California can’t afford to keep driving away high-earners.
It is no secret that California is losing population. Since 2010, according to the Public Policy Institute of California, 7.5 million residents have left for other states, while only 5.8 million people have done the reverse. Anecdotes abound of the rich and famous leaving the state, from Elon Musk to Mark Wahlberg. But how rapidly is the state really losing its tax base, and what are the economic costs of the actions that taxpayers are taking in response to state policies?
Analysis of tax data from California’s Franchise Tax Board is revealing. These data, which represent the universe of individual tax returns with all personally identifying information removed, document both the location decisions and reported income of residents.
To start, California’s 2013 increase in its top marginal tax rate from 10.3 percent to 13.3 percent led to a rise in departures of high earners. Voters passed this measure, Proposition 30, in 2012 by a wide 55 percent to 45 percent margin, and extended it for 12 years by an even wider 63 percent to 37 percent margin in 2016. Tax-the-rich propositions play well at the ballot box, but the economic outcomes have been worrisome. In a typical year, California was losing 1.5 percent of its wealthiest taxpayers, only partly offset by in-migration of 0.5 percent. In 2013, many more of these taxpayers hired moving trucks; in an analysis that I conducted with Ryan Shyu, we found that the departure rate spiked to 2.3 percent, with only negligible changes in in-migration.
From 2014 to 2016, the years immediately following Prop. 30’s passage, high-income taxpayers who stayed in the state saw far reduced average income growth relative to similar high-income taxpayers from other high-tax states. Overall, among top-bracket California taxpayers, outward migration and behavioral responses by stayers together eroded 56 percent of the windfall tax revenues over the first three years that Prop. 30 was in place, relative to what the treasury would have received had everyone’s behavior remained unchanged.
To some observers, losing “only” 56 percent sounds not too bad. It means that the state treasury did not initially lose money from this tax hike. The Laffer Curve tells us that there exists a rate of income taxation at which increases to the tax rate will not generate any additional income for the government. Beyond that point, increases in departures or decreases in work or reported income will outweigh any revenue increases from the higher rate. Before Prop. 30, California was not over the top of the Laffer Curve—yet.
In 2018, the federal Tax Cut and Jobs Act capped state and local tax (SALT) deductions at $10,000. Another surge in departures from California ensued, as high-income taxpayers suddenly had to pay a lot more of their SALT bills themselves, rather than having taxpayers from other states pick up the tab for almost 40 percent of it. The upturn in departures was similar in magnitude to that following the 2013 spike, and it was concentrated among people who, tax simulations reveal, were particularly hard-hit by the SALT cap. Potential net outflows of taxable income from California hit nearly $4 billion in 2018—and this time, as I found in another analysis, the elevated departure rate persisted into 2019 as well.
Calculations in the Rauh-Shyu paper show that, given the cap to SALT deductions, California has been over the top of the Laffer Curve since 2018. That is, further increases to the individual tax rate are unlikely to boost tax revenue, after the lost income of leavers and the reduced income generation of stayers are considered.
The departure rate of high-income taxpayers in 2020 dwarfed that of the 2013 and 2018 tax episodes: 3.7 percent of taxpayers who had earned over $5 million in 2019 left, along with about 3 percent of those earning over $1 million. I estimate taxable income losses of $10.7 billion to the state from this outward migration.
Where are California taxpayers going? Unsurprisingly, to low-tax states. Weighted by income, the most high-income taxpayers who left California during 2013–18 headed to four zero-income-tax states (Nevada, Texas, Florida, and Washington) and to one high-tax state (New York), which, like California, often attracts residents for professional opportunities. In 2020, however, New York saw reductions in the share of income that it received from departing Californians; Florida and Texas saw further increases, as did, at the margin, states where schools remained open, such as Colorado. Conversely, zero-income-tax Nevada saw its share of income from departing Californians fall in 2020; the state canceled many school days. Taxpayers with dependent children drove the growing share of high-earner income moving to states with relatively few Covid restrictions.
The factors that propelled high-income taxpayers out of California in 2020 were likely a mix of those related to taxes and to Covid measures, along with the deterioration of public services. California currently spends $16,145 per resident on all public services, and Governor Gavin Newsom’s latest budget forecasts spending of nearly $24,000 per pupil in schools in the coming fiscal year. In 2020, residents had to contend with contributing such amounts to the public budget, even as many public services were completely unavailable. The services have since resumed, but they remain poor, especially considering their cost.
The top 1 percent of California taxpayers shoulder 50 percent of the burden of the state’s income tax. Evidence shows that they are highly responsive to tax policy, and a new law taking effect in 2024 will raise the effective top individual tax rate to 14.4 percent, due to the removal of a limit on payroll taxes. Attempts to squeeze more income from California’s high earners will backfire. Instead of constantly seeking an elusive revenue solution to its overspending, California should cut tax rates and reform its profligate spending policies. Such changes would bring back residents, generate more income, and put the state back on a path to prosperity.
City Journal is a publication of the Manhattan Institute for Policy Research (MI), a leading free-market think tank. Are you interested in supporting the magazine? As a 501(c)(3) nonprofit, donations in support of MI and City Journal are fully tax-deductible as provided by law (EIN #13-2912529).