The wealthy have been the subject of much discussion lately, from the protesters on Wall Street to lawmakers in Washington. President Obama has even provided a definition of who’s wealthy in arguing that taxes should be raised for those households with incomes of at least $250,000 a year.
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US 1040 tax form
But is that really the marker of wealth? After all, earning $250,000 a year in New York does not buy as much as it does in, say, Iowa or Alabama.
Or put another way: Why doesn’t the tax code account for regional differences in tax burdens?
While the question begins with households earning more than $250,000 a year in places like Boston, New York and San Francisco, the issue of fairness is not just for the top 2 percent to ponder. Workers at all income levels are affected by regional differences in federal taxes. Local taxes may also be high in these areas, though economists argue that residents at least get something for those taxes, like good schools and safe neighborhoods. According to David Yves Albouy, an assistant professor of economics at the University of Michigan and an expert on geographic tax inequality, teachers in New York may be among the highest paid in the country, but their salaries don’t give them any extra buying power because the cost of living is so high.
The average pay of a New York public school teacher in 2009-10 was $78,885. But rent for a two-bedroom apartment in Manhattan averages $3,715 a month.
In an article, “The Unequal Geographic Burden of Federal Taxation,” published in the Journal of Political Economy in 2009, Dr. Albouy wrote that wages in New York were 21 percent higher than the national average. At a 33 percent federal income tax rate, workers were paying a 7 percent federal surtax for working here. But even for someone making $50,000 a year, that surcharge worked out to about $3,500 extra a year, he said.
“A lot of the 1 percent lives in New York,” he said, “but I’d say 98 percent of the people who live in New York are part of the 99 percent, and they get the short end of the stick.”
But while one presidential candidate after another has been proposing new tax regimes, none so far has mentioned equalizing the regional differences.
“The system is not totally fair, but I guess the question is, who is it most unfair to?” said Mark Luscombe, principal federal tax analyst for CCH, a publisher of research and software for tax lawyers and accountants. “It’s most unfair to the New Yorker, and no one has much sympathy for the New Yorker.”
Or as Joseph J. Thorndike, the director of the tax history project at Tax Analysts, said, any regional adjustment “might as well be called the Bicoastal Elite Tax Relief Act.” He added, “It would shower all these benefits on Palo Alto and New York City, and the rest of the country would be outraged.”
Still, there are some interesting issues here that raise questions about how we think about fairness and taxation. If nothing else, they will help inform your next cocktail party conversation (or argument).
CURRENT SYSTEM
The debate over regional differences is nothing new, Dr. Thorndike said. When the modern tax code went into effect in 1913, “it was viewed as a way to tax those rich Northerners, and to be fair, that’s what it was,” he said.
But starting in World War II, when the tax base widened beyond the wealthiest people, he said, the tax system had to be sold as a shared sacrifice. With this came the idea of horizontal equity — that people at the same level pay the same rate across America.
Today, residents of New York pay about $15 billion a year more in federal taxes than they receive in benefits, Dr. Albouy said. He noted that that money would make quite a dent in the cost of the Second Avenue subway line, which is estimated at $17 billion.
Still, the high earners living in expensive areas are able to take deductions that reduce some of their federal tax burden. These include breaks on mortgage interest, state income and property taxes and charitable gifts.
A flat tax may seem, at first glance, more equitable, but it may mean that people in high-cost areas would lose the deductions that lower their tax bills, Dr. Luscombe said.
GEOGRAPHICALLY FAIR SYSTEM
So how would you make the tax system fairer for people who live in more expensive regions?
A cost-of-living adjustment is one way. The military offers that to soldiers stationed in different parts of the country. But measures of the cost of living are considered pretty inaccurate.
“We have good consumer price indices, but they just show the change in prices between Detroit and New York City,” said Rudolph G. Penner, a former director of the Congressional Budget Office. “They don’t show a true cost of living in different places.”
He added that measuring such costs for tax purposes could be too abstract. “If you like mountains, you have a certain level of happiness in Colorado that you can’t have in Kansas,” he said.
Another way to equalize the federal tax burden would be to look at its impact on wages and employment, which is what Dr. Albouy did. He said that companies were willing to pay workers more in high-expense areas but only up to a point. Even if workers are more productive in New York or Palo Alto, once the cost of those workers gets too high, the company will hire cheaper, if less productive, workers elsewhere. This is obviously at play in moving jobs overseas, but it has also been a factor in moving jobs from the Northeast to the South and Southwest.
“Your wage reflects the fact that firms are more productive in these larger cities, but you don’t get to keep that premium,” he said. “Your landlord is going to charge you that additional amount. You’re not consuming more than you would anywhere else.”
Dr. Albouy calculated that the two cities that are most balanced between what their residents pay the federal government and what they receive are Harrisburg, Pa., and Peoria, Ill. (The least balanced, in terms of overpaying, is not New York, but San Francisco.)
WHAT COULD HAPPEN? Jerrold Nadler, a Democratic representative whose district includes parts of the West Side and other affluent sections of Manhattan, introduced the Tax Equity Act in 2009, which proposed “to amend the Internal Revenue Code of 1986 to provide for adjustments in the individual income tax rates to reflect regional differences in the cost of living.”
The bill mustered eight co-sponsors, all from New York except for Representative Jim Himes, who represents Fairfield County, Conn. It went nowhere.
In September, Senator Charles E. Schumer, Democrat of New York, said that “$250,000 makes you really rich in Mississippi, but it doesn’t make you rich at all in New York, and there ought to be some kind of scale based on the cost of living on how much you pay.”
Of course, people in Mississippi surely feel they pay enough in taxes, and their elected officials are not likely to ask the federal government to charge them more. This alone makes a change politically infeasible. But there is something else stopping a geographic adjustment to the tax code.
Eugene Steuerle, the economic coordinator of the 1984 Treasury Department study that led to the Tax Reform Act of 1986, said he could see both sides of the argument. But he came down against making any change based on geography.
“At modest income levels, the cost of food might make a big difference between New York and Kansas,” he said. Yet computing that difference would be a bureaucratic nightmare. “Once you pick a formula you get into this box and have to adjust it all the time — and the adjustments are infinite.”
Alas, the tax inequity is likely to remain the stuff of cocktail party conversation. But consider this thought from Dr. Albouy: “The federal government effectively taxes workers for living in large cities while subsidizing them to live in rural areas.”
In the end, you can decide which side of that equation you want to be on.