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Wait, California Has Lower Middle-Class Taxes Than Texas?

Ultra-high earners can cut their tax bills a lot by moving from a high-tax state to a low-tax one. For most other people, that’s not at all a sure thing.

A lot of people left California for other states over the past decade, with 912,038 more going than coming from 2010 to 2019, according to Census Bureau population estimates. Who was leaving? Mainly those without college degrees and with middle to lower incomes, the Public Policy Institute of California calculated recently on the basis of a different Census Bureau data set. Here’s the breakdown by income:

I would not take this to mean that all is well with the state. An exodus of people with lower and middle incomes is not a good thing, and the net inflow of those with higher incomes slowed over the course of the decade. The data also don’t cover the upheavals of 2020, and there’s statistical evidence that out-migration from California accelerated last year as well as lots of anecdotal evidence that high-income people were among the emigrants.

These statistics are relevant, though, to any discussion of why so many people have been leaving California. Taxes often dominate public discussions of such trends, thanks in part to the unrelenting efforts of Republican policy entrepreneurs Arthur Laffer and Stephen Moore, whose 14th annual, mostly tax-based economic competitiveness report for the conservative American Legislative Exchange Council is out this month. But it’s awfully hard to argue that taxes have been the main thing driving the California exodus, given that (1) it has been concentrated among the less affluent, (2) their No. 1 destination has been Texas, according to 2010-2018 Internal Revenue Service data that I tallied up early last year and (3) lower-income and middle-income people face higher effective tax rates in Texas than in California.

Middle-class taxes are lower in Nevada, the No. 2 beneficiary of net migration from the Golden State, but for a household at the 2019 California median income of $75,235 the 1.8 percentage point difference in effective tax rate adds up to $1,354 whereas the difference in average annual rent for an apartment or house between metropolitan Los Angeles and metro Las Vegas is $6,336, according to Apartment List’s April estimates.

For those in the top 1% of the income distribution, who in California in 2018 had adjusted gross incomes that started at $680,687 and averaged $2.2 million, the story is much different.

These estimates are from 2018 because that’s the last time the Institute on Taxation and Economic Policy, a left-leaning Washington think tank, updated its distributional analysis of state and local tax systems, a massive “microsimulation” exercise that “relies on one of the largest databases of tax returns and supplementary data in existence, encompassing close to three quarters of a million records.” The right-leaning Tax Foundation recently published its estimates of the 2019 state and local tax burden, and one can get a rough accounting of the 2020 take by comparing the Bureau of Economic Analysis’s state personal-income and disposable-personal-income numbers, but neither of those gives any indication of how taxes vary by income group. So ITEP’s 2018 estimates are what we’ve got to work with.

California’s tax rates for high earners were the country’s highest in 2018, and the tax-rate differences between states were bigger for high earners than for middle-income taxpayers. Also, because the incomes involved are higher, the tax bills are bigger relative to real estate costs. The 9.4 percentage point difference in top-earner tax rates between California and income-tax-free Washington, the No. 3 recipient of California net migration and one that welcomed people with higher incomes than those headed to Texas and Nevada, works out to $210,443 for the average California one-percenter, while the difference in annual rents for a four-bedroom dwelling (not the perfect metric, I realize, but it’ll do) between metro San Francisco and metro Seattle is $7,320.

Changes in the last few years have made such tax differences loom even larger for those with very high incomes. The 2017 Tax Cuts and Jobs Act increased interstate variance in affluent people’s tax bills because those who face high state and local taxes are no longer able to deduct most of them for federal tax purposes. Then the sudden move to remote work during the pandemic brought a sharp rise in residential mobility among high-income workers, according to an Apartment List survey. Most of these moves were within the same metropolitan area, but the barriers to moving across state lines to avoid taxes have definitely been lowered. Also, New York has just passed a law that will likely make its top earners the country’s highest-taxed, surpassing California.

There are good reasons for states to care about the tax incentives facing one-percenters. In California and New York, they account for close to half of state personal income tax revenue. If too many leave, state finances could be hammered. A recent study by economists Joshua Rauh of the Stanford Graduate School of Business and Ryan Shyu of Amazon.com found a “substantial one-time out-migration response” to a 2012 increase in the state’s top income tax rate, concentrated among those making more than $2 million a year, and concluded that the departures had eroded at least 60% of the revenue gains from the tax hike. Rauh and Shyu also speculated that the impact of the changes in relative tax rates among states brought on by the 2017 federal tax law would prove even larger.

On the other hand, income tax revenue kept rising briskly through the pandemic in both California and New York. California now has a $75.7 billion budget surplus! An exodus of the rich may turn out to be a big problem, but it isn’t one just yet. Meanwhile, these two states have been bleeding poor and middle-class residents for years. High real estate costs are one big reason. Another is what Massachusetts Institute of Technology economist David Autor calls “The Faltering Escalator of Urban Opportunity”: Wages used to be much higher in big cities (California and New York are home to the biggest) regardless of where you were on the education or income spectrum, even adjusted for the higher cost of living. This is still quite true for college-educated workers, Autor has documented, but not for those with some college or less.

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