[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.