Date of this Version
National Tax Journal, December 2012, 65 (4), 1069–1092
Since at least Musgrave (1971) and Oates (1972), it has been argued that tax-induced migration severely hinders state attempts at redistribution, and this function of government should thus be administered at the federal level. Nevertheless, states continue to engage in redistribution. Furthermore, results from recent research on the relationship between taxes and migration are mixed, with some studies suggesting that tax-induced migration may be fairly small. Additionally, even if state-level redistribution is less effective than federal action, a role for state governments may remain if tastes for redistribution vary substantially across states.
This paper develops a simulation model that is used to examine the effectiveness of state attempts at redistribution under a variety of migration elasticity assumptions. Key outputs from the simulation include the impact of tax-induced migration on state revenues, excess burden, and fiscal externalities. With modest migration elasticities, the costs of state-level redistribution are substantial, but state action may still be preferred to a federal policy that is at odds with preferences of a state’s citizens. At higher migration elasticities, the costs of state action can be tremendous. Overall excess burden is greater, but this is dominated by horizontal fiscal externalities. Horizontal fiscal externalities represent a cost to the state pursuing additional redistribution, but not a cost at the national level. For example, with a migration elasticity of 0.3, a 3 percent surtax increases overall excess burden by just 1 percent (compared to a case where the federal government implements the identical policy). However, because of horizontal fiscal externalities, the welfare loss to the state imposing the surtax increases by 18 percent. For higher surtaxes and higher migration elasticities, these effects are magnified. With a 10 percent surtax, overall excess burden rises by 8 percent (again compared to identical federal policy) and the burden borne by the state imposing the surtax rises by 43 percent. With a migration elasticity of 1, these numbers roughly double.
The Institute for the Study of Labor (IZA) Discussion Paper version (August 2012) is attached below as an "Additional file."