moynihan decided that trying to redress this deficit by arguing for more federal spending was fruitless, since the tax increases that financed federal spending ultimately came from the very same states, and politicians in other places weren’t about to let that change. “Keeping more of our money at home,” Moynihan argued, “won’t happen until we break the century-long habit of preferring that it go to Washington first.”

Instead, Moynihan proposed a “new federalism” that created a smaller national government focusing on things like national defense supported by much lower federal taxes rates. Leave money in the states, Moynihan argued, where the citizens of each state could decide what kind of government they want and how much they were willing to spend to pay for it.

Moynihan’s idea, of course, was widely ignored, and since then we’ve gotten bigger national government courtesy of the Republicans, and will get a still bigger one courtesy of Democrats. Which only proves, to paraphrase Runyon again, that the only thing people like Moynihan get for coming up with ideas like that is a reputation for coming up with ideas like that.

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