After rapid growth in 2021 and early 2022, federal and state income tax revenue collections have stalled, and, in some cases, declined. This may be a temporary soft patch arising from Federal Reserve tightening or a longer‐term phenomenon. For governments with high‐income tax dependency, the durability of this downturn will be an issue hovering over their next budget cycle.
The latest Monthly Treasury Statement shows personal income tax revenue running well below prior year levels and budgetary forecasts. Together with higher‐than‐expected debt service costs, these weak income tax collections are driving the federal deficit well above expected levels.
The effect on states varies. While several states collect minimal or even no personal income tax, Census Bureau figures show that nine states obtained most of their tax revenue from this source in 2021. Among these are the big blue states of California and New York as well as other states with varying political orientations including Georgia and Utah. The state most dependent on income taxation is Oregon, which derived 63 percent of its tax revenue from that single source in 2021.
Thus far, New York State’s challenges have been most apparent. For the first three months of its current fiscal year—April, May, and June—income tax collections were down 32.8 percent from the same three‐month period in 2022.
Because New York has a highly progressive income tax system, collections depend on a relatively small number of taxpayers. The top state tax rate is 10.9 percent, but for New York City residents marginal tax rates peak at 14.776 percent. Preliminary revenue data for 2021 indicates that 1.5 percent of income tax filers accounted for 43.5 percent of total state personal income tax revenues.
Those in the highest tax brackets tend to have volatile incomes from capital gains (or losses), cash bonuses, and equity‐based compensation. Stock market weakness in 2022 crimped these income sources. That could also be a cause for optimism because the stock market has been rebounding in recent months.
But New York is vulnerable to another issue with high‐bracket taxpayers: their propensity to relocate. The State Comptroller reports that 1.9 percent of taxpayers reporting income of over $1 million left New York State in 2021 and that outmigration among this category of taxpayers has continued since, albeit at a slower rate.
The main beneficiary of outmigration from New York is Florida, which has seen rapid in‐migration often attributed to its business‐friendly regulatory environment and lack of a state income tax. But recent Census data show that Miami, a city that had been attracting New Yorkers, lost population between 2019 and 2022. This finding led Paul Krugman to conclude that “the buzz around finance moving to Miami seems to have died down.” Krugman goes on to note, however, that it is Miami’s rising home prices that appear to be driving residents out (mostly to other parts of Florida). A higher median home price is unlikely to be much of a deterrent to high‐income individuals looking to relocate from New York. It is also worth noting that West Palm Beach, which has been attracting New York‐based hedge fund managers, continues to grow.
Another state that has seen declining income tax receipts is California, where marginal rates top out at 13.3 percent. June 2023 income tax collections of $9.6 billion fell far shy of the $13.5 billion the state received in June 2022. While May collections were relatively flat, April saw a 71 percent drop in collections, although that was mostly due to the postponement of the 2022 tax year filing deadline to October due to floods.
Like New York, California has been suffering outmigration, but a recent Bloomberg article cited by Krugman questions whether it is the rich who are leaving. Bloomberg cites state data that shows a 116,000 increase in the number of taxpayers reporting over $1 million of annual income between 2019 and 2021. But it is likely that most of this increase is due to existing residents reporting higher income due to the stock market boom of 2021. We will need to see data for subsequent years to determine whether California is retaining, let alone attracting, high‐income taxpayers using this metric.
By contrast, IRS migration data show that California that net outmigration cost California $29 billion of taxable income in 2021, although it is not clear how much of that amount is related to high‐income taxpayers.
Earlier, I mentioned that Georgia and Utah, two more fiscally conservative states are also highly dependent on income tax revenues. But, unlike New York and California, these states do not have highly progressive income tax rates. Utah has a flat 4.85 percent rate while Georgia has graduated rates of up to 5.75 percent but is now migrating to a flat rate of 5.49 percent.
Unlike New York and California, these states had net inflows of taxable revenue in 2021. But they may not be doing so well in 2023. An analysis of Georgia’ monthly revenue reports suggests a 25.4 percent decline in income tax revenue for 2023’s second calendar quarter versus the prior year, which is only marginally better than New York State’s results. Utah does not provide monthly figures but for the full fiscal year ended June 30, personal income tax collections declined 5.3 percent.
So, it appears that relatively low‐ and flat‐income tax rates do not fully shield against the revenue volatility that comes with levying a personal income tax. While the best policy is to eliminate state income taxes, those states that retain them should monitor revenues carefully and use reserves to cushion the impact of fluctuations.