California needs to prepare for recession, Jerry Brown says
The Republican-backed federal tax bill flipped the tables on a never-ending question for California politicians: Will high taxes lead the state’s wealthiest residents to flee the Golden State for the comparable tax havens of Florida, Nevada and Texas?
Republicans reliably raise that alarm when Democrats advocate for tax increases, like the 2012 and 2016 ballot initiatives that levied a new income tax on very high-earning residents.
But now, with the federal tax bill cutting off deductions that benefited well-off Californians, the state’s Democrats suddenly are singing the GOP song about a potential millionaire exodus.
“People with higher incomes pay a lot more money, and some of them may be tempted to leave,” Gov. Jerry Brown said when he unveiled his 2018-19 budget proposal last week. “This was an assault by the Republicans in Congress against California.”
That fear animates Senate President pro tem Kevin de León’s bill that would allow California residents to write off their state taxes on their federal returns as a charitable deduction, as well as other proposals that Assembly leaders have hinted they’re preparing to offer. De Leon’s bill cleared a second committee this week and is on its way to a vote on the Senate floor. Trump administration officials say it won’t pass muster with the IRS.
Democratic state lawmakers are worried because California relies so heavily on the income taxes it collects from high earners to fund government services. The state’s wealthiest 1 percent, for instance, pay 48 percent of its income tax, and the departure of just a few families could lead to a noticeable hit to state general fund revenue.
“It is a genuine concern and that’s why the legislatures in high-tax states are swinging into action immediately,” said Katie Pratt, a professor at Loyola Law School in Los Angeles who specializes in taxes.
The new federal tax law poses problems for high earners in the Golden State because it caps two deductions that Californians used to limit their federal income tax liability, restricting their ability to write off mortgage interest and their state and local taxes.
Because real estate in coastal counties is so expensive with median home prices in the nine-county Bay Area topping $768,000, the cap on mortgage interest deductions probably will bite some middle class Californians, too.
In two reports last month, the Institute for Taxation and Economic Policy found that 11 percent of Californians would wind up with a tax increase because of the federal changes.
Among high-income brackets, about 38 percent of Californians who earn more than $877,560 – the top 1 percent – would see a tax hike. About 25 percent of Californians earning between $130,820 and $304,630, also would see a tax increase, according to the tax policy institute.
Will the numbers add up to encourage a high-earning family to leave California?
“The new tax law is kind of like icing on the cake for some who were thinking about moving out of the state,” said Fiona Ma, a Democrat on the tax-collecting Board of Equalization who is running for state treasurer. “If they don’t have to stay here because of work or family, it doesn’t give them a lot of incentive.”
So far, research on the migration of wealthy Californians suggests that most very well off people are tied to their communities or businesses and do not often migrate for tax reasons.
A 2012 study by Stanford researchers, for example, found that millionaires are mostly rooted to their locations for economic reasons. The work, “Millionaire Migration,” was based on data from the Franchise Tax Board and looked at Californians who earned more than $1 million in a year and paid a special tax for mental health services.
The authors expanded on their report for a 2016 study that incorporated more data from other states. It found, “elites are embedded in the regions where they achieve success, and they have limited interest in moving to procure tax advantages.”
Another 2016 study by Next 10 found that more people moved out of California to other states than immigrated to California from other parts of the country between 2007 and 2014, although the Golden State continued to attract high earners in that period.
“Despite the rhetoric regarding California’s oppressive tax regime and its overall hostility to business, individuals coming to California are primarily concentrated in high wage occupations, which enable them to absorb the state’s high housing costs and cost of living,” the report said.
But State Controller Betty Yee, a Democrat who was a member of the Board of Equalization when it commissioned the Stanford study, said the combination of the state’s high housing prices and the cap on mortgage interest deductions present a different problem than that report considered.
Previously, the state income taxes on high earners only affected residents when their incomes exceeded certain thresholds. If their income depended on stock market gains or bonuses, they didn’t pay the special taxes every year.
Now, they’ll have to budget for the changes in the federal tax law every year, and Yee said that may lead some people to make a different calculation when they decide where to live.
“The GOP tax plan I think has a much broader impact on a cross-section of California taxpayers,” she said. “It’s a much more volatile situation.”
Other members of the Board of Equalization, who have spent years weighing appeals from people fighting California tax bills, aren’t worried about the 1 percent leaving California because of the new tax law. They say they’re more concerned about middle- and upper-middle-class Californians deciding they’d be better off in another state.
Extremely wealthy people “are not leaving,” said George Runner, a Republican member of the board. “They don’t have to for the same reason they have $100,000 of wine in the basement. It doesn’t affect them.”
“What I’m concerned about is the people in the middle class, retired cops and teachers,” he said, arguing that those kinds of residents in the Central Valley and inland Southern California would benefit from the overall tax cuts in the GOP plan.
Joseph Vranich, who leads an Orange County business that advises people on where to locate their businesses, called the tax law “one more nail in the coffin” that would cause small- and middle-size entrepreneurs to leave California.
Often, he said, high income taxes, high gas taxes and strict environmental regulations lead his clients to choose other states. “When you add it all together, I call it death by a thousand cuts, and this latest law is one more cut,” he said.
Brown and Yee so far are not endorsing de León’s bill to strike back at the federal tax law.
Both said that they need more time to see how the changes will play out, and both have argued that the state should consider broader changes to its tax code so the general fund is less reliant on high earners having good years.
Neither could say for sure whether they believe well-off Californians would leave, and Brown at his press conference last week contrasted his worry about a migration of successful entrepreneurs with a reminder of what brought them here in the first place.
“California has a lot of opportunity. That’s why people are here,” he said.