By Brad Polumbo
Thursday, August 20, 2020
In a comical yet revealing turn of affairs, New York governor Andrew Cuomo is so desperate for wealthy New Yorkers to return to his state that he has resorted to personally calling them and offering to cook for them if they come back. The governor finds himself in this situation because New York’s sky-high taxes, restrictive business environment, and abysmal COVID-19 response have prompted many successful citizens to move elsewhere. No matter how many martinis Cuomo offers to buy them, many won’t be coming back.
Governor Gavin Newsom may soon find himself in a similar situation. The California Democrat has already witnessed a mass exodus from his state in recent years, as tax-weary citizens move on to new pastures. The exodus may turn into a stampede if California lawmakers’ latest “soak the rich” legislative push is successful.
Democratic state legislators have introduced a new Assembly bill that would raise the state income tax on California’s highest earners from the current rate of 13.3 percent to 16.8 percent. This would mean that, after factoring in federal income taxes, California millionaires would face a top tax rate of 53.8 percent. The proposal would even apply this tax retroactively, applying the levies to income dating back to January 2020.
Meanwhile, progressive state legislators have introduced a wealth tax that would fall on Californians with a net worth of $30 million or more.
“[California’s] astounding level of income and wealth inequality is the best, most compelling argument in favor of Assembly Bill 1253, which would raise personal income taxes on the state’s top earners,” wrote Los Angeles Times columnist Nicholas Goldberg in defense of the proposal. “Sure, we have high taxes on the rich already — but California has enormous needs, not to mention an impending budget crisis, and the rich have deep, deep pockets.”
When one considers that nearby states such as Nevada have no income tax at all, the problem with this approach quickly becomes apparent.
The legislation is basically a giant incentive “for California high-earners to take their money and run,” the Wall Street Journal editorial board wryly noted.
“The tax hikes would be the tipping point for many taxpayers,” said California Taxpayers Association president Robert Gutierrez, “prompting them to book a one-way trip to one of the 49 states with lower taxes.”
Critics are right to note the perverse incentives this new California tax would create. The wealthy are in many cases the most mobile members of society, and the less appealing you make your state for them financially, the more likely they are to take their success elsewhere.
“Individuals respond to taxes by changing their behavior,” the Tax Foundation’s Kristina Zvinys explains. “Hence, when there are tax differences between [areas], some might respond by moving to a lower-tax area. For higher-income individuals, the benefits of moving as a result of higher taxes are greater because they have more income or wealth at stake.”
Put another way, the higher-tax region faces the risk of capital flight. Capital flight occurs when assets move from one region to another in response to economic changes, usually resulting in harsh economic consequences for the departed area, but the loss, of course is greater than that. When people move, it’s not only their assets that go with them, it’s also their income and their earning capacity. This means that revenue from new taxes on the wealthy often falls short of projections and sometimes ends up decreasing revenue.
We don’t have to guess that another tax hike on the wealthy would have this effect. There’s ample empirical evidence showing this trend already in action in California.
In 2012, Californians voted to increase the state income tax for top earners by 3 percent. A recent academic paper researching this tax hike’s impact found that it prompted a greater number of higher earners to leave the state, and that “eroded 45.2 percent of state windfall tax revenues within the first year and 60.9 percent within two years.”
This has played out in similar fashion across the country. For example, the state of Maryland passed a so-called millionaires tax in 2008, projecting it would bring in $106 million in new revenue for public services. In actuality, the result was $1 billion of its tax base lost to other states due to out-of-state migration. The tax ended up corresponding with a decrease in total tax revenue from the affected group by $257 million.
In fact, we have reason to believe that right now, the well-off could be more responsive than ever before to increases in taxation. Because of the COVID-19 crisis, many industries have shifted their work force to remote work. In Silicon Valley, for example, tech giants such as Twitter and Facebook plan to allow many employees to work from home on a permanent basis. Why wouldn’t successful software engineers and other high-earners move out of high-tax cities and states, if they are no longer tied there for employment?
This inconvenient economic reality poses a real problem for California’s finances given how heavily the state relies on its wealthiest residents for tax revenue. The top 1 percent of Californians pay nearly half the state’s total income taxes, and the income tax is by far the state’s biggest revenue source. As KQED notes, the Palo Alto zip code alone contributed nearly $1 billion in revenue in 2016.
There’s every reason to think that more efforts to “soak the rich” would only undercut the state’s tax base and leave everyone in California worse off. Yet the proposed tax hikes may still go through — because politics is what’s really driving the move.
Former representative Dick Armey once noted that “demagoguery beats data in making public policy.”
When it comes to taxing the rich, California’s progressive state legislature seems determined to prove the late congressman right.
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