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Sunday
Dec092012

California's Budget Goes Off the Cliff

Contributed by Chriss Street. Specialist in corporate reorganizations and turnarounds, former Chairman of two NYSE listed companies. His latest book, The Third Way, describes how to achieve management excellence and financial reward by moving organizations from Conflict and Confrontation to Leadership and Cooperation. He lives in Newport Beach, CA.

California State Controller John Chiang just announced that total State revenue for the month of November 2012 fell $806.8 million, or 10.8%, below budget.  Democrats thought they could hammer “the rich” by convincing voters to pass Proposition 30 to create the highest state income tax in the nation.  But it now appears that high income earners have already “voted-with-their-feet” by moving themselves and their businesses out of state, resulting in over $1 billion shortfall in corporate and income taxes last month and the beginning of a new financial crisis.

Passage of Proposition 30 set off euphoria and expectations of higher spending for public employees.  The California Teachers’ Association (CTA) trumpeted:

“California students and working families won a clear victory today as voters clearly demonstrated their willingness to invest in our public schools and colleges and also rejected a deceptive ballot measure aimed at silencing educators, other workers and their unions.” 

State bureaucrats immediately ramped up deficit spending far beyond $6 billion annual tax increase, with the Departments of Health Services and Developmental Services increasing this month’s spending by over a $1 billion versus last year.  The lower tax collection and higher spending drove the State’s deficit after the tax increase to $2.7 billion for the first 5 months of this fiscal year.  State Controller John Chaing reported:

“November’s disappointing revenues stand in stark contrast to recent news that California is leading the nation in job growth, has significantly improved its cash liquidity to pay bills, and even long-distressed home values are starting to inch upward,” said Chiang. “This serves as a sobering reminder that, while the economy is expanding, it is doing so at a slow and uneven pace that will require the State to exercise care and discipline in how its fiscal affairs are managed in the coming year.”

The improved “cash liquidity” Chaing referred to, turns out to be $24.9 billion of debt!

During the election campaign, Governor Jerry Brown and his pro-tax coalition had the California Board of Equalization request a report from the Stanford Center on Poverty and Inequality, which claimed to have looked at state tax records and found no risk of the super-rich leaving.  Based on their access to California state income tax records from 1992 to 2009, the researchers concluded that millionaire migration is a myth by anti-tax advocates and “other factors, such as personal and business contacts, seem to weigh more heavily in deciding where to live.

The study’s authors, Stanford’s Cristobal Young, an assistant professor of sociology, and Princeton’s Charles Varner, a doctoral candidate in sociology, expounded that the temporary nature of high earnings may help explain why the additional taxes didn’t cause a noticeable flight of millionaires.  Top income tax payers seem to fall into and out of the millionaire income bracket as their income rises and falls across the million-dollar mark from year to year.

Personal connections weigh more heavily than tax rates in deciding where to live and “people are tied to states for different reasons,” Young said.  “They don’t want to take their kids out of school; they want to stay connected with friends, with families … with business contacts.  People crowd together, from Silicon Valley to New York City, because of the returns associated with collaboration.”  The findings dispel the “market metaphor,” in which states advertise low tax rates in a competition to woo high-income individuals. “This is a poor representation of how people decide where to live.”

Young added that looking at the tax flight issue only scratches the surface of state financial woes. “People need to think about the depth of California’s budget problems,” he said.  “I think there’s much, much bigger things to worry about than this issue of tax flight because it’s really hard to find any evidence of it” … “I hope people hear, listen to and absorb what the evidence says on this issue,” Young said.

Following the tax increase victory, Reuters News Service published: “Super-rich flight from California? Not so fast” to reassurance there would be very little risk that wealthy Californians would depart for income tax free Nevada, Washington and Texas.  Although “some Silicon Valley business owners had expressed interest in a move after California’s top rate was raised by 29% to 13.3%, “business groups from the Beverly Hills Chamber of Commerce to the tech industry policy group TechNet backed the tax, and the state Chamber of Commerce took no position.”

As panic is spreading that goosing taxes on the rich may have created enough “tax flight” that the California will actually collect less taxes, there was welcome news that a business had committed to opening in the State.   Executives of the 99 Cents Only Stores Inc. proclaimed they would be opening a new location in Beverly Hills on formerly posh Rodeo Drive. Cross Posted from Chriss Street's blog.

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Reader Comments (13)

It is not about the people that move in the first place. It is about the tax base that move and with it tax revenue. Usually the rich pay income taxes at different levels. In their businesses as corporation tax. Similar spread over several countries. Dividend or capital gains. Timing differences.

You donot have to investigate if people move, you have to investigate if 'consolidated' they will pay the same taxes over the same parts of their income in your place. The guy is simply completely 'oversymplistic'. Aka an idiot that hasnot got a clue what he should look for.
Migrating of the natural person is just one of the things. He can move his business, make new investments somewhere else, transfer IPR to a lower taxed place (basically cream off profits in high tax in favour of low tax). Reduce salary and live from asset sales. Etc.
Have a look at the UK the taxrise made the number of high incomes drop with 2/3. Papers assuming it is people leaving. Probably some did, but most likley will have changed the structuring of their taxbases.

You furthermore have to research the longer term effects. Because of the links when most people move or they move income/profit somewhere else there is delay. Say wait till the kids go to college. Or wait till you want to open that new factory. Another miss here.

It is indeed the links that stop people from moving, hardly any links and even minor changes can cause substantial outflows. And the linkage gets weaker and rapidly. You could eg run this website from under a palmtree in Bali or Goa and nobody would notice unless you would tell. Traditional family life is rapidly not the 90% standard way of living. More and more places become acceptable to live (communication, stuff from home available and at reasonable prices, good staff available, etc).

Problem is that taxes look to be as far as the rich and business are concerned at the peak of the Laffer curve or pretty close. It is simply worthwile to work on taxreduction if half your income or more is taxed away. So people simply invest their time in it. You can easily 'invest' 25% of your income in tax evasion if the alternative is 50% tax.
December 9, 2012 | Unregistered CommenterRik
This is an incredibly ignorant piece. The numbers stated are grossly misrepresented. I invite anyone who has any ability for critical analysis to follow the reference links.

The revenue shortfall of $802,369 is for FIVE months, not one month. As such, it represents a 2.8% shortfall from expectations (problem enough, indeed).

The $24.9B of debt is a correct figure. HOWEVER, the perspective is truly ignorant. As you might think, on reflection, revenues are certainly uneven across a fiscal year (California FY is from July 1 thru June 30). As such, much of the tax revenue falls in the 3rd and 4th quarters (Jan 1 thru June 30). Since expenditures are relatively constant, at this juncture of 5 months into the fiscal year, there is a large gap between expenditures and income based on timing. Perspective would be to examine where the borrowing total stood in the previous fiscal year. It stood at $13.28B. This fiscal year, the loan balance stands at $15.288. So the operating degradation is $2.0B of loan balance (again, bad enough). This is a FAR cry from the implication that somehow or another California has all of a sudden taken on an unexpected $24.98B of additional debt.

Last Fiscal year, California had an FY operating deficit of $1.429B. Making a VERY ROUGH extrapolation, if conditions do not get worse (or better) one could extrapolate that by next June 30, California would have an FY2012-13 deficit of $6.5B (again, bad enough - actually VERY bad). Which would send their operational loan balance at FY end from $9.6B at the beginning of this FY to over $15B next June. Certainly a daunting prospect.

I am seriously disappointed in Chris Street. Ah well.
December 10, 2012 | Unregistered CommenterEconomics Considered
The important question has not be asked yet. If the author loathes the new tax situation in CA why does he stay in Newport Beach CA?? Answer that question truthfully and that would have been more insightful than all the background materials.
December 12, 2012 | Unregistered CommenterJohnMc
I wonder why the tax increase proponents had the study performed by socioligists and not tax experts?
December 12, 2012 | Unregistered Commentermlm
-Economics Considered-
Well, you seem to be a real expert at number crunching. Shill at best. Lefty plant. And don't be disappointed in Chris. He is reporting the numbers on the wire, just not the supporting criteria. Yes, the $806M number is cumulative but to show the month to month change you need to reference the numbers from the previous month (October 30). It was $4.4M in the positive so the net change during the month of November goes from a plus $4.4M to a negative $802.4M. This is a net change month to month of a minus $806M. Sorry to disappoint you. Dummy -

And, CA is in the crapper. No one in Sacramento will pubically admit their socialist agenda is not supportable.
December 12, 2012 | Unregistered CommenterBudgetMan
There are a great many reasons why California is has slid into oblivion. Not the least of which is their tax code. I left because I was in downtown LA the day of the Rodney King riots. There was no way my family would be subjected to that again. Great weather and beaches are useless if your family is widowed and orphaned by street mobs for sport and Live-At-Five entertainment. I recieved a tremendous additional benefit of lower taxes, regulation, and a more libertarian environment.

California not only lost my personal and investment tax income but those of my family (the kids are all grown up and productive members of society now too). Net flow of productive people is not to California but away. California lost 798,000 tax returns, 2.3 million people, totaling $51 Billion in taxable income between 1993-2010 according to (http://interactive.taxfoundation.org/migration/).

http://interactive.taxfoundation.org/migration/graph.php

Any way you slice it, that's gotta hurt!

Sincerely,
Colorado Economist
December 12, 2012 | Unregistered CommenterColorado Economist
Agreed mlm, I also wondered why the study to predict the effect of increased tax rates was done by sociologists.
December 12, 2012 | Unregistered Commentercg
@cq
If I would have to make a guess probably because the real decisionmaker also has a sociology or pretty similar background and thinks that other subjects are easy to handle when you have studied that pinnacle of human knowledge and civilisation: sociology. Especially if you have no practical experience with it and have done the 50 hour course at college.
You see it as well with economists that use normal logic to solve a legal issue (or lawyers doing it the other way around, forbidden so cannot happen and things like that).
December 12, 2012 | Unregistered CommenterRik
My guess, having degrees in sociology, is that they performed a demographic analysis and, not knowing the nuances of tax policy, didn't account for all of the factors. And their multi-variate an analysis was probably off. Either way, an economist should have performed the study. I'd also like to know their population sample, who's considered wealthy, etc. In addition, social scientists are notoriously known for being liberal, so the study could have been skewed.
December 12, 2012 | Unregistered CommenterNickcaeb
"some Silicon Valley business owners had expressed interest in a move after California’s top rate was raised by 29% to 13.3%"

Really so the richest people in California had -15.7% as their tax rate? No wonder the state is in debt. In Australia we have top tax rate of over 60%!
December 12, 2012 | Unregistered CommenterArry
@Nickcaeb
You need an economist to make the survey, but you also need a tax specialist that can tell you in which way taxes are reduced. At the end of the day you want to know if policies work. And if not the reason why.
In the UK they had a drop of roughly 2/3 of those earning >1 Mn, because the highest rate went to 50% . Most will be by taxplanning and not emigration. But all the papers mentioned emigration.
Easiest way to do is take year Tminus1 take all people with taxable income above a certain amount and see if at T they still live there. With a properly automated system that will take you probably less than a day. All those data should be in the computer. Compare with general data about people moving from and to the state (should be available in statistic agency or whatever it is called). No sample problems. Probably too easy so they will have done something with samples.
Problem is people donot move at ones. Increase tax and it usually take some time before the real locals move (international citizens move faster). Kids finish school first or the schoolyear, transfer part of a company to another state or abroad (as you have to work there). Shorter term effect like you see here as the law is very new is mainly by way of taxplanning.


Good point about the 'liberal' effect. Looking at the UK the taxrise is imho overall probably negative. If you take extra-spending, but also new foreign investors moving abroad iso going to the UK, 50% looks very high to a lot of people. Still it is still there mainly for political reasons. A bit like the Buffett tax. Just to show that the rich pay their part, more than for anything else.

@Arry
That is only incometax at State of Calif. level, Obama also wants his pound of flesh at national level.
December 13, 2012 | Unregistered CommenterRik
Little mMrty O'Malley, Gov of Maryland, tried a millionaire tax just a couple of years ago and got HOSED. Millionaires moved out of state or reaaranged their fiances.

Why do LIberals always think raising taxes is the answer, when every time taxs are raised the state gets LESS money......
December 15, 2012 | Unregistered CommenterJ Man
@arry Try this, mate- 13.3 / 1.29 - Their previous STATE rate was 10.31%. I'm guessing they can't deduct their Federal taxes so, combined, they're REALLY getting reamed.

It's a wonder they don't chuck it all and just go catch a wave.
December 16, 2012 | Unregistered Commenterhessler

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