Plans to 'tax the rich' hold risks and rewards for California

SACRAMENTO, Calif. — Fueled by a backlash against the wealthy, California Gov. Jerry Brown and left-leaning groups want voters to tax the rich next November.

Californians have shown strong support for the idea in polls so far, despite the fact that they haven't passed a statewide tax hike since 2004. Brown said this month "the only tax that's overwhelmingly popular is the tax on wealthier people."

Partisans have feuded for years at the federal level over tax rates for the rich. Republicans argue that tax cuts spur investment and economic growth. Democrats say such "supply-side" theories are unfounded and that lower rates are merely a giveaway to the wealthy.

As a state, California has particular considerations.

Chief among them are a fear that taxpayers will flee for lower-cost states, a widening gap between rich and poor, and a volatile income tax stream.

Critics say high-income earners and business owners will leave California for states with no income taxes, such as Nevada or Texas.

"There's nothing more portable than a millionaire and his money," said state Sen. Bob Huff, R-Diamond Bar, the ranking Republican on the Senate budget committee.

The concern is not limited to Republicans. In July, Democratic state Treasurer Bill Lockyer told the Sacramento Press Club he thought California was near its reasonable limit for taxing the rich. California voters in 2004 opted to tax millionaires to pay for mental health programs. In 2006, they rejected a tax hike on the top 1 percent of earners to pay for public preschool.

A 2004 "millionaire's tax" in New Jersey had little effect on migration, according to a study by Stanford University sociologist Cristobal Young and Princeton University sociologist Charles Varner published this year in the National Tax Journal. Moving from California to escape taxes is even more difficult.

"Many people in New Jersey could move 30 or 40 miles and find themselves in lower-tax Connecticut or Pennsylvania," Young said in an email. "If you are in the Bay Area, it is a 500- to 700-mile move to competing urban areas such as Las Vegas or Phoenix. That is a tough move - you will be starting a new life."

The New Jersey Department of the Treasury issued its own research in October that countered the Young-Varner study. The department is led by an appointee of Republican Gov. Chris Christie, a vocal opponent of a new "millionaire's tax."

In a state with 8.7 million residents, the department said that all tax increases - not just those on the wealthy - resulted in 20,000 fewer taxpayers.

For California business owners, such a change would be one more factor among many to consider when thinking about location. Businesses consider weather, transportation, regulations, market size and labor costs, among other factors, said Brad Williams, former chief economist for the Legislative Analyst's Office.

"Businesses will need to think about what they're getting for those taxes," Williams said. "Do businesses think they're getting something in return?"

Proponents of taxing the rich call it a matter of fairness. They point out that the rich got richer over the past three decades while the poor lost ground, resulting in a widening inequality gap.

In the midst of the technology boom in 2000, the top 1 percent of California households had 27.5 percent of the state's income. That was more money than the bottom 60 percent of the state's tax filers combined, according to the Franchise Tax Board.

The income gap shrank during the Great Recession as investments plummeted, but state Department of Finance officials believe it is again widening as the economy recovers.

Meanwhile, the Occupy movement and frustration over joblessness have fueled the tax drive.

"It's better to ask those who can afford it to pay a little bit more so that we can fund education, higher education and public safety," said Senate President Pro Tem Darrell Steinberg, D-Sacramento. "I think people intuitively get that. And it's been exacerbated by what's gone on in the country over the last couple years with the whole Wall Street scandal."

Federal income tax rates on the rich have fallen since the mid-20th Century. During World War II, the highest rate was 94 percent, and it was 50 percent as recently as 1986. The highest rate currently is 35 percent after reductions signed by President George W. Bush and later extended. Tax rates on capital gains also fell under Bush.

Wealthy earners "are the ones whose incomes have grown substantially in recent decades, and they have benefited disproportionately from the federal tax cuts," said Jean Ross, executive director at the California Budget Project, which advocates for low- and middle-income residents. "We ought to use state law to even that out somewhat."

Notions of fairness differ. Scott Drenkard, an analyst with the right-leaning Washington, D.C.-based Tax Foundation, argues that it is less fair to impose higher tax rates on the wealthy than flat rates that capture a more proportionate share of income.

"A lot of people try to push these things under the auspices of fairness," Drenkard said, "and you rarely get a definition of fairness from them."

Higher taxes on the wealthy would provide more money to spend on programs, but it could make state revenues more unpredictable.

California's tax system relies on upper-income earners to pay the bulk of state income taxes. In 2007, the top 1 percent of earners - households and individuals making at least $494,826 that year - paid 48.1 percent of income taxes.

Unlike middle- and lower-class workers who rely mostly on wages, the wealthy depend more on investments and stock options, which can swing wildly from year to year.

During the dot-com boom, the state added funding for schools, health care and transportation and cut taxes on vehicles and income in 2000.

When markets crashed and a recession set in, then-Gov. Gray Davis faced a deficit he estimated at $34.6 billion in 2003. A similar cycle occurred under then-Gov. Arnold Schwarzenegger during and after the housing bubble.

"We have a much more volatile revenue structure that contributes more in good times and results in much deeper cuts in bad times," Williams said.

One way to address the problem is to rely less on income taxes. But doing so, as a proposal by the Think Long Committee for California does, would shift more of the tax burden to low- and middle-class taxpayers. That would be unpopular, and many would consider it unfair.

Another way is to control spending in good years and push money toward a "rainy-day fund." California has soft measures in place that require such savings.

But the state has a hard time stashing money away because advocates and voters would rather use extra money on public services, especially after a period of deep cuts. Or they may want tax rebates.

Brown's proposal relies on a half-cent sales tax hike in addition to taxing the rich, so volatility may be less of an issue. A bigger problem is that his plan expires after 2016, at which point programs may continue to demand spending at a higher level without the money to pay for it.