California’s budget deficit has swelled since last January by $9.3 billion to a daunting $31.5 billion. In soft-peddling the state’s current fiscal woes, Gov. Gavin Newsom said, “A progressive tax system allows us to stack away billions and billions of dollars for exactly this moment.” He seemed pleased to point out that at least one-half of the revenue the state government relies on comes from just 1% of the population.
The governor is undoubtedly correct in characterizing California’s income tax as progressive. For single filers, California’s nine tax rates move up steeply from a low of 1% on taxable income between $0 to $8,809 to 13.3% on incomes above $1 million. California’s income tax is ranked by the Tax Foundation as second-highest in the nation, below only New Jersey and just above New York.
What Newsom doesn’t appear to see is the deleterious long-term effects of a highly progressive tax system. Case in point: The “one-percenters” who pay 50% of the tax are voting with their feet by leaving California in droves.
According to IRS data, the inflow of new domestic migrants to California making $200,000 or more had a total adjusted gross income (AGI) of $7.3 billion in 2018. The outflow of migrants from California to other states on the part of the filers in this highest tax bracket was a much higher $13.0 billion. The resulting net outflow was $5.7 billion. That net outflow of high-income earners and taxpayers in 2018 swelled to $9.9 billion in 2019, to $13.7 billion in 2020 and to $20.4 billion, as shown in the most recent 2021 IRS report.
What should be even more alarming to Newsom and his fellow Democrats, who have commanding control of the Legislature, is that these losses in AGI are cumulative. That is, the net outflow of AGI in 2018 of $5.7 billion continues into 2019 and beyond. So, too, do subsequent losses in AGI. The net AGI out-migration, once gone, doesn’t come back. No one swims back to Alcatraz.
That means California’s loss in AGI from the migrating one-percenters is not simply the sum of annual losses over that period but the cumulative total that sums to $100 billion over the 2018 to 2021 period. The continuing loss of California’s population in 2022, resulting from a record net domestic outflow that year of 406,000 Californians to other states, points to accelerating losses in AGI in 2022 and beyond.
Although those who have AGIs above $200,000 pay the bulk of the California income tax, it is telling that all of the other classes of AGIs under the $200,000 threshold also experienced net losses in AGI. As a result, the aggregate net outflow from all classes of AGI increased from $17.6 billion in 2018 to $22.6 billion in 2019, to $23.5 billion in 2020, and to $29.6 billion in 2021. Those losses between 2018 and 2021 represent a cumulative decline in California’s AGI of $215 billion.
Of the $17.6 billion in California’s lost AGI in 2018 from all classes of AGIs, 32.4% was accounted for by those in the $200,000 or more category. That 32.4% grew to 44.0% in 2019, to 58.6% in 2020, and to 68.9% in 2021. Clearly, the “one-percenters” represent an increasing proportion of those leaving the state. That’s not surprising since they have a greater incentive to move to friendlier environs than do other classes of AGI earners.
Rather than focusing only on California, we analyzed all 50 states in order of the Tax Foundation’s ranking of each state’s 2021 income tax. The ten states with the lowest income taxes — Florida and Texas are in this group — gained a cumulative net inflow from all AGI classes of $391 billion during the entire 2018 to 2021 period.
The 10 states that ranked the highest in income taxes — California, New York and New Jersey are in this group — lost a cumulative net inflow in AGI of $391 billion. The fact that the 10 states with the lowest income taxes gained in AGI the same amount as the loss in AGI for the 10 states with the highest income taxes is not a coincidence.
Of California’s $29 billion loss in net AGI inflow in 2021, most of that lost AGI moved to the 10 states with the lowest income taxes including $3.4 billion to Florida, $5.6 billion to Texas, $4.4 billion to Nevada and $1.2 billion to Tennessee.
In light of California’s increasing net outflow of AGI, its current budgetary woes should not be surprising. Perhaps that explains Newsom’s recent rejection of various legislators’ proposed tax increases to balance its budget. But he should go one step further: Rather than just hold the line on taxes, Newsom should consider decreasing marginal tax rates to stem an accelerating migration out of the state.
Given the clear evidence of people moving from states with high-income tax rates to those with lower rates, especially those with higher AGIs, Newsom might find that lowering tax rates results in higher rather than lower tax revenues. The Laffer Curve is likely to be even more relevant for states than nations. It’s a lot easier crossing state rather than national boundaries.
James Doti is president emeritus and professor of economics at Chapman University. Art Laffer is an economist and chairman of Laffer Associates.