Lawmakers in states like California often advocate for higher taxes on the wealthy, but there's a potential downside: the wealthy might choose to relocate.

Last week, Assemblymember Alex Lee announced his plan to introduce a new tax on "extreme wealth." This isn’t his first attempt at such a measure, but this year he has additional support.

On the same day, legislators from seven other states—including Connecticut, Hawaii, New York, Illinois, and Washington—were also proposing new taxes targeting the rich.

Lee acknowledged the counterargument that wealthy individuals might simply relocate. "This is somewhat a strategy of 'You can run, but you can't hide,'" he said.

His proposal targets individuals with a net worth of $50 million or more, imposing an annual tax of 1% on their wealth. For those with wealth exceeding $1 billion, the tax rate would increase to 1.5%. This tax would affect approximately 23,000 households, representing the wealthiest 0.1% in the state, and is projected to generate around $21.6 billion annually, according to UC Berkeley economist Emmanuel Saez, who has also contributed to the design of Massachusetts Sen.

Elizabeth Warren’s national wealth tax proposal and several state-level initiatives.

A wealth tax, unlike an income tax, is unprecedented in the U.S. This proposal would cover assets such as shares in privately held companies, art and collectibles, and "financial assets held offshore."

Despite its introduction in the heavily Democratic state Legislature, the proposal faces significant hurdles. When Lee presented similar legislation last year, it did not even receive a preliminary hearing, let alone a vote.

Lee remains hopeful despite challenges. He noted that while the state was financially robust last year, California is now facing a projected $22.5 billion deficit. This deficit is nearly equivalent to the annual revenue the proposed tax is expected to generate.

Robert Gutierrez, CEO of the California Taxpayers Association, which opposes the tax, pointed out that the top 5% of income earners contribute 70% of personal income tax revenue, California’s largest revenue source. He warned that if some of these high-income earners decide to leave the state, it could significantly impact the state budget.

The question remains whether wealthy individuals actually relocate in response to higher taxes and, if they do, how significant that migration is. Research on this topic is expanding, but a clear consensus is still lacking. In 2018, Charles Varner and Cristobal Young, alongside Allen Prohofsky at California's Franchise Tax Board, analyzed decades of tax data to assess the impact of tax changes. They compared top earners affected by tax increases in 2004 and 2012 with those just below the income threshold.

Their findings indicated that before 2004, there was a net outflow of million-dollar earners from California. After the 2004 tax increase, this outflow diminished, and by 2007, more million-dollar earners were moving to California than leaving. This trend continued after the 2012 tax increase, although the data only extends through 2014.

The research also showed that fluctuations in the number of million-dollar earners in California are largely due to residents moving in and out of this income bracket rather than migration alone. For example, the average number of million-dollar earners varies by about 10,000 annually, but net migration accounts for only 50 to 120 individuals.

Further analysis of the 2004 tax increase revealed a slight decrease in the rate of top earners leaving the state, while the rate for almost-top earners remained unchanged. Similarly, the 2012 tax increase, which raised rates significantly for high earners, led to a small increase in outmigration—about 40 individuals per percentage point increase in tax rate.

Overall, California's population of million-dollar earners has grown significantly, from about 75,000 in 2009 to over 158,000 in 2019. However, a 2019 Stanford study found a more noticeable impact: the 2012 tax increase resulted in a 0.8% increase in the rate at which top earners left the state, translating to approximately 535 additional high-income individuals leaving due to the tax.

Not all studies agree, though. Saez, the Berkeley economist, notes that while some wealthy individuals might move to avoid higher taxes, the effect on the overall tax base is typically minimal. He believes Lee's proposal may drive some wealthy people away, but the number would be relatively small compared to the overall population of high earners in the state.

Opponents of the tax also raise concerns about potential legal challenges, especially since the tax would apply to individuals even after they leave California, and about the difficulties in assessing the full value of ultra-wealthy individuals’ assets. Lee counters that California already successfully taxes real estate and can apply similar methods to other forms of wealth, such as yachts.