OPINION:
This November, California voters will choose whether to implement Proposition 40, a one-time 5% wealth tax on billionaires to fund a failing healthcare system. It’s part of a disturbing trend toward socialism in the U.S., wherein people misunderstand basic incentives and how taxes that target the wealthy end up harming everyone.
High net-wealth folks like Larry Page, Sergey Brin and Peter Thiel already have preemptively moved out of state to avoid the tax. These and other billionaire departures have likely reduced Prop 40’s $100-billion expected haul by about a quarter. But these departures also risk killing the Golden Goose that has funded the Golden State’s bloated budget for decades.
California gets almost half of its personal income tax revenue from the top 1% of earners, so every one of these high-earner flights is also a major blow to the state budget for years to come, partially offsetting the one-time revenue from Prop 40.
At first blush, the exodus may seem like an overreaction, since the 5% levy sounds modest next to California’s 13.3% top marginal income tax rate, but that’s an apples-to-oranges comparison. Wealth is a stock, and income is a flow. The honest comparison to a tax on income would be a tax on the change in net wealth, or the return on an asset.
Under that calculus, the proposed 5% wealth tax is, in many cases, equivalent to a multiple of California’s sky-high top tax rate on income — and in some cases equivalent to an income tax exceeding 100%.
California municipal bonds yield roughly 4%, while 10-year Treasury notes yield about 4.5%. The wealth tax liability will exceed those returns, leaving investors at a loss. Average equity returns in the long run easily exceed 5%, so a good year might surrender one-third or half its gains to this wealth tax. But a flat year would require liquidating and surrendering capital.
Municipal bonds, a favorite among high-income earners because of federal tax treatment, deserve particular attention because Californians pay for that one. If large purchasers of these bonds suddenly eschew them because the after-tax rate of return becomes negative, the governments then must offer much higher yields to sell those bonds, increasing their borrowing costs.
That leaves less money in the budget for roads, water systems, schools, hospitals, etc., all because this wealth tax would destroy the incentives for billionaires to finance the Golden State’s public services.
Proponents of Prop 40 might say these analyses are irrelevant since it’s a one-time tax, but nearly all the revenue is already allocated to permanent and growing healthcare obligations. A single infusion of cash doesn’t solve the negative cash flow problem. Therefore, once California burns through these funds, the budget hole returns and another tax is needed.
Then there are exemptions which will create additional market distortions. Since real estate can escape the tax depending on ownership structure, it creates a tremendous incentive to shelter wealth in an already tight housing market by buying up supply, either directly or through a revocable trust, reducing homeownership affordability for middle-class Californians.
Furthermore, advocates for this tax seem to think wealthy individuals hoard gold coins in a vault somewhere, whereas high-net-worth individuals actually have most of their fortunes actively invested, often in their own companies. Confiscating that wealth means liquidating a portion of the investment, thereby reducing whatever flows from that investment.
In the case of business equity, like stocks, that typically means fewer jobs and slower wage growth for workers, along with less innovation that would’ve benefited customers. If an owner has to sell an equity stake to pay the tax bill, it can even depress share prices, harming other owners, like middle-class Californians holding stock in retirement plans.
Taxing wealth is much more economically harmful than taxing just the increase in wealth and combining the two is even worse. Prop 40 would do just that.
For example, capital gains are already taxed by both the federal government and California, while Prop 40 would tax the capital gains again along with whatever asset generated those gains.
What is being sold by proponents of Prop 40 as “the wealthy paying their fair share” is actually a massive economic distortion that will further incentivize tax shelters, encourage unnecessarily risky investments by chasing higher rates of return, and worsen California’s ability to provide public services in the long run.
If California is looking to kill the Golden Goose, they’ve found the silver bullet.
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E.J. Antoni is a senior fellow at Unleash Prosperity and chief economist at the Heritage Foundation. Annie Heim is a research assistant in Heritage’s Institute for Economic Policy Studies.
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