The D.C. Council is considering various proposals to increase income taxes on high-income earners. Supporters of the tax increase argue that a tax hike is necessary to meet important needs such as childcare and reducing homelessness. They also argue that higher income taxes would not drive away high-income taxpayers or weaken the tax base, and is in fact, demanded by voters. These are politically and emotionally powerful arguments. But two of the three arguments offered in support of raising taxes (paying for a good cause and public support for higher taxes) are only tangentially related to what constitutes good tax policy.
Good tax policy raises as much money as possible with as little disruption to economic activity as possible, regardless of what the revenue pays for and how politically saleable it is. Thus, missing from the debate is an analysis of fundamentals: how the income tax base has been impacted by the pandemic, and whether the District can continue to rely on a trend of strong growth in personal income tax collections in the long run, with or without tax increases.
Our analysis of the District’s income tax filers suggest that prior to the COVID-19 pandemic, high-income tax filers (those who have reported $200,000 or more on their federal tax returns) have been the biggest contributors to both domestic out-migration and the growth in taxable personal incomes in the city. Importantly, income tax base growth has been driven by strong household formation and by the growth in the incomes of non-migrant households—those who chose the District as their home and have remained in the city as they formed families and their incomes rose.
It is not clear that these trends will continue after the pandemic. New data suggest that household formation has slowed down, and domestic out-migration has more than doubled since the March of 2020. If these new trends are not reversed, they will impair the District’s revenue raising capacity from personal income taxes.
Prior to the pandemic, the growth in the tax base was largely a function of rising incomes, and not growth in the number of tax filers.
Through 2013, tax filers, along with number of households, continued to grow, even when total taxable income fell through the Great Recession. Since then, the growth in the tax base has largely been driven by income growth, and not by the growth in the number of households filing for taxes.
This trend is a function of how the District’s demographics have changed over years. Throughout the 2000s, the population growth was largely fueled by strong domestic in-migration—adding new households and taxpayer units. As young people who moved into the city started forming families, the source of population growth slowly shifted from adults to babies. In the 2010s and through today, the main source of population growth has been natural growth (births minus deaths) and international in-migration. While these two sources add to the population, they do not always add to the tax filers.
This may look like a good thing—that households, on balance, are getting much more affluent, largely staying in the city, and paying much higher taxes. But it is, in some ways, also a picture of exclusion.
While the number of tax filers had stabilized by 2013, new household formation continued to play an important role in maintaining the income tax base.
The relatively stable number of tax filers through 2019 masks the fact that there was significant turnover among households, and the District still relied on brand new tax filers to maintain its tax base. To see that, consider the in- and out-migration of tax filers: Migration data suggests that the District has been, on net, losing tax filers to other jurisdictions for much of the last decade. But the number of tax filers who reported the District of Columbia as their home state continued to grow, making up for this loss, and some more.
For example, between 2018 and 2019, the District lost 1,991 tax filers to domestic out-migration (on net). During the same year, the total number of tax filers grew by 3,651. This means there were 5,642 brand new tax filers that year.
Where do these new filers come from? Part of this growth was the result of policy change: the District expanded eligibility for Earned Income Tax Credits to single adults in 2016, which incentivizes more residents to file for taxes even when their income is low. The other source of growth—at least for this dataset—is non-migrant tax filers (or taxpayers who did not move from somewhere else in the previous year), including those the IRS cannot match to a return anywhere else in the country in the previous year. They are likely young people who have never filed taxes on their own before—a college graduate who just took a job in DC, or young people leaving their parents’ house for the first time.
The growth in high-income earners is largely a function of those who stay in place as their incomes rise.
Since 2011, the District has lost more high-income tax filers to out-migration than it received through in-migration. Between 2011 and 2019, nearly 11,000 tax filers who earned more than $200,000 moved into the city, bringing along approximately $5.2 billion in taxable income. In contrast, 17,000 tax filers with incomes above $200,000 moved elsewhere in the country, taking away $7.8 billion in taxable income. In 2019 alone, the net loss of high-income earners to out-migration cost the city approximately $26 million in tax revenue.
Yet, during this same period, the District added nearly 30,000 new tax filers, and the total taxable income across all income levels grew by approximately $11 billion ($23.4 billion to $34.5 billion). Most of the growth in taxable income can be tied to increasing incomes of non-migrant taxpayers and 70 percent of the growth came from those who earn more than $200,000 in taxable income.
This is to say that prior to the pandemic, and through much of 2010s, while more high-income earners had left the city than those who moved in, many households chose to stay in the city as their incomes grew.
Since the beginning of the pandemic, both sources of growth in the number of tax filers and taxable income appear to be at increased risk.
Risk #1: Since the beginning of the pandemic, household formation is looking weaker in the District.
Monthly data from the Current Population Survey suggest that household formation has slowed down in the District since March of 2020. The estimated number of households hit bottom in November 2020, representing a loss of nine thousand households compared to their peak in March of 2020 (roughly equivalent to 15 months of growth). Since then, the numbers bounced back up but not have yet caught up with the high point in April 2020.
One contributor to the loss in household numbers is the increased share of younger adults moving back with their parents. In 2019, approximately 23 percent of adults between the ages of 18 and 29 lived with their parents. Through 2020, this share increased to 26 percent. These young adults may go back to living on their own as the pandemic related restrictions are removed.
Risk #2: Domestic outmigration has spiked since March of 2020 to previously unseen levels.
When we analyzed the most recent data on the components of population change released by the U.S. Census Bureau, we were pleasantly surprised to see that domestic net in-migration was still negative but looked much better than the previous year. This data captured the one-year period that ended on July 1, 2020 and suggested that the District’s population growth remained relatively strong during the first year of the pandemic and the city escaped much of the theorized and observed impacts of COVID-19 on cities.
New information released since then suggests otherwise. A recent publication by Ginger Moored on Districtmeasured.com (the blog of the Office of Revenue Analysis) presents finding from change of address data through May of 2021 to show that 17,882 more people left the District since COVID-19 restrictions began in March of 2020 than those who left a year prior. While about 45 percent of who left reported a temporary address change, more than 9,000 reported a permanent move.
Importantly, nearly 16,000 people who were previously D.C. residents report moving somewhere else in the metro region. Some of them are likely to be residents who have family nearby and have moved temporarily to save money or escape the city during the worst of the pandemic. But others may have permanently chosen the suburbs over the city in search for more space, cheaper housing, or other suburban characteristics.
Image Source: Districtmeasured.com
While these numbers are not comparable to Census data since they use completely different sources of information, they still suggest a strong spike in out-migration not captured by the Census Bureau data (but could be captured in the 2021 data).
Need for better-informed tax policy
Given the uncertainties about the District’s economic future, our focus should be on the District’s overall revenue raising capacity and ability to meet its current expenditure obligations.
The economic shocks that followed the COVID-19 pandemic might permanently alter the most important components of the District’s tax base—including general sales volume, real property valuations, and income earned in the city. In the first year of the pandemic, general sales tax revenue, for example, declined by nearly 40 percent and despite easing of COVID-19 related restrictions, has not yet fully recovered. During the first three quarters of Fiscal year 2021 (October 2020 to June 2021), general sales tax revenue was 20 percent(approximately $208 million) below where it was the same time last year (which was already lower than the year before).
Further, May 2021 revenue estimates released by the OCFO project a $110 million decline in real property tax collections in Fiscal Year 2022, largely due to increased vacancies in commercial office buildings. Commuters have stayed away, and only about one in four office workers are working from their office on a given day. We likely won’t know the full effects of the pandemic on commuters, office rentals, and whether residents will return to the city until after schools open and the Metro resumes a full schedule.
Income tax collections have remained as one bright spot, due to both strong stock market performance and, for personal income, growing withholding taxes. But this remains as a puzzle given the out-migration trends captured in change of address data.
The District’s own revenue (excluding federal fiscal aid that has temporarily increased spending) is now hovering around $8.5 billion, or over half a billion less than where it was prior to the pandemic. If commuters do not return, office leases remain weak, and residents who left the city decide to stay in their new homes, the current tax regime, which heavily relies on commuter activity, strong demand for office space, and a growth in personal incomes, could be deeply shaken. The city must then find other ways to raise this revenue or cut spending.
Rather than increasing taxes to add more spending, the city should carefully examine its tax code—through a Tax Revision Commission—to ensure that it would continue to be able to meet its spending commitments. Otherwise, the city could find itself with fewer options and face the necessity of raising taxes on all households—rich and poor.