That Big Sucking Sound (or The Tax Rush of 2013)

Ross Perot coined the phrase “giant sucking sound” in 1992 to refer to the job loss that he thought would result under NAFTA. Twenty years later there is a different sucking sound – the sound of California’s eroding tax base under the Proposition 30, which was approved last fall. Proposition 30 increases the California sales tax rate and imposes higher taxes on taxable income over $250,000. Best of all, it applies retroactively to January 1, 2012, so you could end up paying more tax on income earned a year ago. Based on the new tax rates, California is actually expected to have a budget surplus this year.

Or will it?

With the increased federal taxes, California taxpayers would now pay a marginal rate of tax of up to 56.7%.  According to the Tax Foundation, a non partisan tax research group based in Washington D.C., California now has the highest statewide sales tax in the nation (7.25%), the second highest personal income tax in the nation ((10.3%) and the highest corporate tax rate in the West (8.84%).

Can you guess where I am going with this?

Several years ago, while I was on some (don’t laugh) business related junket to Las Vegas, I had the opportunity to hear state governmental and business leaders pitch their benefits to out of state companies. The basic theme was simple, not at all subtle, and very direct: “We Are Not California”. Yes we have drugs and gangs and OJ Simpson, but at least We Are Not California. The corollary was “So Move here Now.”  I was so impressed by the pitch that I ran right out and took the Nevada Bar exam (PS – I passed [yay!]). And then…. I waited…. And….Not much happened. I would have to admit that I did not get much benefit out of taking the bar exam, other than four days of testing in balmy Las Vegas in late July.  They held the exam in Vegas in July, by the way, because apparently the surface of the sun was all booked up.  Now it looks like I may be able to dust off my Nevada bar license and help some soon-to- be-former Cali’s move.

And I am not trying to pick on Nevada. Many other states have followed suit. Arizona and Oregon have regularly harvested companies from California with their more business friendly climates back when we had lower taxes. What do you suppose is going to happen now?

We call it erosion of the tax base, i.e., when you tax the rich with the expectation of getting more revenues, you end up losing a certain percentage of taxpayers. Because 14% of 0 is less than 10% of anything, you end up with less tax revenues from the taxpayers that leave, so the big question is “will enough people stay to make up for those who leave?” And will the extra 4% on the Richie Riches that stay be more than the 0% on those who leave.

Obviously, no data is yet available but we do have anecdotal evidence.  By anecdotal evidence, I mean that I have stories about what taxpayers look like after I advise them of what to expect if they stay in this state. The early anecdotal evidence suggests (are you ready for this?) that it is going to be ugly. Ten percent tax rates people could live with – 13 and 14 percent many will not. Prepare for a great outbound tax rush to rival the inbound gold rush of 49. In fact, I am going to call it the “Tax Rush of 2013” ™. If you are smart, you already own property in Incline Village. If you are like the rest of us, you are studying your options.

It’s not all bad, of course. There will be the poor saps who stay. In addition, did I mention that the tax is retroactive to January 1 2012? That means even the Cali expats will not be able to escape one year of 2102 tax increase (so it looks like that budget will be balanced after all, but look out for 2013).

I think that we must resign ourselves to losing a few rich folks. The bigger question is what will this do to business. After all, I am also a business attorney, so I should be concerned about what happens to business. Fortunately, not all business decisions are based solely on tax, believe it or not, and businesses sometimes locate in California for business reasons. Personally, I moved here to watch drug free professional cycling, and you know how well that turned out. However, sometimes companies set up shop in California for the talent and brains that reside here. Sometimes they come for access to customers and technology or maybe even for the $30 billion of venture capital that is looking for a home. We call those companies “startups” and they do Not Pay Tax. Hardly ever. If they do, we revoke their office ping pong tables and make all their employees wear adult clothes, and call them “middle market.” Middle market sounds like middle age and it is just about as sexy (not) to the technoistas that hang out in my neighborhood.  Therefore, to avoid becoming middle anything, the founders exit before getting profitable and start all over with a new non taxpaying company. We call them “serial entrepreneurs” (or Peter Pan Syndrome Sufferers).

Besides, for someone who survived the dot bomb crash of the last decade, I can tell you that tax is not a bad problem for a company to have. It means they have income, just long enough to exit and start the next non-taxpayer. And that brings me to the subtle point that needs to be made. (whew! Finally).

The fiscal cliff deal gave startups and VCs a huge bennie when it brought back the 100% exclusion from gain for qualified small business stock. You can read all about it here, but in a nutshell, a founder or investor could escape ALL federal income tax on up to $10 million of gains from the sale of certain small business stock. IF that founder is smart enough to move to a tax haven state, like Nevada or South Dakota (the little known weaker sister of its much more prominent neighbor, North Dakota), they could avoid paying US income tax at all on sales gains. Think about that for a minute. Zero rate of tax. Nevada would be like the Cayman Islands, without the scuba diving.

Would California business owners actually do that? Would they dare to leave and “stiff” California out of its share of taxes? Would they actually buy a house in one of those states (in most states you can get a mansion for the cost of a windowsill in California) and maybe end up living next to a neighbor with a monster truck and a girlfriend named Porsche?

You bet your ass they would. It happens all the time. Even now.

Ross Perot was talking about something different when he came up with “giant sucking sound” but I think the name is still good, almost as good as “The Tax Rush of 2013” ™ which I invented. It sort of sounds like an IRS frat party thing, but I still like it.

Of course this is all speculation on my part. The California magic of innovation, film, finance and technology may offset the increased costs. As I said, no hard data is yet available. Unfortunately, by the time it is ready, it will likely be too late.

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