Some Americans like to mock France and Sweden for their high taxes. Yet California — whose economy is bigger than that of both countries — has comparable tax rates, when federal and state tolls are combined, and a new study suggests that they are causing some top earners to leave the state entirely.
This is an issue for more than America’s 39 million Californians. Despite the long-held consensus among many analysts that state-level tax rates don’t matter much, some states seemed to have reached a point at which tax rates are driving many residents’ decisions. That raises the question of whether taxes can continue to rise without significant negative economic consequences.
California’s highest income tax rate is 13.3%. That is in addition to a top federal tax rate of 37%. California also has a state sales tax rate of 7.25%, and many localities impose a smaller sales tax. So if a wealthy person earns and spends labor income in the state of California, the tax rate at the margin could approach 60%. Then there is the corporate state income tax rate of 8.84%, some of which is passed along to consumers through higher prices. That increases the tax burden further yet.
Part of the problem is that the state-level expenditures do not seem to be translating into correspondingly higher living standards. California schools are uneven in quality, while many parts of the state are struggling with homelessness and crime. I myself love California — the weather, the scenery, the cuisine, the dynamic and successful companies — yet I also see as a state in crisis, especially in state-level government.
How are residents fighting back? In part by leaving. California had a net population loss of more than 700,000 from April 2020 to July 2022. Some of that was likely pandemic-driven, but the trend has not reversed.
And higher taxes are playing a role. Researchers Joshua Rauh and Ryan Shyu, currently and formerly at Stanford business school, have studied the behavioral response to Proposition 30, which boosted California’s marginal tax rates by up to 3% for high earners for seven years, from 2012 to 2018. They found that in 2013, an additional 0.8% of the top bracket of the residential tax base left the state. That is several times higher than the tax responses usually seen in the data.
These high-earning California residents seem to have reached a tipping point: Maybe many of them could afford the extra tax burden, but at some point they got fed up, read the signals and decided the broader system wasn’t working in their interest.
Overall, Proposition 30 increased total tax revenue for California — but not nearly as much as intended. Due to departures, the state lost more than 45% of its windfall tax revenues from the policy change, and within two years the state lost more than 60% of those same revenues. This history doesn’t quite validate the infamous “Laffer curve” (i.e., the idea that tax hikes lower revenues), but these responses indicate something has gone wrong with how California is raising revenue. Part of the social loss from the higher taxes is that, all else being equal, these residents would have preferred to live in California, and might have added more value there.
Due to data limitations, the longer-term effects of the California tax hike are unclear. But many people may still leave the state, especially if they conclude that the state’s higher tax burden does not result in better services. Or there could be some other negative change that finally pushes them over the threshold. A proposed wealth tax failed last month in the state legislature, but the sentiment in favor of it lives on.
Of course, the number of people affected by any tax on wealth or high earners will by definition be very much a minority, in both California and the US. But they are an important minority for national competitiveness and national security. So many of America’s new ideas, including in the cultural realm, come from California, so it is in America’s interest for the state to be as well-run as possible. Yet this latest new idea from California — very high taxes for the very wealthy — is one that ought not to spread.
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