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Month March 2013

Alabama: Living In And Leaving A Death Spiral State

If you live in Alabama then you live in a death spiral state.

This is not good news to me but I can’t say it was completely surprising. Alabama has lost a lot of its traditional agricultural base over the years. It still is a state where there is a significant federal presence. Public sector teacher’s unions are strong. Government benefits are rich. Public pension funds are underfunded. The largest counties voted for President Obama in the last two Presidential elections.

William Baldwin of Forbes magazine wrote an article late last year where he identified eleven states that he considered to be “death spiral” states that were dangerous for investors who might be considering starting a business, buying a house or purchasing a municipal or state bond.

He based his list on a simple formula that took into account the ratio of takers compared to makers in the state. In other words, the number of individuals in the state who were receiving some form of government benefits (as an employee, government pension or welfare recipient), “takers”, compared to the number employed in the private sector, “makers”.

To arrive at the number of takers, Baldwin used the number of individuals on Medicaid as a proxy for those on welfare, the number of total state and local employees for government employees and calculated the pension number as being 1 for every $100,000 of unfunded pension liabilities (this seems fair as if the pension is unfunded it will need to be covered by future taxpayers. Funded pension assets should have no effect on taxpayers as the assets are in place to support the pension promise).

To arrive at the makers, he simply used the number of persons employed in the private sector. After all, the bill for any payments any government entity pays (worker, pensioner, welfare recipient) must be paid by someone. And all that money ultimately must come from the private sector because government does not create anything. It merely is a transfer agent or middleman.

The death spiral is so-named because as the number of takers increases in a state the more pressure it puts on the remaining makers. Baldwin puts it this way.

Let us give those takers the benefit of our sympathy and assume that every single one of them is a deserving soul. This person is either genuinely needy or a dedicated public servant or the recipient of a well-earned pension.

But what happens when these needy types outnumber the providers? Taxes get too high. Prosperous citizens decamp. Employers decamp. That just makes matters worse for the taxpayers left behind.

Let’s say you are a software entrepreneur with 100 on your payroll. If you stay in Huntsville, your crew will support 139 takers. In Texas, they would support only 82. Austin looks very attractive.

I saw this first-hand a couple of weeks when I was in Austin, Texas for an investment symposium. The firm that sponsored the event used to be headquartered in Santa Monica, California. It moved its offices to Austin several years ago and with it they took several hundred high paying jobs (and taxpayers) to Texas. Good for Texas. Bad for California. And especially bad for the taxpayers left in California. How long do they keep paying the bills before they also decide to move?

That is how the death spiral works. Every spiral down creates another spiral down. At some point you reach the point of no return.

Here are the 11 death spiral states according to Baldwin along with the Taker Ratio (the number of takers compared the the number of makers).

The five strongest states, in descending order, are North Dakota, Nebraska, Utah, South Dakota and Virginia.

What if you live in a death spiral state and you think about leaving to avoid the future tax bill?

Have you ever heard of an exit tax?

I was a tax attorney and CPA for a number of years and I must admit I never had heard about an exit tax until I saw this article in Real Clear Markets. However, the determination and creativity of a government entity to find ways to raise revenues should never be underestimated. Insatiable appetites require an infinite aptitude in separating taxpayers from their money.

What is an exit tax? It is a tax imposed on a citizen who chooses to leave the jurisdiction of a government entity. Exit taxes imposed on emigrants have a long history, including their use in both Nazi Germany and the Soviet Union. They were imposed under the theory that, since citizens were educated by the government and were either provided benefits or allowed to profit from jobs and business held while living under the government’s protection, they were obligated to pay back some of that money on their way out.

Sounds like something only a Hitler or Stalin would love? If only. Try surrendering your U.S. citizenship and moving to another country. Thanks to a series of expatriation tax laws passed by Congress dating back to the 1960s, with the most recent revision sponsored by Rep. Charles Rangel (D-N.Y.) (no stranger to tax evasion himself), emigrants leaving the U.S. must pay capital gains tax, including on unrealized gains, across all their holdings marked to market as of the day of departure. In addition, expats are liable for gift taxes on amounts above $12,000 a year given to anyone in the U.S., for the rest of their lives, even though they are no longer citizens themselves.

To date, the Supreme Court has had no problem with any of these laws. So what is to stop, say, California from imposing exit taxes on the steady stream of citizens heading off for Texas, Arizona, and Nevada? More than 200,000 people flee the Golden State every year, taking their money with them while leaving behind their share of the state’s $617 billion in state debt, which comes to about $16,000 per resident. That’s $3.2 billion a year in tax evasion!

I would be especially be mindful of exiting stage left in a state with leftist politicians at some point in the future. That is not to say that exiting stage right might be any better. When a politician runs out of money they run out of power. It does not matter what party they are in. You never want to be the person between the government and its appetite for spending. It would be better to be between a piece of red meat and a grizzly coming out of a long hibernation.

If you are reading this please consider the bulls-eye painted on your rear. Move if you can, move if you can- now.

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