Despite Tax Increase, California State Revenues in Freefall

California State Controller John Chiang has announced that total state revenue for the month of November 2012 fell $806.8 million, or 10.8%, below budget. 

Democrats thought they could hammer “the rich” by convincing voters to pass Proposition 30 to create the highest state income tax in the nation. But it now appears that high income earners have already “voted with their feet” by moving themselves and their businesses out of state, resulting in over $1 billion shortfall in corporate and income taxes last month and the beginning of a new financial crisis.   

Passage of Proposition 30 set off euphoria and expectations of higher spending for public employees. The California Teachers’ Association (CTA) trumpeted: “California students and working families won a clear victory today as voters clearly demonstrated their willingness to invest in our public schools and colleges and also rejected a deceptive ballot measure aimed at silencing educators, other workers and their unions.” 

State bureaucrats immediately ramped up deficit spending far beyond the state’s $6 billion annual tax increase, with the Departments of Health Services and Developmental Services increasing this month’s spending by over $1 billion versus last year. The lower tax collection and higher spending drove the State’s deficit after the tax increase to $2.7 billion for the first 5 months of this fiscal year. State Controller John Chiang reported:

November’s disappointing revenues stand in stark contrast to recent news that California is leading the nation in job growth, has significantly improved its cash liquidity to pay bills, and even long-distressed home values are starting to inch upward… This serves as a sobering reminder that, while the economy is expanding, it is doing so at a slow and uneven pace that will require the State to exercise care and discipline in how its fiscal affairs are managed in the coming year.

The improved “cash liquidity” Chiang referred to turns out to be $24.9 billion of debt.

During the election campaign, Governor Jerry Brown and his pro-tax coalition had the California Board of Equalization request a report from the Stanford Center on Poverty and Inequality, which claimed to have looked at state tax records and found no risk of the super-rich leaving. Based on their access to California state income tax records from 1992 to 2009, the researchers concluded that millionaire migration is a myth by anti-tax advocates and “other factors, such as personal and business contacts, seem to weigh more heavily in deciding where to live.”

The study’s authors, Stanford’s Cristobal Young, an assistant professor of sociology, and Princeton’s Charles Varner, a doctoral candidate in sociology, expounded that the temporary nature of high earnings may help explain why the additional taxes didn’t cause a noticeable flight of millionaires. Top income tax payers seem to fall into and out of the millionaire income bracket as their income rises and falls across the million-dollar mark from year to year. 

Personal connections weigh more heavily than tax rates in deciding where to live, and “people are tied to states for different reasons,” Young said. “They don’t want to take their kids out of school; they want to stay connected with friends, with families… with business contacts. People crowd together, from Silicon Valley to New York City, because of the returns associated with collaboration.” The findings dispel the “market metaphor,” in which states advertise low tax rates in a competition to woo high-income individuals. “This is a poor representation of how people decide where to live.”   

Young added that looking at the tax flight issue only scratches the surface of state financial woes. “People need to think about the depth of California’s budget problems,” he said.  “I think there’s much, much bigger things to worry about than this issue of tax flight because it’s really hard to find any evidence of it… I hope people hear, listen to and absorb what the evidence says on this issue,” Young insisted.

Following the tax increase victory, Reuters published an article titled “Super-rich flight from California? Not so fast.” Authors Jim Christie and Peter Henderson attempted to reassure readers there was very little risk that wealthy Californians would depart for income tax-free Nevada, Washington, and Texas. Although some Silicon Valley business owners had expressed interest in a move after California’s top rate was raised by 29% to 13.3%, they wrote, “business groups from the Beverly Hills Chamber of Commerce to the tech industry policy group TechNet backed the tax, and the state Chamber of Commerce took no position.”

As panic spreads that goosing taxes on the rich may have created enough “tax flight” that the California will actually collect less taxes, there was welcome news that a business had committed to opening in the State. Executives of the 99 Cents Only Stores Inc. proclaimed they would be opening a new location in Beverly Hills on formerly posh Rodeo Drive.