Next month, Californians will vote on Proposition 40 to decide whether to authorize the state to impose a 5% tax on the entire net worth of roughly 200 residents, each of whom is worth more than $1 billion. Supporters call it a one-time ‘contribution’ to save health care from Washington’s cuts.
The reality is quite different.
The Hoover Institution’s Josh Rauh has done amazing work on his Substack, Fiscal Reality Check, with help from various coauthors, to set the record straight and remind us what’s at stake. I thought it was a good use of my time to summarize some of their contributions on the topic, in part because the work is excellent, but also because the call for a wealth tax in America will not end in California, whether this proposition wins or loses. So there are lessons for all of us.
California’s budget problems aren’t new. They didn’t start with the pandemic, and they didn’t start with the Trump administration, as some would like us to believe. And they have nothing to do with billionaires. Instead, they have a lot to do with state officials who, for decades, made promises to various interest groups they never intended to pay for and spent money they didn’t have. When they got federal funding, which they got a lot of, they expanded state spending. They didn’t create new programs they disliked or existing programs they didn’t want to expand. When that spending led to too much red ink, the big spenders kept spending, and now they’re looking for others to stick with the bill.
Start with pensions. For more than a decade, California’s state and local governments told public workers their retirements were secure and assured taxpayers the cost was manageable. Both claims rested on an arbitrary assumption that pension funds would earn about 7% a year. Josh Rauh and his colleagues have tracked what that fiction costs. Faced with enormous public pension holes, the state has had to grow its contributions to the state’s 33 largest pension funds from 20% of payroll in 2015 to 32% in 2024. By 2024, California governments sent $38 billion a year into those funds, about one-tenth of tax dollars. The private sector’s remarkable performance in the last few years has helped dig the government out of the hole. Still, the system’s pensions are, by their own rosy measures, only about 81% funded. If we value the pension promises the way a private insurer would, as guaranteed obligations discounted at Treasury rates, the funding ratio drops to roughly 63%.
That additional payroll tax money going to pensions has to come from somewhere. One source of that revenue is California’s schools. Rauh and Gregory Kearney write: “Over the past decade, pension contributions have consumed an increasingly large share of education budgets to pay down existing liabilities. In our own analysis of nearly 12,800 school districts nationwide, we find that in California pension costs nearly doubled as a share of the education budget meant for covered employees.” They found that pension costs nearly doubled as a share of the relevant education budget while enrollment fell 14%. If districts had held pension costs to their 2015 level, they would have saved nearly $6 billion more for other priorities in 2023 alone. Families aren’t losing school funding to billionaires. They’re losing it to retirement promises politicians made long ago to state employees.
The legislature still hasn’t learned. This summer, legislators in both houses passed AB 1383, in a bipartisan vote, which would have unwound part of Governor Jerry Brown’s 2012 pension reforms and sweetened benefits even further. CalPERS estimated the added cost at least $4 billion, excluding the county systems. Governor Newsom vetoed it, to his credit. But a legislature that votes to dig the hole deeper during high state deficits has told us how it thinks and what it prioritizes.
Then there’s health care, the cause Prop 40 claims to serve. The campaign says federal cuts are gutting Medi-Cal. They aren’t. Federal Medi-Cal funding is projected to rise from $117 billion this fiscal year to $133.5 billion next year, an increase of more than 14%. Much of that comes from hospital supplemental payments financed through a provider tax: the state taxes hospitals, uses the money to draw down federal matching dollars, and pays the hospitals back more than they put in. It’s the same trick California played with its tax on Medi-Cal insurers. Last year, Congress rightfully limited both, phasing in the limits over several years, and Sacramento is racing to collect every federal dollar before they take hold. That’s what Prop 40 advocates call a “cut”: modestly slower growth in federal money for financing schemes, in a program whose national spending is still projected to keep rising quickly for the next decade. Meanwhile, enrollment has slipped very slightly from 14.4 million to 14.2 million. Whatever Medi-Cal crisis California has, Washington didn’t cause it, and a billionaire tax won’t fix it.
Adding insult to injury, the Prop 40 revenue fix won’t fix much else either, except to satisfy those who believe success should be punished and that billionaires, as a class, shouldn’t exist. Rauh and his coauthors estimate that Prop 40 would raise $30 billion to $40 billion in direct revenue–not the $100 billion promised by those defending the tax. That’s about a tenth of the yearly state budget, collected once. In addition, billionaires who have left and who will leave the state in response to the wealth tax will stop paying taxes in California every year going forward. And these guys are enormous contributors, as you can imagine. Once you count those losses, Rauh and his team put the net present value of the measure at negative $25 billion. California would end up poorer.
The damage goes beyond the people who write the checks. About 1.2 million Californians work for venture-backed startups. Roughly 40% of the venture money flowing into the state comes from investors outside it, and they can put that money anywhere. Mark Cuban has already said he’ll require startups to locate outside California before he invests. Founders whose companies are valued on paper at $1 billion, but who have little cash, would have to sell large blocks of illiquid stock, pay capital gains tax on the sale, and give up control of companies they’re still building – all to pay a tax on value that might disappear. Investors understand this reality. Many of the next generation of large employers will simply be born, and remain, in Texas, Florida, or Nevada.
Supporters insist it’s a one-time tax. This claim is doubtful, if only because taxes rarely go away and never stay small. Further, the revenue need that gave rise to this wealth-tax campaign in California will not go away, especially if Prop 40 raises far less than its boosters predict and the legislature keeps behaving like the irresponsible spenders it has become. The measure lets the legislature amend the law as long as the changes further its purposes, which are to raise money and spend it. Wealth-tax thresholds of $100 million and $50 million are already part of the conversation. Once the principle is established that the state can tax the unrealized value of what you own rather than what you receive as income, politicians won’t stop taxing wealth to finance continued excesses.
Prop 40 also faces many legal issues. There is a strong case that the courts will strike this down.
Ultimately, California can either reform its pensions and stop gaming federal matching funds now, control its Medicaid spending, or spend the next decade looking for someone else to blame for its deficits. Prop 40 falls in the second category. I fear this is just the beginning.