The US is famed for its patchwork of states all operating under a variety of laws. There is considerable variation in local taxes, some of which might surprise the outsider.

When Alexis de Tocqueville traveled to the US in the 1830s to write Democracy in America, he viewed the states as small autonomous republics. The states “exercise the largest share of authority over the people because they are places nearest to its level,” the French aristocrat wrote in his classic book on the American national character. The federal state has grown massively since, especially in the twentieth century, but states are still different, not the least in tax terms.

The federal part makes up the greatest share of the income tax take, with a top rate of 35 per cent for people earning $379,150 and over a year, according to the Internal Revenue Service. On top of that, the state income tax can vary between zero and 11 per cent.

“From a tax point of view, the number one state is probably Florida, because there is no state income tax,” David Nave, tax director at the multi-family office Pitcairn, told Family Wealth Report. “Many of my clients establish second homes in Florida. Then you have to stay there for 181 days a year, you need to vote there and have your driver’s license there.

“South Dakota does not have an income tax either, but I don’t see people moving there because it’s in the middle of nowhere,” Nave said.

The other states with no state income tax are Alaska, Nevada, Texas, Washington and Wyoming. However, it is important to remember that the absence of a state income tax is often paid for in another way; Florida, for example, has high property taxes.

“I think the State of Washington is the best one to live in,” David Treitel, tax director at London-based US Tax and Financial Services, told this publication “Bill Gates lives there, so there are high net worth individuals in the state. And it’s good for business as well.”

“Texas is the state with the lowest tax burden per capita,” Brent Mead, state government affairs manager at the National Taxpayers Union, told this publication. “Florida is doing a pretty good job as well, but all states have room for improvement.”

The NTU is a grassroots organization campaigning for lower taxes.

The mystery of where rich people live

The highest state income tax is found in Hawaii (11 per cent), followed by California at 9.3 per cent, paid by everyone earning over $46,767 a year compared with $200,000 in Hawaii, according to the Federation of Tax Administrators. New York has one of the highest state income taxes at 8.9 per cent, but it is only paid by those earning $500,001 and more a year; along with Connecticut and Maryland this is the highest upper limit in the US.

Some states have flat rates instead of income brackets. Illinois, home to the economic powerhouse of Chicago, has a flat rate of 5 per cent. Some of the others with flat rates are Massachusetts (5.3 per cent), Michigan (4.35 per cent) and Pennsylvania (3.07 per cent).

Perhaps surprisingly, the states with the highest top rate of income tax are the ones with the highest number of ultra high net worth individuals. California had most wealthy residents last year, with about 9,800 people worth more than $30 million living in the golden state, according to Wealth-X. New York had about 7,300 UHNW individuals. Alaska, with no state income tax, is one of only three states with fewer than 100 UHNW individuals. It is worth noting that California is by far the most populous state in the US, while Alaska is one of the least.

“California has been difficult for taxpayers’ for years; it has a very expansive government,” Mead commented.

Most experts agree that successful industry is the reason why people have been able to gain wealth in California and New York.

Does the tax tail wag the dog?

Wealthy people are generally thought to be one of the most mobile groups in society, but are they really prepared to move state to pay lower tax? Just 1.7 percent moved from one state to another each year on average between 2001 and 2010, the Center on Budget and Policy Priorities, a Washington DC-based think tank, said in a study released earlier at the beginning of August. The report, titled Tax Flight Is A Myth: Higher State Taxes Bring More Revenue, Not More Migration, also concluded that cheaper housing was a more important driver than taxes.

“A lot of people ask me where to go and live, but in the end they will live where they want to live,” Nave said. “Maybe schools matter, maybe you want to be near a beach, maybe you’re interested in culture and arts, and then you will probably want to live in New York anyway. But maybe you’re someone who wants to live in a place like Wyoming, like Dick Cheney (former vice president).”

Allison Shipley, Miami-based principal with PwC’s private company service practice, advises her client not to “let the tax tail wag the dog”; in other words: not to move to another state solely for tax purposes.

“One thing that is important to remember is the nuances,” Shipley told Family Wealth Report. “You have to take the cost of living into account, for example price of property and insurances. Then you have sales tax, which can vary within the states as well. Sales tax has not traditionally been a decisive factor for high net worth individuals in determining where to live, but it’s important to make them aware of it. The state sales tax is 6 per cent in Florida.”

The highest state sales tax is found in California with 8.25 per cent, according to the Federation of Tax Administrators, a think tank based in Washington DC. New York has 4 per cent but can go as high as 8.52 per cent when the local rate is added.

Taxes from six feet under

Inheritance tax is another important consideration. There is no such tax in Florida, compared with one of the highest rates which is found in New Jersey at 16 per cent on bequests exceeding $1,700,000. The so-called “death tax” is in place in Indiana, Iowa, Kentucky, Maryland, Nebraska, Pennsylvania and Tennessee, according to the law firm McGuireWoods.

On top of that, there is a federal estate tax, gift tax, and generation-skipping transfer tax of 35 per cent. However, President Obama’s tax relief act last year increased the gift tax exemption from $1 million in 2010 to $5 million, a change that allows a tremendous amount of wealth to be transferred. At the same time, most of the Republican presidential candidates have pledged to repeal the federal estate tax altogether.

Treitel has a theory concerning one high-profile celebrity who some years back moved to the US from the UK shortly before dying from a long-term illness in order to, he believes, avoid inheritance tax. It is worth noting that the person in question was born in the US.

No wealth drain, but slower growth?

Apart from extreme examples, it seems to be something of a consensus that businesses are more likely to move to lower their taxes than individuals, and that scrapping state income tax is only politically possible in smaller states. Oklahoma is one example of a state which is looking to gradually out-phase state income tax this year. Judging from the latest statistics from Wealth-X and the report by the Center on Budget and Policy Priorities, a wealth drain does not look like a looming crisis for New York and California.  

“States should not be looking to lower income taxes to become safe havens for rich people; they should do it to create growth and development,” Mead said. “Income taxes are one of the largest restraints on economic growth, often more so than property taxes.”

Tocqueville was full of fear and hopes when he wrote his masterpiece Democracy in America in two parts in 1835 and 1840, respectively, and one can speculate that today’s complicated and diverse tax systems would have pleased him. On the other hand, the fact that the lion’s share of the tax cake is collected by the federal government would have been unrecognizable to the Frenchman who hated uniformity.