How High Will California's Taxes Go Before There's No One Left To Tax?

The new taxes lawmakers are proposing to fund a universal health care system will likely drive even more Californians out of the state.

As the mad scientist laboratory for bad tax policy in America, California is constantly striving to come up with poorly designed and harmful taxes to pay for ever-increasing spending. But even by its own lofty standards, California has truly outdone itself with its latest proposal to fund a state single-payer health care system.

A proposed constitutional amendment, ACA 11, would accomplish the unlikely goal of making the taxes that California currently demands from its residents look restrained. Not only would the proposed $163 billion in new tax revenue nearly double last year's total revenue for the tax-happy state, but California would structure these new taxes in such a way as to be even more harmful than doubled tax liabilities already imply.

The bill would raise the additional revenue through three taxes: a 2.3 percent gross receipts tax on business revenues (with an exemption for the first $2 million in profits), a 1.25 percent payroll tax on businesses with 50 or more employees (with an increased rate for wages paid to employees making over $49,900), and 0.5 percent to 2.5 percent increases to the personal income tax rate depending on income.

It's hard to say which of these is the "worst," but the 2.3 percent gross receipts tax sticks out. That gross receipts taxes are an awful way to structure a business tax is one of the few things that tax policy experts across the political spectrum almost universally agree on. That's because they make no allowance for the large variance in profit margins that different types of businesses make—whether a business has a profit margin of 0.1 percent or 10 percent, it would still have to pay the same percentage of its total revenues.

That's a problem with any gross receipts tax, but California's proposed tax would exacerbate this inherent problem with a rate that is three times the level of the nation's current highest. The higher the gross receipts tax rate, the more low-margin businesses that could be put in a position where operating in California would lose them money.

Almost as bad is the proposal to institute a payroll tax on businesses with 50 or more employees. Not only are payroll taxes a regressive tax (even if the tax is imposed on the employer, it would be passed on to employees in the form of lower wages), but the 50-employee threshold would create an obvious disincentive for businesses to hire their 50th employee.

On top of that, the additional 1 percent payroll tax on wages paid to employees making $50,000 would punish employers for paying a wage that is tens of thousands of dollars below the median household income in the state. Taken together, the payroll tax would discourage both hiring employees and paying them higher wages, a disastrous outcome for workers.

Even the blandest proposed tax increase of the three, increases to individual income tax rates, is badly structured. Combined with the payroll tax proposal, taxpayers would effectively be subject to an 18-bracket tax structure with a top marginal tax rate of 18.05 percent. Combined with the 37 percent top federal individual income tax rate, wealthy Californians could expect to have to hand over more than half their income.

Not only would all these tax increases hurt the state's residents, but they would also exacerbate a trend that California appears to have its head in the sand about: overtaxed businesses and individuals fleeing for greener pastures. The latest release of IRS tax migration data, covering 2018 through 2019, shows that California lost over 71,000 taxpayers and over $8.8 billion in adjusted gross income. U-Haul's 2021 data had California as the worst in the country for net outward migration.

At the same time, the "tech flight" phenomenon of innovative companies fleeing California for lower-tax climates is very real: One analysis found that 265 companies moved their headquarters out of California in just the period between January 2018 and July 2021. It's hard to imagine that that trend wouldn't go into overdrive should ACA 11 succeed.

But California has long refused to acknowledge that there are consequences to squeezing its citizens for every dollar it can get. In fact, another recent proposal to institute a 0.4 percent wealth tax would have attempted to subject taxpayers to the tax on a sliding scale for 10 years after they had left the state—a requirement that would almost surely be unconstitutional.

If the harm that these tax proposals would inflict upon its residents is not enough of an incentive for California to consider the consequences of its actions, then perhaps the steady erosion of its tax base will be. There are many broken things that need fixing in California, but massive new middle class and small business tax increases would be yet another enormous leap in the wrong direction.