There seems to be a never-ending debate about the extent to which taxes affect our behavior. The US uses its tax code not only as a source of revenue but also as a way of encouraging or discouraging certain behaviors. Tax policy has consequences (both good and bad), and people do factor taxes into their decision process. The State of Maryland found this out the hard way.

On both May 27, 2009 and today, the Wall Street Journal ran opinion pieces about Maryland's "Millionaire's Tax" that was passed by the state legislature in 2008. You see, in 2008, Maryland, like many states, faced a large budget deficit. In order to help bridge this gap, Maryland raised its income tax on households with incomes above one million dollars from 4.75% to 6.25%. They did this because, in the words of Governor O'Malley, those people (the richest 0.3% of filers) were "willing and able to pay their fair share." Sound familiar?

Let's take a look at how the great state of Maryland is faring. In the piece from May 27, the Wall Street Journal had this to say:

One year later, nobody's grinning. One-third of the millionaires have disappeared from Maryland tax rolls. In 2008 roughly 3,000 million-dollar income tax returns were filed by the end of April. This year there were 2,000, which the state comptroller's office concedes is a "substantial decline." On those missing returns, the government collects 6.25% of nothing. Instead of the state coffers gaining the extra $106 million the politicians predicted, millionaires paid $100 million less in taxes than they did last year -- even at higher rates.

Yes, some of that decline is due to the recession, which the article correctly points out. However, Maryland's state revenue office conceded even then that they didn't yet know how many millionaires moved out of the state. Today's article points out that they have a much better idea now:

Well, the state comptroller's office now has the final tax return data for 2008, the first year that the higher tax rates applied. The number of millionaire tax returns fell sharply to 5,529 from 7,898 in 2007, a 30% tumble. The taxes paid by rich filers fell by 22%, and instead of their payments increasing by $106 million, they fell by some $257 million.

Still not convinced? Here's more:

A Bank of America Merrill Lynch analysis of federal tax return data on people who migrated from one state to another found that Maryland lost $1 billion of its net tax base in 2008 by residents moving to other states. That's income that's now being taxed and is financing services in Virginia, South Carolina and elsewhere.

The moral of the story here is that tax policy has consequences. If you punish success, you will have less of it. When people have lower cost alternatives, they'll usually take them. Better luck next time, Maryland.