Dashing the hopes of Cavaliers and Knicks fans, LeBron James is moving to Miami. Did New York lose out on LeBron because of our astronomical income tax?
Maybe — but we’re losing a lot more than basketball stars because of it.
In addition to sunny beaches and fabulous people, one of Miami’s finest features is its lack of an income tax. Florida’s zero rate compares favorably to Ohio’s top rate of 6.24% (plus 2% local tax in Cleveland). And it looks like heaven compared to the top rate of 12.62% in New York City, which is the highest in the country due to a 2009 “temporary” tax increase.
In 2011, New York City’s income tax will be more uncompetitive than ever. While top nominal rates were higher in the 1970s (peaking at 19.65%), changes in federal tax law have amplified the differences between high and low tax jurisdictions, to the Big Apple’s detriment.
In the disco era, the top federal income tax rate was 70%, but you could fully deduct state and local income taxes against your federal tax. So while earners in the LeBron bracket got hit with nearly 20% income taxes in New York City, they effectively got 70% of that money back from the feds.
As a result, the top effective tax rate in the city — the excess tax you paid because you lived in New York City instead of a no-income-tax state — was just 5.9%. Moving to Florida would save you some money, but you couldn’t escape the astronomical federal taxes.
Today, federal income tax rates are much lower; even after the expiration of the Bush tax cuts next year, the top federal income tax rate will be 39.6%. A lower federal tax rate means the federal deduction for state and local tax paid is less valuable.
Over the years, Congress has enacted rules that limit deductions for high-income taxpayers, including the deduction for local taxes. President Obama wants to take further steps to curb writeoffs by the wealthy, which will put New York at an even greater tax disadvantage.
Because of these changes, New York City taxpayers in the top bracket can expect to face an effective state and local tax rate of 9.9% in 2011, four points higher than in the late 1970s. No wonder LeBron signed with the Heat.
You might object that New York attracts its share of high-profile sports stars. High taxes have not prevented the Yankees and the Mets from attracting top talent. But structural differences between baseball and basketball provide a nice example of how tax competitiveness affects some industries more than others.
Baseball has no salary cap, allowing the Yankees and the Mets to compensate for New York’s high taxes with higher pay. They can afford to do this because the enormous New York media market gives them higher revenues than other franchises.
But the NBA salary cap keeps spending roughly equalized across the league, meaning the Knicks can’t pay players more to offset the tax disadvantage. NBA players essentially have to take a pay cut to work in a high-tax state.
Professional athletes pay tax on salary income to every state where they play away games, so even LeBron will have to pay some state income tax. All told, living in Florida will save him about $1 million of his roughly $15 million salary compared to living in Manhattan.
Endorsement and investment income, however, is entirely taxed in your state of residence. And as of 2007, James was taking in about $25 million per year from endorsements — more than any other NBA player. At that rate, living in Florida will save LeBron $2.5 million per year in tax on endorsement income.
Of course, the goal of tax policy is not to make the Knicks better — and even if New York’s taxes weren’t so high, LeBron might have gone to Miami anyway. But the choice LeBron made is illustrative of those made by many entrepreneurs, hedge fund managers and other business people deciding whether to set up shop in New York or in a lower tax jurisdiction.
The question is, are most industries more like baseball, where the locational advantages of the New York market offset higher taxes, or basketball, where they don’t? The answer is that it depends.
Certainly businesses don’t face the sort of explicit salary cap you see in the NBA — they can and do pay higher salaries to attract talent to New York, despite high taxes and high cost of living.
But a recent study of New Jersey suggests that many find location isn’t worth the price. Researchers at Boston College found that New Jersey experienced $70 billion in net outmigration of wealth in the five years following a 2003 “millionaire’s tax” increase. While roughly the same number of households moved in and out of the state, departing households had net worth on average 70% higher than arriving households.
Wealthy people can react to tax increases by taking their wealth to friendlier jurisdictions. If you’re Derek Jeter or David Wells, you can leave without really leaving — Jeter makes his primary residence in Tampa, and Wells also lived in the Sunshine State during his Yankee tenure.
But most entrepreneurs don’t have that option because they need to be in New York more than 81 days per year if they want to conduct their business here.
At the end of next year, New York’s “temporary” millionaire’s tax increase is scheduled to sunset, which would take the top tax rate back to “only” 6.85%, and 10.5% in the city. But to allow that sunset to occur, Albany will need to show more budget discipline than it has recently.
Andrew Cuomo and Rick Lazio, the presumptive Democratic and Republican nominees for governor, have both declared their intent to allow the sunset on schedule. For the sake of New York’s economy — not just the Knicks — let’s hope they keep that pledge.
Josh Barro is the Walter B. Wriston Fellow at the Manhattan Institute.