Are High Taxes About to Make Silicon Valley Pack Up and Leave?

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California Governor Jerry Brown is at it again.

He's cut a deal with the teachers' unions that would take the top rate of state income tax from 10.3% to 13.3%.

If passed on the November ballot, that would increase taxes on the top tier by a hefty 29%.

Since that would be the highest rate in the nation, it begs the question: How high would taxes have to go before Silicon Valley's zillionaires decided to make the great escape?

It's a very important question considering the condition of California's state budget.

After all, the Facebook IPO alone is expected to produce $2.5 billion in state tax revenue over the next five years. What if high tax rates set in motion the law of unintended consequences?

Like in the late 1990s when dot-com revenues enabled the state to go on a massive spending spree.

Not long after the tech bubble burst, the sudden budget crunch that followed in 2001-02 caused Governor Gray Davis to be recalled in a referendum.

It's a different set up this time, but the results could be the same.

Higher Taxes Create Capital Flight

Silicon Valley's tech sector provides both capital gains taxes from tech giants selling their stakes after companies go public and massive income tax revenues from their salaries and bonuses in the interim.

Faced with higher taxes the threat of relocation is very real – even among large, well-established companies. For instance, Boeing (NYSE: BA) relocated from Seattle to Chicago in 2001.

California's taxes and other living costs are already large enough to cause flight; in 2007-10 an annual average of 135,000 more people left California than arrived there.

However, the largest generators of California's tax base are not established companies, they are the young, brilliant entrepreneurs, venture capitalists and engineers involved in Silicon Valley enterprises.

These people are exceptionally footloose, with few family ties.

On the plus side, Silicon Valley is very tightly networked, so at least the more junior members of the tech sector would be tied there by their colleagues, competitors and mentors.

Still, the corollary of the Valley's networked nature is that the departure of a small number of key people could cause a mass exodus, with junior employees following their bosses and mentors.

Needless to say, almost all those key people will pay California's new top rate of income tax, if it is introduced.

What is a One-Percenter to Do?

The questions are: What tax differential would make a critical mass of Silicon Valley zillionaires leave, and where would they go?

Just because California now has the highest state income tax, other high tax states need not jump for joy and hope for a huge influx of business.

New Jersey, with its 8.97% top income tax rate and New York, with its 8.82% top income tax rate (12.6% in New York City) should not expect to get much of the business, since it's not worth schlepping across the continent and putting up with winters for a mere 4% differential.

On the West Coast, Oregon's 9.9% top marginal rate would not generate much business either.

Relocating California zillionaires would presumably head for one of the nine states that don't impose a state income tax.

Of these, Wyoming, South Dakota and Texas would suit fine, but are probably culturally unthinkable.

That leaves two alternatives: Washington state and Nevada.

Washington state has no state income tax, but has a business and occupations tax, which levies a rate of about 0.5% on gross receipts – probably not a problem for high-tech companies with high margins. That's an alternative if you don't mind the rain.

Then finally there's Nevada, which makes most of its state revenues from casinos, and is fine if you're young, hip, not so bright, and like casinos and showgirls. Personally I'd choose the rainfall and scenery of Seattle over Nevada (or indeed over California) but I'm 25 years too old to be a tech zillionaire and nowhere near rich enough.

The Real Threat Created By Higher Taxes

Then there's the possibility that some California zillionaires could decide the chances of rising federal tax rates make relocation overseas attractive.

As for domestically, high-tax countries like Europe and Japan, they shouldn't hold their breath. However, even without relocating to true tax havens like the Cayman Islands, there are some other possibilities.

Singapore, notably, has a top income tax rate of only 20% and a substantial tech sector of its own, making it a very attractive destination. It even has a casino now, for those considering Nevada as an alternative.

For venture capitalists, Switzerland is also attractive, with a tax burden in a favorable canton such as Zug that also runs about 20%.

Personally, were I a zillionaire venture capitalist, I would ignore Switzerland and head for the more exclusive Liechtenstein, which also taxes you at about 20% but you get a population of only 35,000, beautiful mountain scenery and the joy of being the world's only citizens still ruled by a Hapsburg, Prince Hans-Adam II.

But all jest aside, the chance of a Silicon Valley exodus is very real.

The extra 3% on the top rate of state income tax makes California even more onerous than in Manhattan.

That might well be just enough to trigger one.

California citizens should be very afraid. The unintended consequences of higher taxes are quite real.

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Join the conversation. Click here to jump to comments…

  1. Jeff | March 30, 2012

    Your comment, "Texas culturally unthinkable." Are you kidding me? Texas has the #1 business climate/culture in the nation. I guess the 1,000 jobs Ebay moved from California to Texas at an average salary of $122,500 per year didn't have a problem with the Texas culture, right? And Ebay is just one example of many technology companies and companies of all types moving from California and other states to the business-friendly Texas. Just look at the 2010 census … ooops, Texas gained 4, let me repeat FOUR, new house seats and eletoral votes. Something right is happneing in Texas … both business-wise and culturally that is attracting businesses and people to relocate there.

  2. Benton H Marder | March 30, 2012

    Why did you not mention Florida, which also does not have state income tax? Further, before the Leg' could even think of imposing one, it would have to get a referendum-initiated ban lifted. Florida has a lot of available land all over the state, business-friendly local governments, Yes, there is a cultural milieu as well. My state has a lot to offer, y'know. Don't blind yourselves by thinking tourism and Disney.

  3. Steve | March 30, 2012

    Gated communities solve the cultural problems.

  4. Thomas Jefferson | March 30, 2012

    Colorado is actively pursuing the techies as well.

  5. nick beck | March 30, 2012

    brown & co. simply are TOO ignorant and or arrogant to learn from others [new jersey ]. they think that ca. has a monopoly on life quality so much so that no one would even consider leaving their paradise. time will tell–when the dam breaks——–

  6. Larry Corn | March 30, 2012

    Hey, your overlooking Ohio. Yes, check it out, our Governor has already started the recruitment process by bring Mark Kvamme, Sequoia Capital, to Ohio and giving him a government job.

    Many more of his billionaire friends will quickly follow as the tax rates increase in California. Do the math, Ohio is centrally located within hours of 50% of the USA population, business, and commerce centers.

    Go east rich man, go east. Ohio has open welcome arms!

  7. Calif Susie | March 30, 2012

    For those who love the outdoors, for recreation and natural beauty, few states rival CA. It is the fabulous climate and 'quality of life' which includes the old frontier spirit and opportunities to "follow your bliss" that make CA a unique place to live. But high taxes are making it more difficult to live here, and retirees are leaving in droves. As a little old lady, I may have to return to Texas where it is affordable (no income tax) but full of intolerant/believe as I do people, not to mention the horrid summer climate, poor air quality, and all those nasty bugs everywhere! Fine for business, but I hate riding a horse in 105 degree weather!

  8. eric taylor | March 31, 2012

    Wasn't it the Terminator that said "I'll be back" ?

    Jerry Brown is going to ride the 49'ers down, but he did inherit a lot of excess baggage, and the
    country as a whole is in big debt to GNP. On a hopeful note, in the 20th century post WW two
    we were able to handle very large amounts of debt along with high personal and corporate
    tax rates with optimal efficiency. Symmetrical bell curves don't really work in the real world!!!

    I did like Arnold S. for his optimistic view of the world, even during hard times. California may
    once again need a Terminator if the things get much worse under old Jerry Brown.

  9. BruceB | March 31, 2012

    Your comments about Washington state reflect typical impressions of those who think of Washington as only the west coast. This state extends over 200 miles EAST of the Cascade mountains and the EAST side enjoys a much dryer climate as well as a significantly lower cost of living than the crowded Puget Sound area. Spokane, Moses Lake, and the Tri-cities of Pasco, Richland, and Kennewick have much to offer relocating businesses.

    Washington isn't perfect – we have our financial problems too. However, implementing a state income tax requires a vote to amend the state constitution. The fools in Olympia (the state capital) keep trying but so far the voters have been smart enough to reject such legislation.

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