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Reason Foundation

San Francisco Examiner

California's Tax Addiction

Businesses and wealthy individuals flee state because of taxes, but California keeps raising tax rates anyway

Adam Summers
April 13, 2006

Think taxes in the Golden State are too high? You are not alone. Apparently, Steve Jobs agrees with you. BusinessWeek recently reported that Cupertino-based Apple has decided to set up a company, Braeburn Capital, in Nevada to manage its cash and short-term investments. Incorporation in Nevada has significant tax advantages, as Nevada has no corporate income tax, has no capital-gains tax, and doesn't share information with the IRS. California, on the other hand, has corporate income, capital gains, and franchise taxes all in the neighborhood of 9 percent.

Apple is hardly the first business to leave California for "greener" pastures. Numerous surveys in recent years have revealed that many California companies are moving to other states because of the high costs of taxes and regulations. According to the Nevada Commission on Economic Development, 37 businesses left California in favor of Nevada in 2004, at least in part because of the favorable business climate.

Small business owners are particularly hard hit by California taxation. According to the California Taxpayers' Association, the richest 10 percent of earners pay almost 75 percent of the entire income tax revenue in the state, and most of these are small-business owners. Thus, under California's backward tax policy, the very entrepreneurs responsible for economic growth and prosperity are being punished the most severely.

Various studies comparing economic freedom and tax policies across the nation confirm what an increasing number of individuals and businesses have come to realize: California's taxes are overly burdensome and are stifling economic growth in the state.

The Pacific Research Institute's 2004 U.S. Economic Freedom Index took a look at 143 variables to measure states' economic freedom. These measures were divided into five categories: fiscal, regulatory, welfare spending, government size, and judicial (property rights). According to the survey, California ranked 49th overall, ahead of only New York. Among the subcategories, it placed 48thh in fiscal, 48th in welfare spending, and dead last in regulatory.

Similarly, the Fraser Institute in Canada and the National Center for Policy Analysis studied economic liberty among the 50 states and 10 Canadian provinces in their 2005 Economic Freedom of North America report. These organizations analyzed ten variables in three categories (size of government, takings and discriminatory taxation, and labor market freedom) and found that California ranked 43rd among the states.

Yet another study by the Tax Foundation released in February compared the burdens of states' corporate, individual, sales and gross receipts, and unemployment insurance taxes, as well as a wealth index. Once again, California proved lacking, placing 40th overall on the State Business Tax Climate Index.

Unfortunately, things are even worse for individuals than they are for businesses. California ranked 47th in terms of individual taxes, largely because its 10.3 percent rate on income over $1 million is the highest marginal rate in the nation.

You might think this situation would be reason to shy away from additional tax increases, but, alas, even more tax hikes may be on the way.

State Treasurer and Democratic gubernatorial candidate Phil Angelides has said that, if elected governor, he would raise taxes on the highest income earners to give more money to K-12 education. This would be on top of the $3 billion increase in education spending last year and the $4 billion increase proposed by Governor Schwarzenegger this year.

And that's not all. Angelides also supports Rob Reiner's Proposition 82, a June ballot initiative that would raise income taxes 1.7 percentage points on individuals making more than $400,000 a year ($800,000 for families) to raise $2.5 billion for a boondoggle universal preschool program. Recall that Reiner was also behind last year's percentage-point income-tax surcharge for mental health subsidies and the 50-cents-per-pack cigarette tax increase of the late 1990s for children's health care.

Given California's tax-happy political culture, it is no wonder the wealthy and the successful are leaving the state in droves. According to The Wall Street Journal, the number of Californians reporting million-dollar incomes plummeted from 44,000 in 2000 to 25,000 in 2003—at a cost of $9 billion in lost tax revenue. Even the stock market downturn after the "dot-com" bubble burst cannot account for such a dramatic decline.

It is time policymakers finally learned the lesson of the early 1990s, when an increase in the top income tax rate to 11 percent elicited a mass migration of the wealthy to more friendly environs, precipitating a fiscal crisis. Less than a decade later, it appears California is intent on repeating that costly mistake.

Adam B. Summers is a policy analyst at Reason Foundation. This column was written for the California Libertarian Party's Libertarian Perspective. An archive of Summers' work is here and Reason's California research and commentary is here.


Adam Summers is Senior Policy Analyst


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