Proposition 55 on this November’s ballot would extend income tax rate increases for twelve additional years. In 2012, voters approved Proposition 30, which established marginal tax rates as high as 13.3% through 2018. At the time, the tax increase was presented as an emergency measure needed to address the state’s fiscal crisis. But now that this emergency has passed, public employee unions, hospitals and other beneficiaries of increased government spending want to extend the higher rates.
According to a recent Los Angeles Times story: “The tax extension is being pushed by some of the state’s most powerful organizations, including the California Teachers Assn., the California Medical Assn., the Democratic Party and the Service Employees International Union.”
The Secretary of State reports that the committee supporting Proposition 55 has already raised $25.0 million from hospitals, $18.8 million from teachers’ unions and other public education interests, and $2.3 million from SEIU. It is thus not surprising that the estimated $8 – $11 billion of annual revenue expected to be generated by the initiative will be earmarked for public education and Medi-Cal.
Whether these interests need the extra money and can spend it effectively is debatable. For example, total school enrollment has been static over the last four years due to demographic factors. Also, among the 6.2 million students attending public schools, an increasing proportion are opting for charter schools, which operate at a lower cost per pupil.
As the District of Columbia shows, devoting more money to public education does not necessarily translate into better educational results. According to 2014 Census data, DC public schools received funding of $29,866 per pupil – by far the highest in the nation. Yet DC students performed worse than those in 45 of the 50 states, according to the most recent Education Week achievement scorecard. By contrast, Utah, which spends less than California, achieved much better results.
With respect to hospitals, research by the California Policy Center identified one Los Angeles medical center that receives $700 million annually from Medi-Cal along with several more that receive in excess of $300 million each.
Although some smaller hospitals have had financial problems, the hospital industry in California is doing quite well overall, with revenues exceeding expenses by $7.9 billion in 2014 across all hospitals that filedfinancial reports with the state. Further, a number of hospital executives receive very generous compensation. For example, Patrick Fry, the CEO of Sutter Health received $6.3 million in total compensation in 2014, while Kaiser Health Foundation Chairman George Halvorson received $10.4 million.
While few of us are paying the high tax rates that would be extended under Proposition 55, they could ultimately result in economic damage whose effects will be widely felt. A previous experiment with very high state income tax rates back East offers a cautionary tale. In 1971 Delaware increased its top marginal income tax rate from 11% to 18%. The state’s unemployment rate, which had been consistently below the national average vaulted above the national average by 1975. In-migration and economic growth slowed dramatically. The state’s tax revenues failed to keep up with spending increases – despite a further rate increase to 19.8% in 1974 – and its credit rating fell to the lowest in the nation. Delaware’s fortunes turned in the 1980s after its income tax rates were sharply reduced and its budget was balanced.
According to the Tax Foundation, California’s 13.3% top marginal rate is the highest in the nation, and compares very unfavorably to rates in nearby states. Nevada, Washington and Texas have no state income tax, while Arizona, New Mexico and Colorado all have top marginal rates below 5%.
As a result, high income individuals will have a strong incentive to relocate if high marginal rates are extended. To the extent that these individuals move to other states and take jobs with them, state revenues could be impacted.
Thus far, Silicon Valley and San Francisco have been relatively immune to a brain drain because they provide an ecosystem for tech startups unmatched elsewhere in the country. But this situation may change: between now and 2030, we could see competing technology clusters siphon off enough startup activity from northern California to become viable alternatives. Areas that provide potential competition to Northern California include Austin, Boston, Dallas, New York and Seattle.
We may also see a decline in venture capital activity like the one that occurred during the 2000-2001 “Dot Com Bust”. During 2015 and 2016 very few tech companies have gone public, suggesting that many large private firms (the so-called unicorns) are overvalued. If the tech sector does indeed fall back to earth as it has in the past, there is thus no guarantee that Northern California will remain exempt from the tax incentives that often drive relocation decisions.
Relative to other states, California is overly reliant on volatile tax revenue sources such as income and capital gains taxes. Sudden drops in these revenue sources can quickly precipitate a fiscal crisis. Rainy day funds have historically provided little protection from sudden, sharp cuts. A rainy day fund created by a 2004 ballot initiative was never fully funded and did not shield the state from major cuts during the 2008-2011 fiscal crisis. California can reduce revenue volatility and maintain service levels, by relying on broader based taxes rather than gambling that a small number of individuals will remain in the state and continue to earn outsized incomes.
Marc Joffe is a Senior Policy Analyst at the California Policy Center. His research on public finance has been published by UC Berkeley, the California State Treasurer’s Office and the Mercatus Center at George Mason University.