California's Millionaire Tax Mirage
A new report says Jerry Brown's revenue projections are fanciful.
WSJ Editorial, January 22, 2012
Governor Jerry Brown insisted in his State of the State speech last week that California is "still the land of dreams." He's certainly right if he's referring to his latest fantasy that raising taxes on the upper middle-class will generate an additional $5 billion annually over the next five years, eliminate the state's chronic budget deficits and pay down a large portion of its debt. Fortunately, the state's Legislative Analyst's Office, of all unlikely Sacramento institutions, has checked in from realityville.
In a new report, the office warns that the initiative that Mr. Brown wants to put on the November ballot to raise taxes on top earners might not generate as much revenue as he projects because their income is extremely volatile. Mr. Brown wants to increase the rates on individuals making between $250,000 and $300,000 to 10.3% from 9.3% and to 10.8% for those earning up to $500,000. The "millionaires" earning more than $500,000 would pay 11.3%.
The top 1% of earners already pay about 40% of the state's income taxes, a large chunk of which is on capital gains that are taxed at the same rate as wages. In the past, changes in the economy and stock prices have caused huge fluctuations in capital gains income and tax revenue.
Income from capital gains soared to $165 billion in 2000 from $28 billion in 1994. These earnings plunged to $68 billion in 2002 after the tech bubble burst but rose again to $153 billion in 2007 during the real estate boom—and then plummeted to $56 billion in 2009. The crash caused a $9 billion decline in capital gains tax revenue over those two years, which lawmakers made up by raising income and sales tax rates in 2009.
As the Analyst's Office notes, "because the Governor's budget proposal is centered on his idea for these wealthy tax filers to pay more, the state would become more dependent on this uncertain revenue source." The report projects that capital gains income next year will be about 35% lower than what the Governor estimates and that his proposed millionaire tax would raise about $2 billion less annually than Mr. Brown predicts.
"Over time, [the Department of Finance] assumes capital gains begin to approach levels only experienced during previous stock market and real estate 'bubbles,'" the Analyst's Office writes. "We advise the Legislature to regard these estimates with some caution."
The Governor's office has acknowledged that revenue from top earners is challenging to predict, but that hasn't stopped him from pretending. Last May Mr. Brown projected a $4 billion revenue windfall from capital gains. The legislature used the dreamy projections to paper over the deficit, but then the economy slowed and the stock market barely rose for the year. Tax revenues fell $2.2 billion short of Mr. Brown's projections, triggering a billion dollars of mid-year spending cuts.
Department of Finance director Ana Matosantos writes in a joint letter with the Analyst's Office that top-earners' "capital income is highly volatile from one year to the next" and that "given this volatility, estimates of the revenues to be raised by this initiative will change between now and the November 2012 election." Now, that's a convincing argument to take to voters.
All of this merely confirms the experience of states with high-rate, "progressive" tax regimes that seek to punish success but end up punishing everyone else. It's worth adding that the Analyst's report doesn't even account for changes in taxpayer behavior that higher rates may cause—such as more millionaires leaving the state.
But Mr. Brown's plan has little to do with economic reality. It's all about the politics of dreams, pretending that higher rates will produce more revenue in order to spend more, and hoping the economy booms again to bail him out. The Governor is also betting that his proposal to trigger $5 billion of education spending cuts if the tax hikes don't pass will scare the 99% enough to sock it to the 1%. If voters fall for it, they'll get the economy and deficits they deserve.
In a new report, the office warns that the initiative that Mr. Brown wants to put on the November ballot to raise taxes on top earners might not generate as much revenue as he projects because their income is extremely volatile. Mr. Brown wants to increase the rates on individuals making between $250,000 and $300,000 to 10.3% from 9.3% and to 10.8% for those earning up to $500,000. The "millionaires" earning more than $500,000 would pay 11.3%.
The top 1% of earners already pay about 40% of the state's income taxes, a large chunk of which is on capital gains that are taxed at the same rate as wages. In the past, changes in the economy and stock prices have caused huge fluctuations in capital gains income and tax revenue.
Income from capital gains soared to $165 billion in 2000 from $28 billion in 1994. These earnings plunged to $68 billion in 2002 after the tech bubble burst but rose again to $153 billion in 2007 during the real estate boom—and then plummeted to $56 billion in 2009. The crash caused a $9 billion decline in capital gains tax revenue over those two years, which lawmakers made up by raising income and sales tax rates in 2009.
As the Analyst's Office notes, "because the Governor's budget proposal is centered on his idea for these wealthy tax filers to pay more, the state would become more dependent on this uncertain revenue source." The report projects that capital gains income next year will be about 35% lower than what the Governor estimates and that his proposed millionaire tax would raise about $2 billion less annually than Mr. Brown predicts.
"Over time, [the Department of Finance] assumes capital gains begin to approach levels only experienced during previous stock market and real estate 'bubbles,'" the Analyst's Office writes. "We advise the Legislature to regard these estimates with some caution."
The Governor's office has acknowledged that revenue from top earners is challenging to predict, but that hasn't stopped him from pretending. Last May Mr. Brown projected a $4 billion revenue windfall from capital gains. The legislature used the dreamy projections to paper over the deficit, but then the economy slowed and the stock market barely rose for the year. Tax revenues fell $2.2 billion short of Mr. Brown's projections, triggering a billion dollars of mid-year spending cuts.
Department of Finance director Ana Matosantos writes in a joint letter with the Analyst's Office that top-earners' "capital income is highly volatile from one year to the next" and that "given this volatility, estimates of the revenues to be raised by this initiative will change between now and the November 2012 election." Now, that's a convincing argument to take to voters.
All of this merely confirms the experience of states with high-rate, "progressive" tax regimes that seek to punish success but end up punishing everyone else. It's worth adding that the Analyst's report doesn't even account for changes in taxpayer behavior that higher rates may cause—such as more millionaires leaving the state.
But Mr. Brown's plan has little to do with economic reality. It's all about the politics of dreams, pretending that higher rates will produce more revenue in order to spend more, and hoping the economy booms again to bail him out. The Governor is also betting that his proposal to trigger $5 billion of education spending cuts if the tax hikes don't pass will scare the 99% enough to sock it to the 1%. If voters fall for it, they'll get the economy and deficits they deserve.
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