Taxes Don’t Drive Out the California Rich: Study

Taxes Don’t Drive Out the California Rich: Study

As Californians debate the "rich tax" contained in Gov. Jerry Brown's Prop 30, a new report challenges one argument for lowering tax rates on the wealthy: that millionaires simply move to avoid higher taxes, leaving the middle class with a higher burden.

The study, by sociologists at Stanford and Princeton, looked at two tax changes in California, a 1996 tax cut on high-income filers and a 2005 levy called the Mental Health Services Tax that took one percent of income over $1 million. Using tax-return data, the researchers examined how the changes affected "millionaire migration" in or out of the state before and after the tax laws were passed.

The research showed that millionaires not only were unmoved, so to speak, by their taxes being raised, "the highest-income Californians were less likely to leave the state after the millionaire tax was passed," wrote Charles Varner and Cristobal Young in their report.

In fact, the richer the Californian, the more likely he or she was to stay, the study found. Nor did the data suggest that lowering taxes lured millionaires to the state. (Read more: Millionaire 'Munger Sandwich' Squeezes Gov. Brown)

The pair previously studied millionaire migration in New Jersey, with largely the same results. But California's dynamic, tech-based economy may be, if anything, a better testing ground for the notion that job creators are forced out by taxation. "The presumption that exceptionally skilled, monied, and entrepreneurial individuals are also exceptionally mobile is debatable," Varner and Young concluded.

Aware, no doubt, of the politics swirling around their topic, Varner and Young appear to have considered every likely objection to their findings. They looked at the periods before each tax change in order to scoop up any high earners who moved in anticipation of being taxed. They scrutinized part-year returns to capture those who might take a second home to remove their out-of-state earnings from California's purview.

What they found is that California's millionaires, no matter the circumstances, move very little. "At the most, migration accounts for 1.2 percent of the annual changes in the millionaire population," the report said.

Most of the fluctuation in numbers of millionaires, as my colleague Robert Frank pointed out in his book The High-Beta Rich, relates to the rise and fall of personal fortunes. "The remaining 98.8 percent of changes in the millionaire population is due to income dynamics at the top," Varner and Young wrote, "California residents growing into the millionaire bracket, or falling out of it again." (Read more: Maryland Study Says Taxes Chase Out Rich)

This constant turnover in the top income brackets, the researchers say, may explain why millionaires aren't more sensitive to tax changes. A top earner who breaks into the millionaire's club only a few times in his career would be less likely to consider the tax when deciding to stay or go.

Indeed, the typical Californian millionaire only repeated his or her feat 54 percent of the time in the years from 1996 to 2003, the researchers found. Instead of paying one percent of their million-plus income to the government, this typical taxpayer would pay an effective tax rate of one-tenth of one percent over the 13 years. "This is a key question for someone considering whether to migrate for tax purposes," the study said.

The up-and-down fortunes of rich Californians is another reason they don't leave. "Most people who earn $1 million or more are having an unusually good year," Varner and Young wrote. "It is difficult to migrate away from an unusually good year of income."

So what does control millionaires' residential status? Loss of that golden opportunity for one: the greatest exodus of wealthy Californians in the years studied came after the collapse of the tech bubble. (The trend wasn't reversed until just after the Mental Health Services Tax was passed in '05.)

The other clear impetus for millionaires to get out of California was divorce. Knowing that the end of a marriage both occasions a move and shows up in tax data, the researchers used marital splits a "reverse placebo" to test tax data's ability to detect migration. In the first year after a divorce, 1.2 percent of divorcees start a new life elsewhere, according to the study.

"Divorce is something that has a very clear effect on migration, modest changes in the tax rate for high-income earners do not," the researchers concluded.