Two weeks ago the London School of Economics International Inequalities Institute hosted a conference featuring the latest research on income and wealth taxation. The papers generally examined these policies’ impact on migration trends and, to some extent, on a jurisdiction’s overall economic well-being. The main topic was taxpayers’ sensitivity to increases in tax rates and the extent to which this sensitivity influenced their decision-making about migration. Some work also addressed the impact of migration on innovative activity within countries receiving new immigrants.
One of us (Rauh) presented his own migration research on California taxpayers, which finds substantial tax sensitivity in location choices, but most of the policies studied at the conference came from the UK, France, and Italy. We took away the following main points.
1.) Outmigration effects of increases in top ordinary tax rates at the country level in Europe have not been large, but the extent of reduced economic activity by stayers in response to tax policy is unknown.
In one of the papers, Arun Avdani studies the UK’s increase in the top marginal tax rate from 40 percent in 2009/2010 to 50 percent in 2010/2011, and France’s increase in the top rate from 41 percent to 45 percent. The paper estimates baseline levels of departure to address the possibility that tax events might merely have accelerated the departures that would have happened anyway. For both reforms, the authors find small effects. Natives appear not to respond much at all to the tax changes, and foreigners with the least amount of time spent in the country prove most responsive.
But perhaps a narrow focus on migration is going to miss some important effects. Rauh and Shyu (AEJ:Policy 2024) study increase in California’s top marginal tax rates and find intensive margin effects (reductions in the earnings of high income stayers due to reduced economic activity or avoidance) whose revenue impacts are approximately 9 times larger than the effects of people leaving. Behavioral responses by taxpayers eroded 60.9 percent of the counterfactual no-response revenue gains within two years, mostly driven by the responses of stayers.
What’s happening with the UK? It just recently experienced negative per capita GDP growth and has generally seen its standard of living fall behind many peer countries due to its weak economic performance over the last decade. While other countries have faced similar slowdowns in their economic growth rates since the Global Financial Crisis, the UK has performed markedly worse relative to other developed Western countries. Van Reenan and Yang (2023) find that while the UK, U.S., France, and Germany all experienced relatively worse growth rates in the aftermath of the GFC relative to their pre-trends, the U.S. produced 28 percent more value added per hour than the UK, and the French and Germans were 13 percent and 14 percent more productive per hour than their UK counterparts, respectively. According to the authors, half of this outsized slowdown was simply due to a lack of investment in capital and skills. With this in mind, incentivizing higher levels of investment is vital for the UK.
2.) Effects of closing tax loopholes for high-income individuals depend on how “attached to place” the targeted are.
Imagine that you could move to another state or country, leave your investments behind, and neither your new nor old jurisdiction would tax the return on the investments. That could make moving very attractive! As it turns out, almost 30,000 individuals live in the UK under these terms - 86 percent of them are in the top 1 percent and 29 percent are in the top 0.1 percent of the income distribution.
But in 2017, UK lawmakers decided to close this loophole for taxpayers who had been resident for at least 15 years. David Burgherr presented research he conducted with Advani and Andrew Summers, looking at these tax changes. The treated UK residents suddenly had to pay tax on offshore investment returns, which resulted in an 18 percent fall in the share of their income they could keep post-tax. When comparing emigration rates of these taxpayers to those of taxpayers falling just below the threshold, the authors found the implied elasticity of the emigration rate with respect to a 1 percent increase in the net-of-average tax rate was small. Additionally, UK-reported income increased by 165 percent, translating to an increase in taxes paid of more than 150 percent.
Increasing revenues without observing strong behavioral responses is often viewed as a policy victory. Clearly those who have lived in the UK for 15 years are strongly attached. If the goal is simply to raise revenue, this policy change was low hanging fruit. Taken in isolation, the implications of this change for attracting new residents would perhaps be low. But its enactment raises uncertainty about future policy and whether the government will eliminate this tax break entirely, which very likely would negatively impact decisions by the wealthy to move to the UK. As mentioned above, the UK has already struggled to keep pace with other developed countries as evidenced by the decade-long stagnation in wage growth and recent negative trend in per capita GDP growth. Further taxation on the class of individuals with the highest propensity to invest seems likely unwise despite whatever short-run benefits there may be in government revenues.
Olivier Marie presented on a separate but related question that he and his co-authors studied in the Netherlands. Specifically, do recently emigrated, high-skilled immigrants leave a country once they lose a tax exemption? The paper focuses on a law in 2007 that changed the tax exemption to no longer include Belgium and Luxembourg as places from which immigrants could qualify. Those who lost eligibility status stayed on average 5.3 fewer months than those who kept it, and there was a 13 percent decrease in the probability of treated individuals spending more than five years in the Netherlands beyond the loss of the tax break. This response was most heavily concentrated among taxpayers in the top 5 percent and top 1 percent of income earners.
These results serve a warning to policymakers targeting the footloose by closing tax breaks. Doing so either on taxpayers who are not strongly attached, or prospectively on those who might choose how attached they want to become, will have both revenue and overall economic welfare effects. US taxpayers have been shown to be not very attached across states. How attached are they to the US overall? If tax rates get high enough, we might find out.
3.) In at least one prominent case, using new tax breaks to attract those who left to come back has worked.
Giuseppe Ippedico presented a paper that focused on the 2010 Italian tax scheme Controesodo, the “counter-exodus” policy. This tax scheme provided college-educated expatriates roughly under the age of 40 who returned to Italy a substantial income tax exemption for an average time period of 3 years. The authors find that the tax exemption proved successful, in that eligible individuals were 27 percent more likely to return to Italy after the reform. A cost-benefit analysis shows that the program in fact managed to more than pay for itself, even considering that some returnees would have returned anyway.
Perhaps California could try such a policy to incentivize more of the Covid leavers to return. While locals who stayed might cry that this is unfair, the Italy paper suggests that it could be quite effective tax policy.
4.) Impacts of wealth taxes - Beware side effects on income tax base and wealth accumulation.
(i) Spain/Madrid - Exploiting variation in wealth taxes in different regions of Spain introduced after a 2008 tax reform Clara Martinez-Toledano presented a paper studying wealthy-taxpayer movements to Madrid – the only region of Spain which kept a zero effective tax rate on wealth. The authors found an approximate 7.5 percent increase in the wealthy population in Madrid by six years after the reintroduction of wealth taxes and a fall of 1.7 percent in the wealthy populations of all other regions. The paper also measures income tax losses which are 6x the wealth tax losses, highlighting this additional problem with wealth taxes. Thus, when geographical barriers are reduced significantly, wealth taxes could potentially have a catastrophic impact on local budgets.
(ii) Sweden - Camille Landais and co-authors look at Sweden’s abolition of its wealth tax in 2007 to estimate its impact on wealthy earners’ migration patterns as well as that out-migration’s impact on the Swedish economy. The authors find that for every one percentage point increase in the effective tax rate on wealth there is an increase in net out-migration of 0.22 percentage points. According to the authors, this change is negligible and translates to small impacts to the Swedish economy. More specifically, upon an outmigration event, Sweden loses SEK 13k per year from the wealth tax and over SEK 200k per year from lost income tax revenue. However, according to their model these events are relatively rare: increasing the effective average tax rate on wealth only results in a decrease of 1.76 percent to the steady-state stock of wealthy taxpayers.
The key question this research leaves open is what the changes would be to taxpayer wealth building behavior. This could manifest in a number of ways such as increases to private investment as well as new domestic firms registered. We took a cursory look at the data for “new businesses registered” in Sweden before and after the abolition of the wealth tax. The number of new businesses registered in Sweden significantly increased after the tax law’s repeal, and that number has remained consistently much higher than the pre-period over the course of the last decade. Whether or not this change is causally related to this change in the tax law is unknown; however, these are the sorts of considerations that need to be taken into account prior to claiming that the impact of the law on the Swedish economy was relatively small.
5.) Migration, Entrepreneurship and Tax Policy
There were several papers on immigration broadly speaking and its benefits to host countries. Sari Kerr presented her and William Kerr’s paper on immigrant entrepreneurship, showing a series of descriptive statistics that illustrate the extent to which immigrants have contributed to the creation of new companies in the U.S. Studying the Longitudinal Employer-Household Dynamics (LEHD) Survey between 1992-2008, the authors find that immigrants generate approximately 1/4th of all new firms. There was a substantial rise in the share of immigrant entrepreneurs in their data increasing from 16.7 percent in 1995 to 27.1 percent in 2008. Immigrants who come to the U.S. as children are more likely to start larger firms that are associated with the largest employment outcomes.
While the descriptive results and trends found in this paper may hold when constructing newer, more open immigration systems, there are also reasons to believe that this may not be the case. The U.S. immigration system is often lamented as being inefficient and difficult to navigate. For example, in 2018, 27 percent of U.S. immigrants seeking visas through family members already in the U.S. have been waiting 10 or more years to have their requests processed. The types of people who successfully navigate such a complex system may be different from those who fail or opt out. Barsky et al. (1997) find that U.S. immigrants have high propensities for risk-taking relative to the majority population, while Bonin et al. (2009) and Kushnirovich et al. (2018) find the inverse to be true when studying risk-taking behaviors of immigrants in Germany and Israel.
Gianluca Santoni provided more detail on the impact of immigration, presenting his paper which looked at the growth of high-skilled immigration in France between 1995 and 2010 and its impact on patent filings. They too find innovative contributions on part of immigrants, finding that a 10 percent increase in district-level share of skilled immigrants led to an increase, on average, of 2.6 patents per 10,000 manufacturing workers. Results also show that the effect of skilled migrants is significantly higher than the effect of skilled natives.
Noting the outsized impact skilled immigrants have on areas in which they immigrate, it is worth noting the existing literature on tax rates and their influence on skilled immigrants’ destination decisions. Using data from the U.S. and European patent offices, Akcigit, Baslandze and Stantcheva (2016) study out-of-country migration trends finding that while domestic inventors show a small elasticity of just 0.03 (translating to an additional 1 percent of top 1 percent superstar inventors for a 10 percentage point decrease in the top tax rate from a level of 60 percent), foreign inventors are much more responsive with an elasticity of 1. This more substantial elasticity of 1 translates to a 26 percent increase in top 1 percent superstar inventors for the same 10 percentage point decrease in top tax rates. The elasticity is even higher for those foreigners who worked at multinational corporations.
Looking specifically at the U.S. and out-of-state migration, Moretti and Wilson (2015) find much more aggressive migration responses among star scientists to changes to personal and corporate income tax rates. According to their results, the long-run elasticity is 1.6 for personal income taxes, 2.3 for state corporate income taxes, and finally -2.6 for the investment tax credit.
Conclusions
The link between migration and innovation and whether tax/immigration policy can encourage that, i.e. types of migrants who will bring wealth, innovation, and jobs, is an important topic for further study. And while some of the papers at the conference showed little movement on part of taxpayers, particularly among the most attached and native taxpayers, when faced with increased income or wealth taxes, we believe these results do not provide support for increased policies of taxation and redistribution such as wealth taxes and higher top bracket income taxes. Especially in the U.S. national context, one should not anticipate most of the impact coming as a consequence of extensive margin (out-migration) effects, but rather the results of intensive margin effects of reduced economic activity by stayers. Furthermore, the outlooks of the countries emphasized for innovation and prosperity are at best fragile, and a focus on tax policy that improves the business climate would be more productive.