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California wants to raise taxes on the state’s highest income earners, but that would be disastrous

Quite recently, democrats in the state of California have proposed raising taxes on the state`s highest income earners in order to pay for schools and services hurt by the pandemic. This is not the very first proposal regarding raising taxes that has come out in regards to the pandemic. Quite recently a group of millionaires signed a letter asking world governments to permanently raise taxes on millionaires in order to raise revenue to cover the costs brought on by the virus. There have also been similar proposals in New York.

California

Raising taxes is generally not the most efficient idea to raise revenue. But what makes matters worse is the fact that California is already a high tax state.

California’s top marginal tax rate is 13.3%. The new proposal would add three new surcharges on seven-figure earners. It would add a 1% surcharge to gross income of more than $1 million, 3% on income over $2 million and 3.5% on income above $5 million.

So the top tax rate would be 16.8%, on income of more than $5 million and the combined state and federal tax rate for California’s top earners would soar to 53.8%. With the deduction on state and local taxes capped at $10,000 under the Trump tax cuts, the top-earning Californians wouldn’t be able to deduct the new taxes from their federal returns.

The tax would only effect the top 0.5% of California taxpayers. But that small group of super-earners — many of them in tech — pay 40% of the state’s tax revenues, according to California’s Franchise Tax Board. The new tax rate would also apply to capital gains, which accounts for a large share of tech income, since California taxes capital gains at the same rates as ordinary income.

California has already experienced mass exit of top earners

Tax hikes are not new to California history. So it is surprising that they are still being brought up now despite the disastrous effects they have brought. For instance,

Many millionaires fled California after the 2012 tax increase, with one report saying that, “We estimate that California lost 0.04 percent of its top earner population over the two years following the tax change.” The 2012 tax change is now old news, and yet there is still talk about its impact.

But this was not the only downside to the higher tax rates. In addition to this, the rich reported less taxable income compared to prior years. And overall, emigration and other behavioral responses “erased 45.2% of the expected revenue gains from the tax hike on top earners“.

This is generally anti-growth

When California raised taxes in 2012, it still experienced job growth in 2013. But the job growth was slower than the year before. This is one of the biggest downsides to raising income taxes; it does not lead to a complete downfall of the economy. But it erodes growth gradually by discouraging economic activity.

Here is what happens. A tax on income raises the cost of income-generating activity, especially saving. And by discouraging savings, an income tax discourages other things that are fundamental to growth and job creation. It discourages entrepreneurship, innovation, and business formation.

Conclusion

Either way we look at it,  the economy has suffered massive disruptions, and it is bound to stay contracted for some time. Raising taxes on the rich, especially now, is an inefficient way for any state to raise revenue. A wealth tax discourages savings, investment, and business formation. This in turn creates long-lasting damage to the economy. 

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