December 17, 2018

The Millionaire-with-a-suitcase: Man or Myth?

For nearly a decade, it has been the favorite argument of those opposed to higher state taxes for Connecticut's wealthy — migration.

Simply put, if you tax them, they will leave.

For Republicans — and many moderate Democrats — income and wealth migration is not only a very real threat, but a problem that's already upon us as Connecticut increasingly raises taxes to cover surging pension costs.

Among labor, urban Democrats and other progressives, however, the millionaire-with-a-suitcase is a myth, a fiscal boogey man used to scare liberals.

But despite the preponderance of stories of wealthy residents fleeing Connecticut, the empirical evidence shows the rich tend to move less frequently than low- and middle-income residents. The need for employment is still one of the main reasons people move while home and business ownership — most common among high-income households — promote stability.

More importantly, income migration hasn't been a big driver of states' overall economic health. One of the largest tax cuts for the rich in modern Connecticut history nearly three decades ago did not spark a influx of millionaires into this state.

But that doesn't mean Connecticut has nothing to fear.

Research shows the wealthy pay more attention to state tax rates than any other economic class. Although the sample size is small, the ratio of income leaving Connecticut versus that moving in has accelerated in the last few years.

As decades of fiscal carelessness at the Capitol garner increasing media coverage, Connecticut's affluent can see a scenario in which they long have been targeted to pick up the tab. And as politicians raise state taxes with increasing frequency, while the highways and rail systems serving Fairfield County slow down, wealthy families say they are losing patience.

"People move because of professional opportunities," said University of Connecticut economist Fred Carstensen, who heads the Connecticut Center for Economic Analysis. "They retire and choose a lifestyle, which leads some to move. Taxes have ranked as a particularly strong driver. It's not that important. But it's a convenient thing to talk about."

But former hedge fund manager David Stemerman of Greenwich, a Republican who centered his 2018 gubernatorial bid on a message that Connecticut taxpayers have been taken for granted for decades, said a reckoning is underway.

"This assumption that the wealth in Fairfield County would always be there was built up, to some degree, by a lack of engagement from Fairfield County," Stemerman added. "But they also have the view that they've been taken advantage of. Well, the door swings both ways."

Migration trends at first glance

At first glance, income migration appears very real.

Connecticut lost $16.33 billion in annual federally adjusted gross income between 1992 and 2016 according to an analysis of tax data prepared by regular Forbes contributor Travis H. Brown, creator of the website howmoneywalks.com

It was one of 25 states that lost income during that period due to migration.

There are exceptions. Hawaii, which ranks third in median household income, gained a modest $933 million in annual adjusted gross income. [The biggest winners and losers saw differentials in the tens of billions of dollars.]

But many of the biggest losers on that list are states that ranked — and still rank — among the highest in income in the nation. Besides Connecticut it also includes California, New Jersey, Maryland and Massachusetts.

In other words, the people moving out of rich states usually are richer than the people moving in, year after year.

Not surprisingly, the reverse is also generally true.

Of the 10 poorest states based on per capita income, four lost income via migration between 1992 and 2016, and only two — Louisiana and Oklahoma — lost more than $1 billion.

Arkansas gained $2.66 billion during this period, consistently adding income most years — yet still scores badly on most metrics used to measure poverty.

But even after the annual exodus, the rich states usually are still rich and the poor states usually are still poor.

According to statistics from the state Department of Revenue Services, the number of Connecticut households that reported earning more than $1 million erupted upward by 124 percent between 2002 and 2007, after climbing just 8.6 percent over the prior five years. This happened even while income was migrating annually out of the state.

Simply put, the boom within Connecticut overwhelmed any migration trends.

Embedded elites or transitory millionaires?

So maybe migration hasn't been a key factor in moving a state up or down the wealth scale, at least so far.

An analysis published in 2016 in the American Sociological Review concluded the wealthy generally are "embedded elites" and not "transitory millionaires."

"We find that millionaire tax flight is occurring, but only at the margins of statistical and socioeconomic significance," wrote the panel of Stanford University sociologists and U.S. Treasury Department economists, who reviewed census data and 45 million tax records dating back 13 years.

Researchers concluded the wealthy are sensitive to state and local tax rates, more so than the rest of the population.

But they are different in other ways as well.

Wealthy households "are embedded in the regions where they achieve success, and they have limited interest in moving to procure tax advantages," researchers wrote.

Why so? The study found that richer people are more likely to be married — [singles are twice as likely to migrate as couples] — have children, and to own their own homes and businesses.

It also found the business connection should not be underestimated as an impediment to moving.

"When economic success is a joint product—rather than a purely individual accomplishment—there is a difficult network coordination problem for migration: one's own willingness to migrate for tax purposes must align with that of co-founders, collaborators, and perhaps even clients," analysts wrote. "People who achieve top incomes, in this view, are deeply embedded insiders who yield remarkable returns in part because of their social placement in a localized economic world."

The study found the migration rate nationally of households reporting more than $1 million in income per year was 2.4 percent — which is lower than the 2.9 percent rate for the general population.

Researchers did find that "Florida appears to be the core pathway for tax-induced migration," but other low-tax states are nowhere close to being equally attractive to the wealthy.

Florida, which ranked 39th in per capita income in 2017 according to the U.S. Census Bureau, gained the most income through migration. But Florida generally is considered an outlier, given its extremely attractive climate.

"When Florida is excluded, there is virtually no tax migration," the report states.

CT gave the rich a big tax break in 1991

The 2016 study of millionaire migration found much of the growing interest in higher tax rates for the wealthy is a response to federal tax policy of the past three decades.

That policy largely was "a shift away from taxation of the elite," a process "to untax the one percent" that includes reductions in tax rates on top incomes, capital gains and multi-million dollar inheritances.

An Oct. 23 poll commissioned by Sacred Heart University and Hearst Connecticut Media Group found almost two-thirds of Connecticut voters support raising income taxes on millionaires to balance the state budget if cuts to services can't do the job.

One hole in the millionaire migration theory can be found through an analysis of federal tax data and Connecticut history.

One of the forgotten side effects of the establishment of a state income tax in 1991 was that it offered an enormous tax break for Connecticut's wealthiest residents — who already had been paying income taxes for 20 years prior.

Connecticut used to impose taxes on capital gains, dividends and interest — provided a household made enough of them — since the early 1970s.

By 1991, Connecticut taxed capital gains at 7 percent. The top rate on dividends and interest was 14 percent. But once the state income tax was established, all earnings — capital gains, dividends, interest and general wages — were taxed at the same, flat 4.5 percent rate.

That was huge for Connecticut's wealthiest households, which traditionally derive the bulk of their income from investments.

According to a 2018 report from the legislature's nonpartisan Office of Fiscal Analysis, a Connecticut household earning $96,000 per year generates less than 10 percent of its income from investments.

For a household making more than $2 million per year, the average share approaches 79 percent.

Even today, the top rate on the state income tax stands at 6.99 percent. That effectively matches the capital gains rate pre-1991 and represents only half of the top rate from back then on dividends.

In other words, many of Connecticut's wealthiest households pay the same or a lesser effective income tax rate now than they would have in 1991.

And when Connecticut dramatically cut taxes on investment earnings 28 years ago, did the rich come pouring into the state?

According to Internal Revenue Services' tax migration data, the incomes of those moving out of Connecticut topped those of the households moving into the state for the entire decade of the 1990s.

Major tax hikes coming more frequently

But this doesn't mean wealth and income migration don't exist. And there are reasons, Carstensen said, why Connecticut policymakers should be concerned.

For one thing, it's a short ride to any of Connecticut's borders.

"We have the highest proportion of residents who work out of state of any state in the country," Carstensen said, adding that's a major reason one key metric of economic health has been sketchy.

Economists look not just at overall state income tax receipts, but also at what share they represent of overall household income.

Total receipts fell from almost 3.9 percent of total household earnings in Connecticut in 2012 to 3.6 percent in 2014, the last year of available data, Carstensen said.

Much of that decline, he added, involves Connecticut's struggles to regain financial services sector jobs lost in the last recession. Some of those displaced Connecticut residents found new jobs — in New York and New Jersey.

And there is another issue. The state tax hikes are coming more frequently.

A poll released in the summer of 2009 by Quinnipiac University found 55 percent of voters didn't believe increasing taxes would prompt the wealthy to leave Connecticut, compared with 42 percent who said it would.

But a few months after that the legislature and Gov. M. Jodi Rell agreed upon a new budget that increased taxes by nearly $875 million. The centerpiece of that plan was a big bump in the top marginal income tax rate, from 5 to 6.5 percent.

Two years later, Gov. Dannel P. Malloy signed into law a tax hike worth more than $1.8 billion per year. And while it also raised income tax rates on middle-income households, it boosted the top marginal rate to 6.7 percent. Malloy, who warned frequently about the threat of wealth migration, had inherited an unprecedented $3.7 billion deficit, equal to more than 18 percent of the General Fund, during his first year in office.

A third major tax hike in 2015, worth almost $900 million per year, included another boost in the top income tax rate, up to 6.99 percent.

Is income migration starting to accelerate?

Income migration out of Connecticut may be nothing new, but a small sample size shows the rate appears to be accelerating.

Though IRS tax migration data is available going back several decades, the federal government switched to a new measurement methodology beginning with its comparison of the 2011 and 2012 tax years.

According to that new methodology, the ratio of income leaving Connecticut versus that moving into the state is larger now than it was for most of the past two decades.

And the ratio has risen significantly during the last two years on record.

In 2014 the ratio of income moving out of Connecticut grew 1.31 times faster than the incomes moving into the state — when compared against the previous year.

By 2015 the exit ratio was 1.53-to-1, and by 2016 it had reached 1.80-to-1.

"There's a whole cottage industry of financial advisors that are talking to people about this (tax trend,) and showing them where else they can go," said Peter Gioia, chief economist for the Connecticut Business and Industry Association. "That's what is hurting Connecticut now more than anything, and I think it will continue to accelerate."

Gioia also dismissed the argument that migration isn't a problem as long as Florida is the only popular destination. One attractive alternative to Connecticut is risky enough.

"We're an old state and people want sunny weather," he said.

Decades of pension debt take taxpayers for granted

And don't underestimate the impact of growing news media coverage of Connecticut's irresponsible history of amassing pension debt, and the pressure it is putting on state finances, warned state Rep. Chris Davis of Ellington, ranking House Republican on the Finance, Revenue and Bonding Committee.

"If you speak to a lot of people, especially those nearing the end of their working years, they are looking at the state of Connecticut now and they see a mindset of perpetual tax increases," said Davis.

Stemerman, who lost a five-way GOP primary to former GE executive Bob Stefanowski, raised similar concerns during the campaign.

"What's happened in Connecticut is now so bad that people all over the state, including Fairfield County, know something is wrong," said Stemerman.

Connecticut amassed more than $80 billion in retirement benefit debt and other unfunded liabilities, with most of that damage done between 1939 and 2010.

For decades, governors and legislatures routinely shortchanged contributions to pension benefits they pledged to state employees and teachers — effectively mailing a bill to future taxpayers.

Sometimes the fiscal abuse was extreme.

For example, between 1979 and 1988, the state never contributed more than 40 percent of the recommended payment for the teachers' pension.

Analysts now are projecting debt costs will skyrocket over the next decade-and-a-half, placing extreme pressure on state programs — many of which have been cut in recent years — and taxes — which already have increased significantly.

Stemerman said those who discount the theory of wealth and income migration should not underestimate common sense.

The message Connecticut sent for generations is clear: The state could afford to postpone billions of dollars in contributions — thereby forfeiting billions more in potential investment earnings — because its wealthy taxpayers could always make up the difference at some time in the future.

"When I spoke to people about this, they were deeply disappointed, dismayed and disgusted by what they heard," Stemerman said. "The spoke about this in simple terms of fairness. They are being stuck with a bill from a failure to make responsible decisions."

According to state Department of Revenue Services' data, households that earned more than $350,000 per year in 2016 — just 3 percent of all filers — paid 41 percent of all state income taxes.

Stemerman said while he believes taxpayers across Connecticut feel taken advantage of when they hear the state pension history, the sticker shock is severe in Fairfield County because of geography.

"It is part of the New York media market," he said. "They are somewhat disconnected to what is happening in Hartford. Some feel they've been taken advantage of while they were not as engaged, or paying attention, as well as they should have."

Greenwich billionaire Thomas Peterffy attracted headlines in 2012 when he funded a SuperPAC that spent tens of thousands of dollars on commercials criticizing Democrats running for the state legislature.

Peterffy, who grew up in socialist Hungary and immigrated to the United States in 1956, eventually would launch Interactive Brokers, an online brokerage firm based in Greenwich.

"I grew up in a socialist country," he said in a Youtube video titled Freedom to Succeed. "And I have seen what that does to people. There is no hope, no freedom, no pride in achievement. The nation became poorer and poorer and that is what I see happening here."

Peterffy added that "America's wealth comes from the efforts of people striving for success. Take away their incentive with bad-mouthing success and you take away the wealth that helps us take care of the needy."

Peterffy moved to Florida following the 2014 elections.

The most recent Forbes magazine list of the nation's 400 richest people listed nine billionaires from Connecticut, which is two more than last year. But just a few years ago Connecticut boasted 13 billionaires.

Doing too much, or too little, for hedge funds?

And those wary of Connecticut's rising taxes warn that a small-but-vital component of the economy, the hedge fund industry, has great potential to be mobile.

According to the state's nonpartisan Office of Legislative Research, Connecticut has the second-largest hedge fund industry in the U.S. There are 211 hedge fund managers and about 700 hedge funds listed on Preqin's, a leading online industry information source.

Two of the world's largest, Bridgewater Associates of Westport and AQR Capital Management of Greenwich, managed $151.7 billion and $74 billion in assets, respectively, based on 2015 data.

Together they employ about 2,400 people.

Connecticut has provided more than $80 million in grants to the two funds combined — including more than $50 million to Bridgewater to develop a new headquarters in Fairfield County.

Still, at the inaugural Greenwich Economic Forum last month, investment business leaders expressed fears that Connecticut's hedge fund industry could shrink as other states try to lure managers away.

Bruce McGuire of Darien, president of the Connecticut Hedge Fund Association, said the state should be developing high-speed rail services, creating vibrant cities and offering tax incentives to preserve and grow an industry that pays more than its fair share of taxes.

Instead it has allowed its highways to become congested and rail service is slower now than it was decades ago.

"I live here, I spend money here, I bought my house here," McGuire, 54, said, adding that his daughter — a recent college graduate — went to work for a tech company in Boston. "Now I feel like I should be telling my son to go to New York, go to Boston."

Easing the taxes on the rich

If state officials underestimate public indignation when it comes to Connecticut's legacy of pension debt, some argue the estate tax is another major turnoff for the wealthy.

The tax is applied only to estates valued at more than $2.6 million, though the maximum tax liability starting in 2019 is capped at $15 million.

Still, Connecticut is one of 17 states that levies an estate or an inheritance tax, and the trend is headed away from Connecticut.

Indiana and Tennessee repealed their taxes in 2013 and 2016, respectively while Delaware's went away this year. New Jersey's estate tax will disappear starting January 1.

Congress recently raised the exclusion level on the federal estate tax from $5.49 million to $11.2 million.

Connecticut has adopted a plan to gradually raise its exemption level up to the federal threshold by 2020. But with major state budget deficits projected between now and then, it remains unclear whether the General Assembly will stick with that plan.

Eliminating Connecticut's estate tax entirely, while reducing income tax rates, were two of the key recommendations this year from the state Commission on Fiscal Stability and Economic Competitiveness, a 14-member panel dominated by business leaders.

The co-chairmen, health care entrepreneur Robert Patricelli and Webster Bank chairman and former CEO Jim Smith, have taken heat from labor leaders and other progressives for this plan. Even though it recommends boosting the minimum wage to $15 per hour, it hinges on tax cuts that benefit the wealthy the most.

To fund these tax cuts, the commission also recommends boosting sales and business taxes and cutting $1 billion from the state's operating budget. Given that most of the state's debt costs are fixed by contract, critics say this cut likely would fall heavily on municipal aid, driving up property taxes.

"The commission's proposals, taken holistically, can change Connecticut's future," Smith said.

Patricelli says the panel's work is not perfect, adding the group essentially had just two months to chart a blueprint for reversing seven decades of irresponsible budgeting and promoting statewide economic prosperity.

"There's still room for improvement," he said. "For example, we didn't have enough time to deal with property taxes," which disproportionately burden low- and middle-income households.

Gov.-elect Ned Lamont, who will take office early next month, is trying to strike middle ground.

Lamont, who tapped former Bridgewater executive Ryan Drazewicz as his chief of staff, has pledged to keep income and sales tax rates stable despite inheriting major deficit projections for the next two fiscal years.

But when it comes to tax relief, Lamont's focus for his first budget, due in February, is clear. "Connecticut's middle class deserves a break, and that's where we're going to concentrate the energies of this administration and the budget," he said.

Labor pushes back

Critics of the fiscal stability panel often point to one comment from commission member Cindi Bigelow, CEO of Bigelow Tea, who said during a Feb. 9 public hearing that "We want to make sure we are protecting the wealthy because they will just leave."

The state's labor leaders, who've been among the commission's most vocal critics, argue the panel's plan is founded on the myth of income and wealth migration.

Donald E. Williams Jr., executive director of the Connecticut Education Association — the state's largest teachers' union — said the commission report "puts coal in the stockings of the state's middle class and gives diamonds and furs to the state's wealthiest residents."

Salvatore Luciano, the new head of the Connecticut AFL-CIO, said too many state officials won't tell the public the truth: the fastest-growing state expenses have nothing to do with present-day state employees or teachers. Rather they involve fixing the fiscal sins of legislators and governors from decades past.

Meanwhile, spending is draining resources from transportation, education, health care, municipal aid and every other priority voters care about.

Executive branch staffing during the eight years of the Malloy administration is down more than 9 percent.

"That lack of spending is really what's dragging the economy," Luciano said. "Meanwhile the overall tax rate for the wealthy has gone down" compared with 1991.

"People go where their quality of life is high," Luciano added. "The more austerity in our budget, the further away we are from our goal for Connecticut."

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