AGGLOMERATION AND STATE PERSONAL INCOME TAXES: TIME TO APPORTION (WITH CRITICAL COMMENTARY ON NEW HAMPSHIRE'S COMPLAINT AGAINST MASSACHUSETTS).

AuthorShanske, Darien

Introduction 949 I. Background 950 A. The Lawsuit: New Hampshire v. Massachusetts 950 B. Agglomeration Economics 951 C. Doctrine 954 II. Mistaken Contentions of New Hampshire and Its Amici 958 III. Constitutional Does Not Mean Optimal: Other Options 961 Conclusion: The Court Should Not Dictate a Rule 964 INTRODUCTION

Sometimes easy cases make bad law--or at least might make bad law. The Supreme Court is currently considering granting certiorari in New Hampshire v. Massachusetts. (1) At issue is the State of New Hampshire's (and its amici's) claim that Massachusetts's insistence on applying its income tax to residents of New Hampshire, who once commuted to work for businesses in Massachusetts but now remotely work for those businesses in New Hampshire because of the COVID-19 pandemic, violates the Due Process Clause and dormant Commerce Clause. (2) The claim is simple and seductive: if these New Hampshire residents barely leave their own homes, much less their state, how can it accord with due process for Massachusetts to tax them?

This simple analysis, however, should be rejected because it would be applying an old economy heuristic (you earn where you physically are) to a new economy problem (work can happen in many places). If the Supreme Court agrees to hear this case (and I think it should not), and if it were to hold in favor of New Hampshire (and I argue in this Essay that it should not), it would deal a severe and almost comically mistimed blow to the modern urban economy by undermining the ability of central urban areas to impose income taxes on an increasingly mobile workforce. (3)

This Essay proceeds in three parts. Part I provides background about the current lawsuit as well as the policy and doctrinal issues it raises. Part II argues why Massachusetts's arguments against the taxation of remote workers are incorrect as a matter of constitutional law. Part III acknowledges that current state law regarding the sourcing of employee income is not ideal from a policy perspective and suggests an old solution to this relatively new problem: apportionment by formula. In this context, apportionment means achieving a reasonable division as to a matter in which there is no clear right answer. In the case of a remote employee living in one state but working remotely in an agglomeration of talent made possible by another state, this Part argues that the right answer is that both states have some reasonable claim to a portion of that worker's income.

  1. BACKGROUND

    1. The Lawsuit: New Hampshire v. Massachusetts

      As of the time of writing this Essay, New Hampshire has asked the Supreme Court to exercise original jurisdiction over its claim that Massachusetts regulators' choice to treat no-longer commuting New Hampshire residents as Massachusetts employees violates the Due Process Clause and dormant Commerce Clause. (4) The Supreme Court has called for the U.S. Solicitor General's view on the matter. (5)

      On a procedural level, the case faces many challenges, including whether New Hampshire has standing and whether this is the right case at the right stage of development for the Court to exercise original jurisdiction. (6) I am inclined to agree with Massachusetts that this is not a case the Court should hear, (7) but I will leave those arguments to one side and consider the merits of the case in this Essay. It is worth getting to the merits because New Hampshire and its many amici are surely right that the basic issues here are important and unlikely to go away. (8) In particular, this case presents the questions of when and how much a state can tax remote employees. New Hampshire and its amici argue that New Hampshire residents who have not worked in Massachusetts since March 2020 should not be subject to Massachusetts's personal income tax.

    2. Agglomeration Economics

      On its face, one might think this fight is a battle between states. States are the sovereigns imposing these income taxes, and it is states that are given the privilege of asking for the Court's original jurisdiction. This case, however, is about cities--or, at least, the proper resolution of the case requires thinking about cities. This is not because the dormant Commerce Clause applies differently to cities. (9) Rather, it is because thinking about cities provides the answer to the question of whether a state like Massachusetts is entitled to tax these remote workers.

      One might question why Massachusetts is taxing New Hampshire residents who have not been in the state for months and are not likely to come back for months, but the puzzle here is something of an optical illusion. Many of New Hampshire's residents are clustered around the border of Massachusetts because of its proximity to Boston. (10) From the perspective of real economic units, these New Hampshire residents are functionally residents of the greater Boston metropolitan area. It is not surprising or odd that the Boston metropolitan area would want to tax residents, even if those residents technically live in a different state.

      But why are these residents of New Hampshire paying higher housing prices to live near Boston? (11) Not so very long ago, the dominant economic model of local jurisdictions featured people and businesses shopping among competing jurisdictions for the best deal--the best set of amenities at the best price. (12) This is the so-called Tiebout model, (13) and there is some evidence that "homevoters" do behave in this way. (14) To give a classic example, homebuyers will often be very aware of the quality of local public schools and will pay more--or less--for a home based on the perceived qualities of the schools in a given school district. (15)

      When New Hampshire complains in the current suit that it has an "advantage" because it does not levy an income tax--an advantage that Massachusetts undermines--it is in effect stating that it is engaging in Tiebout-type competition with the rest of the Boston metropolitan area. (16) However, armed with only the Tiebout model, it is odd that so many people are clustered together and paying high housing prices around Boston, whether with income taxes or not. And, even more peculiarly, these New Hampshire residents were not so hostile to state income taxes that, at least until the pandemic, they were commuting into Massachusetts and incurring a state personal income tax. The Tiebout model cannot explain this behavior. Considering only housing prices, given there is no income tax anywhere in New Hampshire, why are so many residents of New Hampshire paying more to live near Massachusetts?

      The newer economic models revolve around the benefits of agglomeration--of bunching together. Density in businesses, especially similar types of businesses, can be a big positive, especially for the flow of ideas. (17) If, for example, a person works as a software engineer, then it makes sense to live near a thriving software industry. This is good not only for obtaining a job to begin with but to sharpen skills, hire other employees, and network to obtain one's next job. Thus, the answer to the riddle of the cluster around the border of Massachusetts: there is an agglomeration of talent in the Boston area that these workers benefit from.

      Agglomeration economics is an essential tool for explaining why metropolitan areas exist at all, and, though the types of agglomeration might change in the future, it seems doubtful that its benefits will ever completely go away. (18) I acknowledge that this is something of conjecture. If agglomerations were ever not to matter, or not matter very much, then the analysis that followed might be different, at least as a policy matter.

      It turns out that major agglomerations have often not followed state or interstate lines. While this has led to a variety of governance issues that should generally prompt reconsideration of several constitutional doctrines and of how the federal government should regulate interstate taxation, a greater discussion of these issues is beyond the scope of this Essay. Instead, this Essay questions whether the Supreme Court should address the issue of increased remote work by imposing a new physical presence rule. That such a rule is not advisable is made apparent by the example of agglomerations that cross state lines--that is the very case before the Court. If there were such a rule, then a software engineer in the greater Boston area who lives in New Hampshire could carefully avoid some physical presence threshold as to Massachusetts, and thus avoid paying personal income tax to the primary jurisdiction enabling that worker to earn a high income.

      The Supreme Court excised a similar physical presence rule in a 2018 case called South Dakota v. Wayfair, Inc. (19) For the 50 years prior to Wayfair, the Court had held that only remote vendors with a physical presence in a state could be forced to collect the use tax on behalf of the state. Now, the post- Wayfairrule dictates that any business with a substantial economic presence in the state can be forced to collect the use tax. A similar standard should, and does, govern whether a state can impose an income tax.

    3. Doctrine

      When a state imposes a tax, the tax can be challenged on numerous constitutional grounds. The most important ones--and the primary ones relied on in New Hampshire v. Massachusetts--involve the Due Process Clause and the dormant Commerce Clause. The Due Process Clause '"requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax,' and that the 'income attributed to the State for tax purposes must be rationally related to values connected with the taxing State.'" (20) Since 1992, due process has not required that a taxpayer be physically present in a state. (21) New...

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