Posted 10:20 AM by Robert

Taxing California

Is California a high tax state?

Some people, such as Paul Krugman, say that California is not a high tax state. He focuses on state and local taxes as a percentage of personal income. That measure provides some good information - but no measure provides all relevant information.

It is also important to ask:

How much will a person living in California and making a specified wage be able to buy with what is left of that wage after all taxes are paid?

That question will be important to an individual considering whether to live in California or another state. And it will be important to that individual's employer or potential employer, since that wage will tend towards one that has purchasing parity with other areas. And raising wages in a jurisdiction with a progressive income tax is largely self-defeating, as discussed below. One caveat: It is also important to keep in mind that taxes do pay for things at least some taxpayers want and use - tax money is not just value out-the-door. Nevertheless, this is an important question.

Suppose one starts with the question: What salaries have pre-tax purchasing parity between, say Miami and Los Angeles? According to one on-line service, a salary of $100,000 in Miami equates to a salary of $134,000 in Los Angeles without taking into account items such as taxes.

Suppose that the state-and-local tax burden as a percentage of personal income in Miami were exactly the same for this individual as that in Los Angeles - say, 20% just for a round number. That means a married taxpaying couple has to pay the same federal income taxes in both states after deducting the same amount for state and local taxes. The federal income tax rate is 15% for incomes between 14,000 and 56,800, and after that goes to about 35%.

If a Los Angeles employer attempts to adjust for the 34% purchasing parity ratio between Miami and Los Angeles by paying a higher salary, 20% of each marginal salary dollar goes to state and local taxes (remember, these are marginal dollars the employer has to pay over the Miami base, so it is not correct in this analysis to ignore this 20% on the grounds that Miami and Los Angeles have the sme state-and-local tax burdens) and 15% of each marginal salary dollar goes to federal taxes until the employee is making $56,800 in federal taxable income - at which point 35% of each marginal salary dollar goes to federal taxes. That's a big disincentive for an employer to locate high-wage employees in California.

Also, a major (often, the dominant) reason many important things are expensive in California is already government regulation, so even that purchasing parity differential already represents a state "tax" (in the sense of increased cost caused by regulation) that does not reveal itself in comparisons of taxation to personal income. Just by way of examples, housing - at one time relatively cheap - is now very expensive in California, and fuel, electricity and water costs are all high largely because of inefficient state intervention. One might include the state's irrational and wildly expensive workers comp program and litigation climate in that category, too.

All of these tax and state-added-expense effects are concealed by the use of the tax-as-percentage-of-personal-income measure. That doesn't mean people citing to that measure are being deceptive. But these effects will not be ignored by individuals thinking of moving to California or businesses thinking of moving out. And they are relevant to determining whether California is a high-tax state.

But just as California taxes do not exist in a vacuum free from federal tax and cost-of-living consideration, neither do they exist independently of spending considerations. At least with respect to California state and local taxes one can assume that such taxes are mostly (but not solely) spent in California. The same cannot be said of federal taxes. At the dawn of the Clintonian era, in 1992, the federal government spent 93 cents in California for every dollar it extracted from the state in taxes - but by 2002 that per-federal-tax-dollar spending had dropped by 16 cents to 76 cents. So while in real, macroeconomic terms, federal taxation of Californians is already high because of cost-of-living factors - that burden has become much heavier since 1992 if such taxation is considered in terms of federal taxation of Californians net federal spending in California. [As an aside: Many of the biggest supporters of the same high, progressive federal taxes and altered spending priorities (including reduced military spending) put in place after 1992 are California's own Congressional representatives, especially Senator Barbara Boxer.]

Does that help explain why people like Paul Krugman are so fond of that particular tax-as-percentage-of-personal-income measure of state tax burden in this context?

POSTSCRIPT: One astute reader suggests that most of the above post does nothing more than point out that California is a high cost-of-living state. That may be right. I plan to think further about that, and may revise the above post. In the mean time, I am very glad to receive the comment, and I invite any more that my generally amazingly sharp readers may offer.

MORE: From the Daily Howler.