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Golden Misstep

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Golden Misstep

A proposal to raise taxes in California risks driving away even more residents. January 26, 2022
California
Economy, finance, and budgets
Politics and law

In November 2020, California voters rejected a $10 billion business-tax hike, showing understandable concern about tax increases during an economic downturn. Since then, tax revenues have surged at the fastest rate in four decades, giving the state a $31 billion budget surplus.

One might think that this good fortune would negate the need to raise taxes, but some California lawmakers see things differently. Apparently believing that the 2020 tax referendum failed for a lack of boldness, assembly members Ash Kalra and Alex Lee have proposed Assembly Constitutional Amendment No. 11 to raise annual taxes by $163 billion per year. The package would nearly double California’s tax burden to fund CalCare, a universal health-care program. Setting aside California’s governance weaknesses, the proposal is a poor fit for the new era of interstate tax competition.

California’s current top marginal tax rate is 13.3 percent, the highest in the U.S. The new proposal would add to that burden, generating $31.5 billion through a pair of payroll taxes: one on firms with 50 employees, and the other on employees earning $49,900 or more. Income surtaxes would begin at $149,509 in earnings and generate another $23.4 billion with progressive rates. The result would be a preposterous income tax code, with 18 rate brackets ranging from 2.25 percent to 18.05 percent.

The real money grab is the proposed 2.3 percent excise tax on business gross receipts beyond $2 million, which would generate $108.1 billion in new taxes annually. Gross-receipts taxes hit production cycles multiple times, bringing in tremendous revenues with low rates. Rather than taxing business profits (which California already does), a gross-receipts tax raises revenue from both profitable and unprofitable businesses. Inevitably, some low-profit businesses, such as retailers and grocers, would pay more taxes than high-margin, high-profit businesses.

Californians should be skeptical that a government that has fostered homelessness, out-of-control housing costs, rising crime, and energy shortages can deliver universal, high-quality health care. The California Assembly passed the healthcare spending portion of this package out of committee on January 20, and has until January 31 to pass the bill before the entire Assembly. So suppose the state does manage to enact this gargantuan tax-and-spend program. The state’s tax competitiveness, which the Tax Foundation currently ranks 48th, would move from bad to even worse—and drive away the taxpayers the program depends upon.

Two recent changes make state tax competitiveness more important than ever. First is the federal cap on state and local tax deductions imposed by the 2017 Tax Cuts and Jobs Act. Though Democrats hope to reverse this change, Californians, for now, must pay full freight for their state’s spending programs. Second is the rise of remote work, allowing more workers to live where they choose.

Census migration data show that Americans are moving out of such high-tax states as California, New York, and Illinois and into low-tax jurisdictions. California lost 262,000 residents in 2021, more than any other state besides New York. In contrast, Florida, Texas, Arizona, and North Carolina have seen torrid population growth and inbound moves. Florida and Texas levy no individual income tax. And all four states enhanced their tax competitiveness in 2021: Florida began phasing out its quirky sales tax on commercial rent, Texas enacted a broad spending limit that will lead to tax cuts, Arizona slashed income taxes for businesses and individuals, and North Carolina enacted a massive bipartisan tax reform that will eliminate its corporate income tax and cut personal rates from 5.25 percent to 3.99 percent.

Even if it stands still, California will continue to lose innovators and middle-class residents to states proactively improving their cost structures. U-Haul couldn’t meet demand for all the people leaving California last year. The California Taxpayers Association points out that the revenue estimates for this new proposal don’t consider the inevitable losses to outmigration.

California’s tax-and-spend programs are destined to fail. Competitive Sun Belt states are siphoning off taxpayers and businesses, depriving California of the full revenue of its tax designs. Yet state competition lets policymakers learn from their mistakes and suggests remedies. Nowhere is such competition more needed than in the Golden State.

Photo by Stanton Sharpe/SOPA Images/LightRocket via Getty Images

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