Low Taxes Are Never Enough to Attract Wealthy Residents

(Bloomberg Opinion) -- As high-tax states like California, New Jersey and New York contemplate spending less or taxing even more, the backlash is growing. Now wealthy residents like Jeff Gundlach are grabbing headlines for expressing a sudden interest in “low tax, well governed” states.

Could millions follow Gundlach’s lead, fostering an exodus? Since the 1950s, the question has kept countless social scientists gainfully employed.

Charles Tiebout, an economist and geographer at the University of Washington, cracked open the debate in 1958, publishing a now famous paper in the Journal of Political Economy. At the time, most economists had more or less concluded that public goods and services – schools, trash pickup, and many others – were not responsive to market forces. Unlike ordinary consumers, who can withhold purchases or only buy things when the price drops, taxpayers didn’t have that option: They pay the tax and they get the services, whether they need them or want them.

Tiebolt took issue with this consensus. He argued that geographical mobility offered a way for ordinary citizens to bring market forces to bear on the unresponsive beast of government. Tiebolt put it this way: “Just as the consumer may be visualized as walking to a private market place to buy his goods, the prices of which are set, we place him in the position of walking to a community where the prices (taxes) of community services are set.” As he bluntly summarized his argument: “Spatial mobility provides the local public-goods counterpart to the private market’s shopping trip.”

This was an elegant explanation, and it made a lot of sense: Tiebout’s “consumer voters” would shop around for locales that hit the sweet spot of maximum services for minimum taxes. He gave an example where lifeguards in a town with beaches got higher wages through higher taxes. Residents who didn’t care about beaches would have to make a decision: Eat the cost or pick up stakes. Either way, market forces would triumph.

Academic economists embraced the idea, comparing it to the magic equilibrium they saw in the private economy. But as Tiebolt himself acknowledged, it actually wasn’t so simple. And this was the part that got lost in subsequent popularizations of what became known as the “Tiebout hypothesis.”

First, Tiebout had titled his paper “A Pure Theory of Local Expenditures.” This wasn’t a reflection of the messy reality of life, but a rarefied abstraction. In a footnote, he even acknowledged that he was proposing an “extreme model,” where residents chose to put all their worldly possessions into a moving truck with the same carefree calculation that they brought to the purchase of pork chops.

Despite Tiebout’s warnings, social scientists immediately set out to test the theory as they understood it, making many mistakes in the process. For starters, it was silly to assume that everyone was equally mobile. In fact, the people directly affected by property taxes – homeowners, not renters – were far often more constrained in their ability to move at a moment’s notice. Taxes, then, weren’t the same as prices for ordinary goods and services.

Moreover, critics who started to test this theory found that most mobility was driven by other factors: loss of a job, desire to relocate near children, frustration with cold winters and a host of other variables that have little or nothing to do with taxes. The idea that the average American spends their days weighing where to move exclusively because they’re shopping around for lower taxes wasn’t reflected in the data.

This isn’t to say that taxes weren’t a factor. Plenty of studies suggested that it was an important factor in some cases. But packing the moving van wasn’t most people’s first impulse. Instead, the typical response to an unwanted mix of taxes and services is to get involved in local politics. As one critic put it, “households vote far more often with heads and hands than their feet.” When Californians got angry about rising property taxes in the 1960s, they didn’t move. Instead, they passed Proposition 13, then clung to their houses, and the sweet deal they made for themselves.

Despite the many flaws and qualifications attached to the Tiebout Hypothesis, the idea that localities should compete with one another to attract residents became an article of faith among proponents of a smaller national government. From the 1980s onward, Tieboutian ideas fueled the movement to shift taxing and spending policies away from the national stage and hand it over to states and municipalities. This culminated in the welfare reform legislation of 1996.

By this point, though, a growing chorus of critics pointed out a more unpleasant side to all of this. In the original version of the hypothesis, people voted with their feet. But what if some localities tried to keep certain people from arriving in the first place -- disabled people who needed special services, welfare recipients and others? As these critics pointed out, there would be a race to the bottom, with states cutting certain kinds of benefits, hoping to shunt dependent and needy people to more welcoming, higher-tax locales.

As the studies piled up, though, there was a growing awareness that simply cutting taxes and welfare benefits wasn’t going to magically attract well-heeled residents and keep out everyone else. In fact, a new consensus emerged. Yes, Tiebout’s “consumer voters” will factor in state income tax and local property tax burdens when considering a move. But the actual goods and services gained by moving – you know, those things paid for with taxes – also played a constructive role in their decisions.

Much of this research has found that the quality of the education system has been especially important, and may be as strong a factor as the relative tax burden. This may help explain a state like Massachusetts, which has very high taxes but the highest-rated public schools, isn’t losing population. States like Mississippi, which has low taxes but poor school systems, are suffering an exodus.

All of this has left us with a somewhat paradoxical conclusion: People like to move to places that have both lower taxes and great public services paid for by those taxes. What this means in practice is that residents don’t really object to taxes; they object to the inefficient use of taxes. States that are most efficient at delivering good public schools become the most attractive for prospective residents. And states that simply take a hatchet and cut everything, destroying schools in the process, like Oklahoma, are going to lose residents.

But these are subtleties largely missing from the breathless coverage of wealthy residents threatening to abandon high-tax states. They may well move. But their motives for moving, never mind the destinations they choose, aren’t going to be driven by a simplistic quest for low taxes.

But even Charles Tiebout could have told you that.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to Bloomberg Opinion.

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