Whether the increasing divergence is a phenomenon driven by the pandemic influencing work and living locational preferences temporarily or a more permanent structural trend is an open question. (UBS)

Not surprisingly, income continues to migrate from the northeast, midwest and far west, to the south, southeast and southwest. Florida and Texas registered outsized and moderate net inflows respectively, while New York and California experienced significant outflows.

While the magnitude of income migration measured in absolute dollars provides an important regional perspective of domestic migration, net income flows as a percent of gross AGI for a given state over time provides a better perspective of the impact on a state's long-term economic and credit profile. Two items are particularly noteworthy in this regard. First, Florida and Texas are top gainers and California and New York are top losers of the migration dollars even as a percent of their already large income base. Second, the trend of inter-state income migration accelerated—i.e., the gap between the top gainers and losers widened.

Other notable net AGI recipients are Nevada (destination of a significant portion of people leaving California), the southern states of South Carolina and Tennessee, and the southwestern state of Arizona, as they continue to attract retirees from the northeast and high cost-of-living areas of California. Also, of note is Washington DC, as it continues to lose the most dollars as a percent of its AGI.

Whether the increasing divergence is a phenomenon driven by the pandemic influencing work and living locational preferences temporarily or a more permanent structural trend is an open question. Although there are numerous factors that drive interstate income migration, economists differ in their attribution to specific factors, such as taxes.

That said, in our view, the rise of pandemic-driven remote work trends and the effective increase in tax rates due to 2017’s Tax Cuts and Jobs Act’s USD 10,000 SALT cap have likely contributed to the accelerating trends. A quick evaluation of state-wise net AGI migration rates (as a % of gross AGI) and top marginal tax rates, clearly shows a negative relationship—i.e., higher net income inflow and outflow rates are associated with lower and higher marginal top tax rates, respectively. The average income migration rate for states with no income tax is 2%, while the same for states with 10% and higher top marginal tax rates is –1.7%. While taxes do seem to influence migration, the substantial dispersion around the regression line suggests there are factors other than taxes also at play here.

The argument that taxes impact migration rates is also bolstered when we look at the composition of the income migration data. As an example, Florida not only had a substantially larger number of income tax filers moving into the state than leaving it, the ones that moved in also had substantially higher average incomes than the ones leaving. The same is true for Texas, albeit the disparity is much lower than Florida. The burgeoning move of higher-income people to Florida is clearly an outlier, as its warmer weather, golf courses and zero state income tax rate have made it a very attractive destination. Notably, the increasing severe weather events in the state have not deterred movers, but that may well change in the future if the risks begin to outweigh the benefits.

The prevalence of remote work may also be a contributing factor, as higher-income white-collar jobs are better suited for remote work than lower-paying blue-collar ones. On the other side of the migration ledger, Illinois, New York and California have witnessed just the opposite; the number and average incomes of filers who moved out substantially exceeded the corresponding measures for those who moved in.

So where do we think these trends will lead us in terms of their impact on state credit quality? In the short run, the impact will be muted. However, in the longer term, their impact can be significant as these geographical shifts will influence relative purchasing power and median incomes of states, real estate values, employer choices and ultimately, states' fiscal conditions.

But will these trends continue or will we see a reversal? Taxes, economic growth, employment opportunities, water availability, weather events, social considerations and demographics will all play a role in determining the outcome. However, as the map stands today, the lower tax states are increasingly pulling ahead in the competition for people and dollars on the move.

Main contributor: Sudip Mukherjee, Fixed Income Strategist

Content is a product of the Chief Investment Office (CIO).

Original report - Income migration to lower tax states accelerates , 15 May 2023.