Lawmakers in blue states like California may prefer to tax the rich, but there’s always a risk: What if the rich just move elsewhere?
Assemblymember Alex Lee said last week that he was introducing a new tax on “extreme wealth.” It wasn’t the first time the Milpitas Democrat pushed the idea. But this year, he had some back up.
Lawmakers from seven other states, including Connecticut, Hawaii, New York, Illinois and Washington were introducing new taxes for the rich on the same day.
“The counterargument is that the rich will just leave,” said Lee. “Well, this is kind of the strategy of ‘You can run but you can’t hide.’ ”
Lee’s proposal would apply to individuals with a net worth of $50 million or more, taxing their wealth at 1% annually. Wealth beyond $1 billion would be taxed at 1.5%. The tax would apply to about 23,000 households, or the wealthiest 0.1% in the state, and would raise about $21.6 billion in revenue per year, according to calculations from UC Berkeley economist Emmanuel Saez, who helped design Massachusetts Sen. Elizabeth Warren’s national wealth tax proposal and had a hand in some of the state-level proposals.
Unlike income tax, a tax on overall wealth is unprecedented in the U.S. The proposal would apply to assets including shares of privately owned companies, art and collectibles, “financial assets held offshore” and more.
Even in the overwhelmingly Democratic state Legislature, the proposal is a longshot. When Lee introduced similar legislation last year, it didn’t get a first hearing, much less a vote.
That deficit, Lee said, is almost exactly the same amount that the tax is projected to raise annually.
“The top 5 percent of income earners pay 70 percent of the personal income tax. And the personal income tax is California’s biggest source of revenue,” said Robert Gutierrez, CEO of the California Taxpayers Association, which opposes the idea. “So, if even a few of those taxpayers rethink California as a place to live, that does have an impact on the (state) budget.”
But do wealthy people actually relocate when their tax bill goes up? And if they do, how large is the exodus?
Research on the subject is growing rapidly, but a clear consensus has yet to emerge, wrote Cristobal Young, a sociologist at Cornell, and Ithai Lurie, an economist at the U.S. Treasury in a recent paper.
In 2018, Charles Varner and Cristobal Young, then both at Stanford’s Center on Poverty and Inequality, worked with Allen Prohofsky at California’s Franchise Tax board, looking at decades of California tax data to figure out the impacts of several tax changes. Before and after tax increases in 2004 and 2012, they compared top earners affected by the tax increases to those just below them on the income ladder — people who still make plenty of money, but weren’t affected by the raises.
First, they looked at the number of $1-million-plus- per-year earners leaving the state each year versus moving to it. Before 2004, there was a net out-migration. In the years after the 2004 tax increase, that outflow decreased, and by 2007 it flipped: More million-dollar earners were coming to California than were leaving. That persisted after another tax increase in 2012 (the data goes through 2014).
That leads to another important point: The number of million-dollar-plus earners in California each year fluctuates considerably, but people moving to the state or pulling up stakes only account for a teensy portion of the change, they found.
The average number of people earning more than $1 million per year varies by about 10,000 people each year; net migration accounts for only about 50 to 120 people. The number of super-high earners California has each year, in other words, is almost entirely driven by other stuff; mostly “California residents growing into the (million-dollar-earner) bracket, or falling out of it again,” they wrote.
Next, they analyzed the 2004 tax increase — comparing top earners affected by the tax to the almost-top earners who aren’t — and found that the rate of top earners leaving the state actually declined slightly after the 2004 tax increase, while the almost-top earners continued to leave at the same rate. In other words, the 2004 tax increase didn’t drive the people to pay a larger bill out of the state.
Then, they looked at the 2012 California tax increase, brought on by the passage of Proposition 30, which boosted the tax rate by 1% for individuals earning $250,000 to $300,000, 2% for individuals earning $300,000 to $500,000, and 3% for individuals earning over half a million dollars annually.
“This was one of the largest effective tax rate increases in recent US history,” said Varner.
The researchers did find “a very slight” difference: For every 1 percentage point increase in the tax rate they found that the state lost about .04% of its million-dollar earners to net migration — about 40 people, Varner wrote in an email.
There’s a broader context to this research, teasing out the specific effects that taxes have on rich people moving, Varner said: California has grown its population of million-dollar earners overall. In 2009, that rarified group was about 75,000 strong (adjusted for inflation), and by 2019 it was over 158,000 Varner said, drawing on data he received from the state’s tax board.
In 2019, a different group of researchers from Stanford also used tax data, again to examine the effect of the 2012 tax increase. They found a much larger effect: The tax increase drove an extra 0.8% of top earners to leave the state the year after it went into effect.
That 0.8% translates — with some fancy math putting more weight on the tippy top of the top earners to account for their disproportionate impact — to 535 additional people making $500,00 per year or more leaving as a result of that tax. The impact on California’s budget, of course, is in the revenue lost from that exit rather than the headcount of people leaving.
Not every study of this issue has the same finding, said Saez, the Berkeley economist. But “if I were to summarize the work,” he said, “you will find that some people move to avoid paying higher taxes, but it is quantitatively small, meaning that the fraction of your tax base that you lose … (is) typically quite small.”
He thinks Lee’s proposal would cause some wealthy people to leave, but the number of people would be small relative to the number of wealthy people in the state.
The possibility that ultra-wealthy people — and the taxes they pay, and the dollars they spend — will leave the state is not the only critique opponents of the tax make. They also argue it will immediately face a legal challenge, especially because the tax applies to wealthy people for a few years after they leave California. And they contend that it will be extremely difficult to evaluate the totality of the ultra-rich’s assets.
But, Lee points out, we already tax people on one form of wealth – houses – and “we have developed a whole system of assessment for millions and millions of units of homes” he said. “So we can do the same thing for mega yachts.”