Taxes and telework: The impacts of state income taxes in a work-from-home economy

This paper studies the interstate effects of decentralized taxation and spending when work-from-home allows fully remote work from another state. In this setting, a state’s population and employment levels are decoupled, making the impact of state tax differentials radically different from when individuals must live and work in the same state. The impacts depend on whether income is taxed at the location of the employer (source) or employee (residence). Our main findings show that a shift from a non-WFH economy to a work-from-home (WFH) economy reduces employment and raises the wage in the high-tax state, with larger effects under source taxation. The logic is that wages are lower in the high-tax state in the absence of WFH, and with interstate wage equality required when residences and workplaces are decoupled, WFH causes a loss of employment and an increase in the wage in that state. Once WFH is established, a tax increase in the high-tax state either reduces employment further while raising the wage (source taxation) or leaves the labor market unaffected (residence taxation). We also show that the non-WFH equilibrium and the source-tax equilibrium under WFH are inefficient, while the residence-tax WFH equilibrium is efficient.