In our last Leader Board piece, we showed that California had experienced sharp declines in adjusted gross income (AGI) as more and more people left the state. But we also found that the loss in AGI is even greater than the loss in population.
That can be seen in Chart 1, which shows California’s losses in migratory AGI as a percentage of total AGI during the 2020-21 period have been much greater than the losses in migratory population as a percent of total population.
The latest year we have data on migratory AGI is 2021. In that single year, California lost $30 billion in migratory AGI, a net loss that represents about 2% of total AGI in the state.
That loss in AGI was more than double the 0.9% loss in net domestic migration.
As we showed in our prior Leader Board published on Sept. 18, a major reason for this is California’s state income tax, one that the Tax Foundation ranks as second highest in the nation.
As a result, higher-income people in California have a powerful incentive to move to the “friendlier confines” of states with lower or even no state income tax.
The upsurge in lost AGI in 2020 and 2021 appears to be having a measurable impact on tax collections. As can be seen in Chart 2, personal income tax revenues in California declined during the 2022-23 fiscal year from $135.9 billion to $125.2 billion, a sharp decline of almost 8%.
That decline is the first in the state’s income tax revenues since the Great Recession of 2007-09. At that time, real GDP in the nation was in free fall. That’s not the case now.
During the same 2022-23 period, when income tax collections in the state declined by 8%, real GDP in the nation increased by almost 6%. These data suggest that California’s yield on income tax revenues have gone beyond diminishing returns and may now be in negative terrain.
Various solutions present themselves. A co-author of this article—Gerry Parsky—chaired a blue-ribbon commission in 2009 that recommended structured changes in California’s tax system, one that reduced the income tax rates and proposed a new “net business receipts tax” similar to a value-added tax.
That new tax made it possible to also eliminate California’s corporate income tax. Although there was a strong case for the commission’s changes, they were ignored by a legislature not ready for major structural reform.
A tenable strategy for reversing the out flight of people and AGI from California, therefore, needs to be politically viable; otherwise, any recommended solutions will not get past the starting gate. That’s why rather than proposing structural reform, we propose a more simple, straightforward approach.
That approach is to reduce income tax rates across the board for low-income as well as high-income earners. We would eliminate any income tax for married couples earning less than $47,884.
The tax rates on all other brackets above $47,884 would be cut by 1%.
Chart 3 shows the current tax brackets as compared to our proposed reduction. We estimate that the tax cuts shown in Chart 3 would lead in 2024-25 to a decline in income tax revenues of $15 billion.
But that ignores the positive effects of a tax cut that would offset this decline and possibly lead to an increase in revenues.
Like former President John F. Kennedy’s 1963 tax cut and other tax cuts through the years, a tax cut in California will lead to a stronger economy for our state and result in a concomitant increase in taxable income.
The fact that people would have $15 billion more in untaxed income means that consumer spending will increase, and so too will taxable income.
That may explain why other states are already cutting taxes. According to the Tax Foundation, since 2021, 25 states have cut individual tax rates, including 23 that reduced their top marginal tax rates.
Unfortunately, we don’t have access to the detailed data necessary for us to make an informed estimate of the broader effects of a tax cut on the interstate flows of AGI. But if such a study can be undertaken and it shows that the dynamic effects of our tax proposal will “pay back” the cost of a tax decrease in increased revenues, a compelling case might be made for our recommended tax cut. So, here’s what we outline for a proposed bill in the California legislature.
In 1994, the California State Legislature mandated that the Department of Finance develop a comprehensive multiyear revenue analysis for consideration in the calculation of annual budgets for the next five years. The model was developed and implemented.
With this precedent, the legislature could order the Department of Finance to apply the model it already had developed (updated for improvements in methodology) and apply a multiyear revenue analysis to a proposal to lower personal income rates, as shown in Chart 3.
The revenue analysis should pay particular attention to the annual outflow of individuals with high adjusted gross income from California under the current levels and the revenue gains from deterring that outflow.
Our proposal is not a handout to the rich. Rather it’s a call for an analysis on the part of the Department of Revenue to determine whether an across-the-board tax cut of 1% and entirely eliminating taxes for those making less than $47,884 will have a positive economic impact on our state.
That’s why we hope this proposal will receive bipartisan support from our lawmakers. The fact that people are leaving the state and that exodus is leading to a sharp loss in state revenues is a major problem that shouldn’t be ignored. Rather, it needs to be addressed sooner than later.
