When California taxpayers voted two years ago to sharply – albeit, temporarily – raise income taxes on the state’s highest-income residents, they touched off a debate over whether it would spur the rich to flee to low- or no-tax locales, such as neighboring Nevada.
There have been some anecdotal accounts of such movement, but no evidence of a mass exodus, even though California had raised marginal income tax rates, including federal taxes, to more than 50 percent for the highest-income taxpayers.
The debate is likely to heat up again because unions and their allies in the Legislature are beginning to talk about extending the 2012 tax increases or making them permanent, most likely via a ballot measure in 2016.
It’s no small matter. The top 1 percent of California income-tax payers now finance a third of the state’s general fund, so their ability and willingness to pay taxes is central to the state’s fiscal health.
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If the wealthy were not motivated to change residences en masse by a temporary tax hike, would making it permanent have a different outcome?
It is, one might say, a $36 billion question because that’s what 1-percenters are now paying in state income taxes each year.
By happenstance, a Nevada Supreme Court decision issued this month frames the issue.
More than 20 years ago, technology inventor Gilbert Hyatt moved to Las Vegas from California – just before, he says, he began receiving tens of millions of dollars in royalty payments for his landmark patents.
California’s Franchise Tax Board, claiming the move was a sham to avoid state income taxes, conducted audits for 1991 and 1992 and eventually dinged him for millions in back taxes, penalties and interest.
However, Hyatt – now 76 – fought back, alleging that FTB auditors had waged a vendetta that not only unfairly imposed taxes, but harassed him personally and revealed confidential information to clients that damaged him financially.
In 1998, Hyatt sued the FTB in Nevada state court. The tax agency countered that it was immune to such suits but lost that argument in the U.S. Supreme Court. Hyatt was awarded $389 million by a jury, including $250 million in punitive damages, and the case made its way up the legal ladder to Nevada’s Supreme Court.
The case drew heavy attention from tax authorities in other states, who filed briefs supporting California.
Two years after hearing arguments, Nevada’s highest court sustained Hyatt’s allegations in the main, although it ruled that California is exempt from punitive damages and sent most other damages back for recalculation because of judicial errors.
The ruling implies that high-income Californians seeking tax relief are quite welcome to relocate, and if California’s notoriously aggressive tax collectors try to hit up expatriates for taxes, Nevada will protect them.