Economic Scholars: California’s Tax Increases Drove Out High Earners
[guest post by JVW]
I have been meaning to write about an op-ed piece published earlier this month in Southern California News Group newspapers. Orphe Pierre Divonguy, the chief economist at the Illinois Policy Institute, points us to a study conducted by the National Bureau of Economic Research regarding the effects that the tax increases on wealthy California residents, implemented by the passage of Proposition 30 seven years ago, led to a shortfall in the anticipated revenue as millionaires fled the state, even while overall revenue in the state rose (Prop. 30 also increased the state’s sales tax by one-quarter cent). Here is how Mr. Divonguy explains the findings:
I join the vast majority of my economist colleagues in the belief that taxes on labor income encourage households to shift away from work in traditional sectors and toward untaxed uses of time such as leisure, household production, or even work in the shadow economy.
At the core of the policy discussion is whether or not individuals react to tax hikes by engaging in less productive activities or move to avoid paying higher taxes.
It turns out that people do adjust their behavior because of higher taxes, and top income taxpayers are even more responsive to marginal tax rates than the rest of us.
The negative economic effects of the tax hike wiped out nearly half of the revenue Proposition 30 was expected to bring in. Among top-bracket California taxpayers, outward migration and behavioral responses by stayers together eroded 45% of the additional tax revenues from the tax hike.
So did this revelation come as a huge surprise to the Democrat establishment in the Golden State who repeatedly turns to tax increases to bail out irresponsible spending decisions? Hardly. The language from the legislative analyst that appeared in that fall’s voter guide made it clear that the projected $6 billion annual windfall from the tax increases was, to put it mildly, a hopeful guesstimate [emphasis added by me]:
The revenues raised by this measure could be subject to multibillion-dollar swings — either above or below the revenues projected above. This is because the vast majority of the additional revenue from this measure would come from the [personal income tax] rate increases on upper-income taxpayers. Most income reported by upper-income taxpayers is related in some way to their investments and businesses, rather than wages and salaries. While wages and salaries for upper-income taxpayers fluctuate to some extent, their investment income may change significantly from one year to the next depending upon the performance of the stock market, housing prices, and the economy.
Of course what the legislative analyst apparently failed to consider is that upper-income Californians and those who file as business owners might simply leave for more hospitable business climates. Back to Mr. Divonguy’s op-ed:
California’s rate of departures increased and the state lost 0.8 percent of the taxable base among those earning $250,000 or more. The bulk of the erosion of that tax base came from millionaire taxpayers leaving California resident status into non-resident filing status.
This finding is consistent with a large body of research that has shown that certain segments of the labor market, especially high-income workers and professions with little location-specific human capital, may be quite responsive to taxes in their location decisions.
Proposition 30 also caused a roughly $1.5 million average decrease in non-investment pre-tax income for top earners between 2012 and 2014. This is the result of the change in tax filing behavior as well as a reduction in labor market activity for these workers.
I imagine that our readers and commenters in states such as New York, Connecticut, and Illinois are nodding their heads vigorously after reading that assessment. It turns out that wealthy people have a choice where to reside for tax purposes, and will choose a state that takes substantially less, or perhaps none, of their income when given the opportunity. And it’s not as if this mobility of capital never occurred to California Democrats. Former governor Jerry Brown repeatedly warned that too much of the state’s budget depends upon the wealthiest Californians and that even small downward changes in the stock market can wreck havoc on the budget, though typical of Moonbeam, he diagnosed the problem and then made it worse. Meanwhile, our deluded fellow Californians voted to extend Prop. 30 taxes for another decade.
How then should we fix this mess? Mr. Divonguy has some radical ideas beginning with flattening out tax rates:
California’s experience is not dissimilar from other states that have progressive income taxes. Connecticut – the last state to switch from a flat income tax to a progressive income tax – saw their economy forgo over 100,000 jobs and $6 billion in economic activity as a result of the change, while seeing higher incidences of poverty. My research shows that states with a progressive income tax tend to have worse income inequality and weaker economic growth than states without a progressive income tax. Indeed, according to new data from the U.S. Census Bureau, California was one of nine states where income inequality has gotten worse.
But naturally 2020 will likely bring more efforts to soak the rich. Beyond the repeal of Proposition 13 property tax protections for commercial properties which will be on the ballot in one form or another, it is possible that there will be yet another “millionaire’s tax” ostensibly earmarked for education, and there is still time for even more mischief for progressive groups to make on behalf of eating the rich. Should a ridiculous demagogue such as Bernard Sanders or Elizabeth Warren become the party nominee, don’t be surprised if the California electorate isn’t in the mood to vote “yes” on anything remotely related to sticking it to the high earners of the state, even if the local Democrat party establishment counsels otherwise. They’ve helped mightily to create this monster, and it could yet end up eating them first.
– JVW
Imagine a world where California Democrats are promoting both Elizabeth Warren’s wealth tax and the teachers union’s millionaire tax for education on the same damn ballot! Why, it makes you think the state could switch back to voting Republican! (That latter part is a joke, folks.)
JVW (54fd0b) — 11/25/2019 @ 3:37 pmThere are two issues you discuss: The fluctuation in revenue when a tax is highly progressive because income of the highest income people fluctuates more and a secular decline in income and revenue because people move out of state, or don’t move in. (It’s not everybody who moves, but something that takes place at the margins can have a statistically noticeable effect. )
Differences in housing costs and insurance rates can also cause this population movement, and all these things are happening in California.
Tax law can also help keep people in state. Proposition 13 keeps people from moving, or rather, eliminates what would be a strong incentive to move. Possible federal taxation of large capital gains on the sale of houses also keeps people in state.
Sammy Finkelman (1a8726) — 11/25/2019 @ 5:06 pmThat bit linking progressive taxation and income inequality may be more tenous than the article suggests.
https://www.tampabay.com/news/business/personalfinance/Florida-among-the-top-3-states-with-the-most-income-inequality_170184581/
Florida does not have progressive taxation, because it has no income tax at all.
And it’s not because the rich New Yorkers move hereere (Donald is not the first nor will he be the last), but because the other end of the range is so low
OTOH, Florida confirms the idea about economic growth. Its growth has been above average.
Kishnevi (170c4a) — 11/25/2019 @ 5:23 pmWe have a spending problem. We’re never going to tax our way out of a spending problem. I wish Bush had been successful about getting SS under control. Effin Pelosi.
Time123 (ca85c9) — 11/25/2019 @ 5:42 pmIt’s actually worse than you think, as CA will tax any income someone gets from a CA source, even if you never set foot in California. Think your consulting gig in zero-income-tax Texas is tax-free? Think again. If the check comes from a CA-based company and you do not file CA Form 540NR, you’re a felon.
In some situations you may owe tax two two different states on the same income (the Supremes have said you don’t, but not every jurisdiction read the memo).
So, not only have these high-earners moved out of state, but they’ve cut contact with their former employers to avoid the FTB’s claws. But that doesn’t always work, either … cashing in stock options issued while working in CA, even though it is done years later and the check comes from Wall Street, you still owe the FTB.
Kevin M (19357e) — 11/25/2019 @ 5:46 pmostensibly earmarked for education
Which is a blatant fraud. Here I have $30 billion for schools. Then I get $10 billion from the lottery and $5 billion each from several other taxes.
Add it all up and you get $30 billion for schools. Schmuck.
Kevin M (19357e) — 11/25/2019 @ 5:50 pmAnd all this money I USED to spend on schools I can spend on pensions.
Kevin M (19357e) — 11/25/2019 @ 5:51 pmAnd thanks to Trump all this state tax is largely not deductible to the IRS.
Kevin M (19357e) — 11/25/2019 @ 5:55 pmStrip malls, trailer parks and gated communities.
Los Angeles is a sewer with zip codes. The income disparity thoughout the state is blatant; the middle class is dying fast in California.
DCSCA (797bc0) — 11/25/2019 @ 5:58 pm9. Hmm…I wonder what percentage of the upper class in California consists of movie moguls, studio employees, actors, and politicians? That would be an interesting breakdown.
Gryph (08c844) — 11/25/2019 @ 6:02 pmI do not understand conservative complaints about no federal deductions for state taxes. Without it, the difference between high tax and low tax states is stark. that is a good thing.
kaf (0363f1) — 11/25/2019 @ 6:39 pmI bet you think that Texas is a low tax state. It has huge property taxes and a high sales tax.
Kevin M (19357e) — 11/25/2019 @ 7:46 pmCalifornia’s state budget is high in absolute dollars ($215 billion this year), but 1 in 8 Americans (and some Mexicans) live in California. Per capita, the budget is $5,430, which is 33rd highest (17th lowest).
https://en.wikipedia.org/wiki/List_of_U.S._state_budgets
Kevin M (19357e) — 11/25/2019 @ 7:55 pmOne of the reasons housing prices are so high is because of Prop 13. Empty nest couples with their house paid off are staying in their 2500 sqft 5/3 houses instead of moving into 1100 ft 3/2 houses or condos because it will cost them more to move into a smaller place so we constantly run a shortage of family sized houses. There are a heck of a lot of boomers out there (yes, I realize my audience 😀 ) who would be happier in a patio home who can’t move.
Nic (896fdf) — 11/25/2019 @ 8:21 pmEmpty nest couples with their house paid off are staying in their 2500 sqft 5/3 houses instead of moving into 1100 ft 3/2 houses or condos because it will cost them more to move into a smaller place so we constantly run a shortage of family sized houses.
That’s not true everywhere in California. In many counties, including Los Angeles County, that empty nest couple where one them is at least 55 years old can sell their 2500 sqft 5/3 for $1.2 million and then buy the 1100 sqft 3/2 condo for $600,000, then transfer over their Prop 13 protected annual property tax payment, which is probably something like $5000 if they purchased their place 25 years ago, to their new condo property which otherwise would have socked them with a $6,500 or $7,000 property tax bill.
Maybe a lot of people don’t know about the ability of seniors to transfer their lower property tax bill to their newer property, but I doubt that this is the only reason retirees are staying in their homes. Some just are attached to where they have lived the past three decades.
JVW (54fd0b) — 11/25/2019 @ 9:19 pmI do not understand conservative complaints about no federal deductions for state taxes.
Our gracious host has blogged about this and made strong arguments in favor of continuing to allow state tax deductions on the federal form. You can read his rationale here, here, here, and here.
JVW (54fd0b) — 11/25/2019 @ 9:41 pmCalifornia should cut taxes on the rich so california can be mississippi west! In texas they have solved the issue of low taxes on the rich with its social destruction thru gerrymandering and preventing as many citizens as possible from voting saying democrat voters are illegal aliens no citizen would vote democrat! Texas says it will prosecute all illegal aliens who vote so far we have only found white collar felons who have been illegally voting for republicans but we need every vote we can get to stop the communist illegal alien democrats!
asset (9470e6) — 11/25/2019 @ 10:32 pmasset (a.k.a. perry) sure types an awful lot of words in order to say absolutely nothing.
JVW (54fd0b) — 11/25/2019 @ 10:33 pmOne of the reasons housing prices are so high is because of Prop 13. Empty nest couples with their house paid off are staying in their 2500 sqft 5/3 houses instead of moving into 1100 ft 3/2 houses
This is actually untrue. A subsequent set of propositions (60 & 90) set up a scheme where people 55 or older could (ONCE!) sell their house and buy something less expensive, and keep their original Prop 13 valuation.
http://www.boe.ca.gov/proptaxes/prop60-90_55over.htm
Kevin M (19357e) — 11/25/2019 @ 11:26 pm@15 and 19 I don’t think you can in every county and my understanding is that you mostly have to stay in county?
Nic (896fdf) — 11/25/2019 @ 11:29 pm…I doubt that this is the only reason retirees are staying in their homes. Some just are attached to where they have lived the past three decades.
Who wants to move away from all their friends and places they are comfortable with? If you stay nearby, that new house will cost nearly as much (it’s the LAND, not the house that’s so pricey), and that 6% commission hurts when the price is that high.
One reason retirees move is they can’t pay the mortgage easily. But if that’s the case they cash out completely and take the profits to another state.
Kevin M (19357e) — 11/25/2019 @ 11:33 pm@15 and 19 I don’t think you can in every county and my understanding is that you mostly have to stay in county?
No, you can change counties, but the NEW county has to be on a list. But it’s got many of the the high-priced counties, and if you move to Fresno it doesn’t matter much.
All of southern Cal:
Los Angeles
Orange
Riverside
San Bernardino
San Diego
Ventura
Plus parts of Silicon Valley
Alameda
San Mateo
Santa Clara
and Tuolumne
Kevin M (19357e) — 11/25/2019 @ 11:37 pmOh, and if you stay in the same county, it’s ALL counties. See the link in 19
Kevin M (19357e) — 11/25/2019 @ 11:39 pmSo why do you stay, JVW, Patterico, and all you other Californians?
Yes, I know. My handle indicates California residence for myself, but I moved to Reno (just over the border) a decade ago. I kept the name just for the sake of consistency. By the way, not only is there no state income tax in Nevada, but my property tax is quite low–about $1300 a year for an 1850 square foot house on a quarter acre in a nice part of town.
norcal (eec1aa) — 11/26/2019 @ 2:29 amYou guys don’t get it. How the wealthy operate, control their money.
It’s not about where you live. It’s about where you declare permanent residence.
Texas has no state income tax. So if you live in a state that has an income tax, all you have to do is buy a trailer or a condo or a house in Texas and declare it your permanent residence.
The residency requirement in Texas is occupancy for one month a year, or two weeks every six months.
There is no reason to move from one state to another. You keep your house in your home state, but you buy one in Texas and declare it your permanent residence. That way you avoid paying income taxes in your home state.
The Rio Grande Valley is more than a tourist destination. It’s a state income tax avoidance destination. We call them Winter Texans or Snowbirds, but really what they are is smart.
They come down here every year for a few months, just to establish residency. Hey, temperate climate, easy access to the beach, golf courses, great cuisine, what’s not to like?
They don’t move here permanently. They just use property here as a tax haven. I’ve seen license plates form all fifty states in McAllen, so this isn’t limited to states with high income taxes. It applies everywhere.
There will always be property taxes and sales taxes no matter where you live, but if you want to avoid state income taxes, buy a trailer or a condo or a house in South Texas, and declare it your permanent residence. There are thousands of retirees, high income earners, rich people who have done exactly that. You don’t see them around but once or twice a year, but they know what they’re doing. Protecting their money.
Gawain's Ghost (a89947) — 11/26/2019 @ 7:02 am@24 I like California. Also my family, friends, and job are here and if I move states I have to spend another couple of year re-credentiallying and I don’t want to drain my savings down that much.
@25 If you earn money in CA you have to pay money in CA, regardless of where you claim residence. I’m betting it isn’t the only state where that is the case.
Nic (896fdf) — 11/26/2019 @ 10:00 am25. Gawain’s Ghost (a89947) — 11/26/2019 @ 7:02 am
hat might be true maybe if all you wanted to do was register to vote (and Republicans are creating some difficulties with that, like needing IDs from the new state (a problem for college students) but when it not comes to not paying New York State income tax, a person as to avoid spending 184 or even 183 days a year in the state (and even a few minutes around midnight counts) – they do residency audits. And even that’s not enough – they also look if someone has a permanent residence or keeps their most important possessions in the state. Maybe a person didn’t spend so much time last year in New York, but his heart (his domicile) is in New York.
California, I understand, also isn’t so ready to let go of its residents either.
This is for people who pay large amounts of income tax.
That wouldn’t work in New York, if you attracted the attention of the New York State Dpepartment of Taxation and Finance.
Sammy Finkelman (1a8726) — 11/26/2019 @ 10:13 amnorcal, you and I should get together for a scotch and a steak some time. I’ve lived in Reno (off and on) since 2000.
Chuck Bartowski (6fff93) — 11/26/2019 @ 9:57 pmOne of the things that “traps” people in a given state are professional licensing laws. Lawyers, doctors, contractors and a whole raft of trades and medical specialties. There is some reciprocity, but not every state and not for every profession.
My wife, for example, cannot practice her acupuncture trade in New Mexico without about 2 years of “training” that she already has mastered plus other subjects that aren’t germane but required (e.g. herbal medicine). There is a national acupuncture licensing t3est but California does not use it or accept it and many other states return the favor.
This can be a real stumbling block. Since many trades are really not different between states, this is an artificial barrier to relocating to many people, and smacks of state-wise protectionism, but there seems no interest at the national level to clean up this problem.
Maybe it makes sense for lawyers, as the laws can be quite different from state to state, but plumbers?
Kevin M (19357e) — 11/26/2019 @ 10:47 pmTexas has no state income tax. So if you live in a state that has an income tax, all you have to do is buy a trailer or a condo or a house in Texas and declare it your permanent residence.
Gawain, if you do that, get a check from a CA company and don’t report it on a CA tax form, you are a tax criminal in California. See my #5.
Kevin M (19357e) — 11/26/2019 @ 10:49 pmBecause the University of California isn’t going anywhere?
🙂
For the gloom-and-doomers, I can assure you that life here behind the Orange Curtain is good.
They’re even building a new Raising Cane’s down the street from me that will cut my driving time to the current nearest one roughly in half.
Dave (1bb933) — 11/27/2019 @ 12:25 am