Would a wealth tax really drive the wealthy out of the state?

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Lawmakers in blue states like California may like to tax the wealthy, but there's always a risk: What if the wealthy move elsewhere?

Last week, Rep. Alex Lee said he would introduce a new tax on the “ultra-wealthy.” It's not the first time the Milpitas Democrat has promoted the idea, but this year he had an advocate.

Lawmakers in seven other states also introduced new taxes on the wealthy on the same day, including Connecticut, Hawaii, New York, Illinois and Washington.

“The counterargument is that the rich are just going to leave,” Lee said. “Well, it's kind of a 'you can run, but you can't hide' strategy.”

Lee's proposal would impose a 1% annual tax on individuals with a net worth of more than $50 million, and a 1.5% tax on those with a net worth over $1 billion. The tax would apply to about 23,000 households, or the richest 0.1% in states, and raise about $21.6 billion a year, according to calculations by Emmanuel Saez, an economist at the University of California, Berkeley, who helped craft Massachusetts Sen. Elizabeth Warren's national wealth-tax proposal and has worked on several state-level proposals.

Unlike an income tax, a tax on total wealth would be unprecedented in the U.S. The proposal would apply to assets such as shares in unlisted companies, art and collectibles, and “financial assets held overseas.”

The proposal also has a slim chance of passing in the overwhelmingly Democratic Legislature: When Governor Lee introduced a similar bill last year, it never even got its first hearing, let alone a vote.

But Lee is optimistic. One change is that the state had plenty of cash last year. This year, California is projected to have a $22.5 billion budget deficit.

Lee said the deficit is roughly the amount the tax is projected to increase each year.

“The top 5 percent of income earners pay 70 percent of personal income taxes, and personal income taxes are California's largest source of revenue,” said Robert Gutierrez, CEO of the California Taxpayers Association, which opposes the proposal. “So if even a few of those taxpayers were to reconsider California as their home, that would have an impact on the (state) budget.”

But do higher taxes really make the wealthy emigrate, and if so, how big would that migration be?

Research on the issue is progressing rapidly, but no clear consensus has yet emerged, Cornell University sociologist Cristobal Young and U.S. Treasury Department economist Itai Lurie wrote in a recent paper.

In 2018, Charles Varner and Cristobal Young, then at Stanford University's Center on Poverty and Inequality, teamed up with Allen Prohofsky of the California Franchise Tax Board to look at decades of California tax data to shed light on the effects of several tax changes. They compared pre- and post-tax periods in 2004 and 2012, comparing high-income earners, who were affected by the tax hikes, with those just below them in the income bracket—people who still made enough money but weren't affected by the hikes.

First, they compared the number of people earning more than $1 million a year leaving California each year with the number moving into the state. Prior to 2004, there was a net outflow of people from the state. In the years following the 2004 tax increase, outflow decreased, then reversed in 2007, meaning that more people earning more than $1 million were coming into California than were leaving. This situation continued even after another tax increase in 2012 (data runs through 2014).

Which brings us to another key point: We find that while the number of Californians earning more than $1 million a year fluctuates wildly, the number of people moving into or out of the state accounts for only a small part of that fluctuation. The average number of people earning more than $1 million a year fluctuates by about 10,000 each year, with net in-migration ranging from about 50 to 120 people. In other words, the number of Californians who earn more than $1 million a year is driven mostly by other factors. Most of it is just a matter of “California residents moving to or from the state.” [million-dollar-earner] “It should not come off or fall out of the bracket,” they wrote.

We then analyzed the 2004 tax increase and compared the highest income earners, who were affected, with near-top income earners, who were not. We found that the rate at which top income earners left the state decreased slightly after the 2004 tax increase, while near-top income earners continued to leave the state at the same rate. In other words, the 2004 tax increase did not drive higher tax payers out of the state.

Next, they looked at California's 2012 tax increases brought about by the passage of Proposition 30, which raised tax rates by 1% for individuals earning between $250,000 and $300,000 a year, 2% for those earning between $300,000 and $500,000, and 3% for those earning more than $500,000. “This was one of the largest effective tax rate increases in recent U.S. history,” Berner said.

The researchers found a “negligible” difference: For every percentage point increase in the tax rate, states lost about 0.04% of million-dollar earners, or about 40 people, in net immigration, Varner said in an email.

Varner said there's a broader context to the study, which uncovers the specific impact of the tax on wealthy migration: California as a whole is seeing a rise in the number of people making $1 million. In 2009, this rarefied group numbered about 75,000 (adjusted for inflation); by 2019, it was more than 158,000, Varner said, citing data he received from the state's Tax Commission.

In 2019, another group of researchers at Stanford University used tax data to again examine the impact of the 2012 tax hike. They found a much larger effect: the tax increase caused 0.8% of top earners to leave the state in the year after it went into effect.

That 0.8 percent, weighted more heavily to account for the disproportionate impact on the highest earners, translates to an extra 535 people making more than $500,000 a year fleeing the tax. Of course, the impact on California's budget is the income lost from this exodus, not the number of people leaving.

Not all studies on the issue have reached the same conclusions, says Saez, the Berkeley economist, but “the summary of the research is that, while some people will move to avoid higher taxes, the number is small; the percentage of the tax base lost is usually very small,” he says. Lee's proposal would cause some wealthy people to leave the state, but he thinks the number would be small compared to the number of wealthy people in the state.

The possibility that the super-rich, and the taxes and spending they pay, will leave the state is not the only criticism of the tax. They also argue that the tax would be in effect for years after the wealthy leave California, meaning they would face immediate legal challenges. They also argue that it would be extremely difficult to value the assets of the super-rich.

But Lee pointed out that we already tax homes, which are a form of wealth, and “we've developed a whole assessment system for millions of homes,” and “we can do the same thing with mega-yachts.”