Federal Taxes Distort Geographical Growth

Higher wages and higher cost of living go hand in hand, but federal taxes are on nominal wages. The higher real taxes lowers employment and wealth growth in the more expensive areas of the US, according to a paper by David Yves Albouy, Assistant Professor of Economics, University of Michigan. "The Unequal Geographic Burden of Federal Taxation" by David Albouy of the University of Michigan and National Bureau of Economic Research, Journal of Political Economy, 2009, vol. 117, no. 4, © 2009 by The University of Chicago. All rights reserved.

Since federal taxes are based on nominal incomes, workers with the same real income pay higher taxes in high-cost areas than in low-cost areas, without receiving additional benefits.... For federal taxes to not distort the location choices of workers, the correct principle is that taxes should be independent of where workers live....For example, in the New York metropolitan area, wage levels are 21 percent above the national average, which, interacted with an effective marginal tax rate of 33 percent, creates a 7 percent federal surtax on labor income for locating there.... Because federal taxes are not indexed to local wage levels, workers are induced to leave cities with high wages and move to cities with low wages. As a result, unindexed federal taxes lower employment levels and property values in high-wage cities while having the opposite effect on low-wage cities. In equilibrium, these price changes compensate workers for federal tax differences across cities, but the resulting geographic distribution of employment is inefficient, reducing overall welfare.

Update: Ungated earlier version of paper available for download here.