Location driven by income tax rates

Location driven by income tax rates

By Dr. John Stapleford

Center for Economic Policy and Analysis

December 1, 2020

Delaware is projected to collect $1.7 billion of personal income tax revenue in FY 21.

Research evidences that, over time, states with an income tax lose population to states without an income tax. Many retirees choose Florida, Texas, and Nevada precisely because there is no income tax. According to DEFAC, Delaware is facing two fiscal years of flat General Fund revenues. It would be counter-productive to raise the top Delaware personal income tax rate.

Currently, Delaware’s top personal income rate is 6.6%, and it is applied to all households with an adjusted gross income of $60,000 or more. Since Delaware’s 2019 median household income was $70,176, almost two-thirds of Delaware households pay the top (6.6%) rate.

Delaware households with income more than $25,000 up to $60,000 pay a rate of 5.55%. That means with inflation, as a household’s income rises from below to above $60,000, its personal income taxes go up almost 19% (6.6 divided by 5.55).

Delaware is slowly moving toward a fixed income tax rate of 6.6% (minimally 5.55%). By comparison, the flat tax rate in neighboring Pennsylvania is 3.1%, in Maryland the tax rate on income of $275,000 or greater is 5.75%, and in New Jersey the tax rate on income from $20,001 to $35,000 is 1.75% and is 3.5% on income from $35,001 to $40,000.

What if the Delaware legislature decided to increase the top personal income tax rate by 10%? Going from 6.6% to 7.3%.

Econometric analysis, regressing Delaware annual personal income tax revenue against the top marginal income tax rate from 1977 through 2019, shows a negative relationship at the highest degree of statistical significance. A 10% increase in the current rate will reduce the fiscal year’s tax revenue by an estimated $50 million. And it will inhibit revenue for some years down the road.

In 1979 the top Delaware personal income tax rate was dropped from 19.8% to 13.5%. Over the following four years, Delaware’s gross output went up just 1% while total personal income tax revenue went up 33%.

In 1988 the top rate was dropped from around 10% to 7.7%. Over the next four years, gross output went up 14% while total personal income tax revenue rose 22%.

More recently, when the top rate was dropped from 6.75% to 6.6%, the next four years saw output fall 4% and personal tax revenue rise 12%.

Faced with flat General Fund revenue, it is tempting to raise the top Delaware personal income tax rate, and tax revenue may even go up in the short run. But over time, it is clear, higher personal income taxes result in less tax revenue and discourage households from moving to or retiring in Delaware.