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California

Tom Gray
Beware the Mickelson Effect
California’s projected tax revenue may not live up to its promise.
28 January 2013

Thanks to a tax increase, California’s supermajority Democratic legislature has access to roughly $6 billion per year in new revenue. Now along comes the governor—who did more than anyone else to cajole voters into approving that tax hike—telling legislators not to spend the money. “We have promises to keep,” Jerry Brown said in his annual State of the State speech last week. “And the most important is the one made to voters if Proposition 30 passed: that we would guard jealously the money temporarily made available.”

Brown retold the Bible story of Joseph’s counsel to Pharaoh, who had a dream in which seven lean cows devoured seven fat ones. Joseph explained that the fat cows represented seven years of plenty and the lean cows seven years of famine that were certain to follow. His advice: Set aside grain. Brown’s was to “pay down our debts and store up reserves against the leaner times that will surely come.”

He may be asking the impossible, and if the legislature can’t restrain itself, he will need to take much of the blame. The governor had stumped all over the state to win passage of Proposition 30, which sharply raised tax rates on high-income individuals for seven years and modestly raised sales taxes (by a quarter-cent) for four. Brown now takes pains to point out that the taxes are temporary, and that lawmakers should assume that voters won’t renew them. But it may be a little late for fired-up liberals to accept fiscal discipline. Brown is like the father who gives his 17-year-old son the keys to a 400-horsepower Corvette and tells him to drive the speed limit, forgetting that he’s the adult and the kid is a kid.

But maybe Brown hasn’t forgotten. Maybe he’s genuinely worried about what his fellow Democrats will do. He also might be wondering if the seven fat years granted by California voters through Prop. 30 will be as fat as advertised. His words about the “leaner times that will surely come” suggest that he doesn’t expect voters to renew the tax hikes. If they work as planned, why wouldn’t the public keep them in place?

Brown has good reason to worry. The Prop. 30 tax hike takes California into uncharted territory by raising the rate on those earning over $1 million by a full three percentage points, to 13.3 percent. This rate makes California even more dependent on the volatile income—especially investment returns—of a small segment of its population. In 2009, the latest year for which records are available, only about 34,000 returns reported income of $1 million or more. The new tax rate also makes the state more vulnerable to the mobility of the rich—or what might now be called the Mickelson Effect.

Golfer Phil Mickelson, of course, is the Californian who upstaged Brown and practically everyone else last week by suggesting he may make “drastic changes” because of his tax situation. He apologized for saying even that much, but it was understood that he might leave the state. If he does, he won’t be California’s first tax refugee. Tiger Woods left in the 1990s, in part (he now acknowledges) because of the state’s tax bite. Like many other professional golfers, Woods moved to Florida, which has no income tax.

The Prop. 30 rate spike, coupled with an even steeper increase in the top federal income-tax rate (from 35 percent to 39.6 percent) and new taxes on the rich to pay for Obamacare, has many other wealthy Californians looking for the exits. Nevada tax accountant George Ashley told Fox News that he’s seen “a tenfold increase from various parts of California” in inquiries about the tax advantages of moving: “They are fed up with the situation and feel like they are being unfairly treated.”

How many might actually leave is anyone’s guess. Tax migration by millionaires isn’t closely studied, and research on one state doesn’t necessarily apply to others. And millionaire mobility does have its limits. To escape the California tax bite, one truly has to pull up stakes, not just change a residential address. It means setting up shop out of state, too. California taxes income from in-state business or employment, no matter where the taxpayer lives. But for entertainers and athletes who make their money all over the nation and the world, living outside California has advantages. If they live in California, the state taxes all of their income. Not so if they live in, say, Texas or Florida.

Today’s millionaires are just part of the equation. Even if most stay (as Brown’s revenue projections assume), the state’s steep taxes may take a toll on future millionaires—the entrepreneurs searching for the best places to start businesses and hire talent, taking big risks that require big payoffs to balance the high potential for failure. California offers a great climate and plenty of venture capital, but the state will take 13.3 percent from an entrepreneur’s payout if he makes it big. Austin, Texas, has lots of entrepreneurial action, too—but people there keep what they earn. If California loses these wealth producers to smarter states, its fat years may be few and its lean years well-nigh permanent.

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