Friday, August 21, 2009

City dwellers bear disproportionate federal tax burden

From a recent U of Chicago Journals press release:

Live in an expensive city? Think you pay too much in federal taxes? If so, a study in the current issue of the Journal of Political Economy finds that you're exactly right.

According to David Albouy, a University of Michigan economist, workers in expensive cities in the Northeast, Great Lakes and Pacific regions bear a disproportionate share of the federal tax burden, effectively paying 27 percent more in federal income taxes than workers with similar skills in a small city or rural area.

Why the disparity? Workers in cities are generally paid higher wages than similarly skilled workers in smaller towns, so they're taxed at higher rates. That may sound fair, until one considers the higher cost of living in cities, which means those higher wages don't provide any extra buying power. The federal income tax system doesn't account for cost of living. So the effect is that workers in expensive cities like New York, Los Angeles and Chicago pay more in taxes even though their real income is essentially the same as workers in smaller, cheaper places.

The extra burden wouldn't be so excessive if more federal tax dollars were returned to urban areas in the form of higher federal spending. But according to Albouy's research, that's not the case. His data show that more federal dollars are actually spent in rural areas, despite the fact that cities send far more cash to Washington. The net effect of all this is a transfer of $269 million from workers in high-cost areas to workers in lower cost rural areas in 2008 alone.

Over the long haul, Albouy says, the larger tax burden causes workers to flee large urban centers in the Northeast and settle in less expensive places in the South. So to some extent, it may have been the federal tax system that put the rust on the rust belt.

The article's abstract:

In the United States, workers in cities offering above‐average wages—cities with high productivity, low quality of life, or inefficient housing sectors—pay 27 percent more in federal taxes than otherwise identical workers in cities offering below‐average wages. According to simulation results, taxes lower long‐run employment levels in high‐wage areas by 13 percent and land and housing prices by 21 and 5 percent, causing locational inefficiencies costing 0.23 percent of income, or $28 billion in 2008. Employment is shifted from north to south and from urban to rural areas. Tax deductions index taxes partially to local cost of living, improving locational efficiency.

Journal of Political Economy
August 2009, Vol. 117, No. 4: pp. 635-667

The Unequal Geographic Burden of Federal Taxation
David Albouy

The complete article is available here.

An earlier, related article by the same author, is "Does New York City Pay Too Much in Federal Taxes Relative to Columbus?" published in Proceedings of the National Tax Association 100th Annual Conference on Taxation, 2008, 245-249. and available here.

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