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Voting Away the Tax Base?

Times Staff Writer

To live in California is to pay the highest state income tax rate in the nation, if you’re wealthy enough.

Last week, voters had a chance to raise that tax rate to new heights by approving Proposition 82. They declined.

Did they figure that the Golden State’s rich were already thoroughly soaked -- or did 82, which would have funded universal preschool for 4-year-olds, just not present a convincing enough case?

The question is important to Bob Rodriguez, a principal at money management firm First Pacific Advisors Inc. and someone who is in Proposition 82’s target demographic.

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He fears that the electorate may yet be willing to embrace more tax-the-rich propositions. He sees these ideas as fiscally calamitous in the long run because they may induce high-income people to move out of state to avoid the tax hit. Drive out enough of the rich, Rodriguez says, and the state will have no choice but to demand more tax revenue from people much further down the income scale.

The 57-year-old Rodriguez says he would, in fact, have been driven out of his native state if Proposition 82 had passed. For months before the primary election, he told anyone who would listen that he would leave California if 82 were approved.

Nevada is right next door, after all, and it has no income tax, period. Proposition 82 would have raised California’s top tax to 12% from 10.3%.

“I will not allow my assets to be expropriated,” Rodriguez says.

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The rant of a greedy millionaire who doesn’t want to pay his fair share of taxes? Rodriguez knows that some will say so. But he comes to the discussion with a different perspective from that of many millionaires. His grandparents on his father’s side had their wealth seized in the Mexican revolution of 1910, he says. They came here to start over.

Looking through that prism, Rodriguez sees a tax imposed on a minority by the majority as grossly discriminatory.

“If these services in society are needed, then everyone in society should pay for them,” he says of the preschool program.

The TV ads opposing Proposition 82 did not, of course, feature rich people decrying the prospect of paying higher taxes. But Rodriguez’s frankness on the issue raises a legitimate question: Is there a tax threshold at which a significant number of the wealthy really would flee the state or change the makeup of their income, ultimately leaving California with less tax revenue instead of more?

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First, a bit of history from the Franchise Tax Board: The top tax rate in California was 11% for most of the period from 1973 to 1995. It was cut to 9.3% in 1996, and voters that year narrowly rejected a proposition that would have reinstated the 11% top rate.

But in 2004 the electorate approved Proposition 63, which slapped a 1% surtax on incomes above $1 million to fund expanded mental-health services in the state. It was the first sign that taxing the rich might fly as a way to raise money for specific public purposes.

With that as an entree, the backers of Proposition 82 sought to redefine who was truly well off. The measure would have added a 1.7% tax on incomes above $400,000 for singles and $800,000 for married couples.

That would have meant a top California tax rate of 12% on million-dollar incomes -- 2.5 percentage points above the next-highest state tax rate, Vermont’s 9.5% levy.

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If an 11% tax rate didn’t send every last rich Californian packing in the 1970s and 1980s, would 12% do the trick now?

Nathan James, a spokesman for the Yes-on-82 coalition, says there is “absolutely no data in California or anywhere else” that says wealthy people leave in droves when tax rates go up.

The No-on-82 group, however, commissioned a study that reached a different conclusion. The report by Bill Hamm, a former legislative analyst for the state, estimated that California’s general-fund coffers would have lost at least $4 billion in revenue in the first five years if 82 had passed.

The rich, Hamm said, can and would take steps to protect their income from higher tax rates. Some would leave the state. Others would defer compensation, boost tax-sheltered retirement savings or cut their taxable income in other ways, such as by investing in California tax-exempt bonds, he said.

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His report, he said, was based on “well-established economic modeling” of how people react to changes in marginal tax rates.

What’s key, Hamm contends, is that the high-income group is a sliver of society, but its total contribution to California’s tax revenue base is substantial.

The $1-million-plus annual income group accounted for 28,827 California tax returns in 2003, the latest data available from the Franchise Tax Board. That was 0.2% of all returns filed.

But those people contributed 24% of the total state personal income tax take that year -- $7.33 billion of the gross receipts of $30.37 billion.

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Their fiscal importance is such that “a little change in their behavior can have a very material impact on state revenues,” Hamm said.

Of course, there always are some people exiting California because it’s “too expensive” -- in terms of taxes, housing, insurance or any number of other costs.

Yet even those wealthy Californians who deeply resent higher taxes targeted at them may have a tough time fleeing for that reason alone. If your clients are here, for example, it may not be practical to move your business. If your family is here, and your kids are in school, uprooting to save on state taxes may hardly be worth the psychic cost.

As for changing financial behavior to reduce taxable income, that is always possible for the rich. But some could save far more in taxes by changing their income mix for federal tax purposes. For example, with the maximum federal tax rate on stock dividend income now 15%, people with significant investment assets can save huge sums by shifting away from interest income (taxed at a 35% top federal rate) to dividend income.

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That beats trying to save a few percentage points on your state income tax rate, says Lenny Goldberg, who heads the California Tax Reform Assn., a group dedicated to “equity and social fairness” in tax policy.

The dynamism of the state’s economy also can mitigate tax revenue losses from the established wealthy. The founders of Google Inc. obviously weren’t vexed enough about the state income tax rate to launch their company in Reno instead of Silicon Valley. California has reaped vast tax gains from Google’s success.

But what if the top state tax rate went to, say, 14% because voters found merit in a succession of tax-the-rich proposals that might materialize over the next few years? What if Democratic gubernatorial candidate Phil Angelides is elected and carries out his pledge to force “multimillionaires to pay their fair share” of taxes?

“You don’t go down this road and expect that there isn’t going to be a consequence,” says Rodriguez, who amassed his fortune by racking up market-beating returns for his stock and bond mutual fund shareholders over the last 20 years.

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“I honestly believe this state is close to a tipping point,” he says.

Even Goldberg allows that it’s possible to go too far in taxing the rich. “To say there’s got to be an upper bound, I wouldn’t argue with that,” he says.

Did voters, in defeating Proposition 82, signal that a 10.3% tax rate is high enough?

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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, visit latimes.com/petruno.

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(BEGIN TEXT OF INFOBOX)

Highest state tax rates

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These 10 states, along with the District of Columbia, have the highest marginal income tax rates:

California: 10.30%*

Vermont: 9.50%

District of Columbia: 9.00%

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Oregon: 9.00%

Iowa: 8.98%

New Jersey: 8.97%

Maine: 8.50%

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North Carolina: 8.25%

Hawaii: 8.25%

Minnesota: 7.85%

Idaho: 7.80%

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*For incomes over $1 million; next highest bracket is 9.3%.

Source: Federation of Tax Administrators


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