California’s Wealth and “Exit” Tax Squeezes Rich Americans Trying to Leave the State

By: Sam Watanuki | Last updated: Apr 16, 2024

California is experiencing a mass exodus of its richest residents thanks to a new state tax that targets affluent residents. Aimed at addressing California’s significant budget deficit, reaching $68 billion, the state is taxing the wealthy who stay or leave.

Hoping to avoid California’s already high prices and future wealth taxes, the wealthiest residents are leaving the state, taking their tax dollars with them.

California’s Wealth Tax

Finance expert John Williams recently analyzed California’s new tax policies and attributed the substantial budget deficit in California is what led to this wealth tax, which includes an annual taxation of the rich based on their assets.

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This plan is part of California’s strategy to increase state revenue. However, California’s aggressive pursuit of this plan is causing the richer residents to flee California.

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Those Affected by the Wealth Tax

The plan calls for deploying attorneys to investigate potential wealth tax under-reporting, with litigation a possibility.

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Fearful and unable to sell some of their assets, affluent residents are leaving California in droves. According to the U.S. Census Bureau, the state’s population dipped below 39 million, which is the lowest California’s population has been since 2015.

Economic Factors Driving the Wealth Tax

The introduction of the wealth tax by California is largely driven by economic pressures and the need to address the state’s substantial budget deficit (via Cal Matters).

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As high earners begin to leave, the state is forced to find new revenue sources to fund essential services and infrastructure. This financial strategy reflects an urgent effort to stabilize the state’s fiscal health while maintaining public services.

The Rich Flee California 

An analysis of people who left California in the last three years reveals thousands of high-earners departing the state after the announcement of a wealth tax.

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“People who are leaving are taking their tax dollars with them,” Jelo Kotkin, a fellow at Chapman University, told the Los Angeles Times.

Implications for California’s Economy

The exodus of wealthy individuals from California can lead to significant economic repercussions. As these affluent residents leave, the state could see a decline in both consumer spending and capital investment, which are crucial for job creation and economic stability (via FasterCapital).

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This scenario poses a risk that could extend beyond just the loss of tax revenue, potentially stalling economic growth.

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The Ultra-Wealthy Push Back Against Higher Taxes

The new 14.4 percent tax rate is a significant tax compared to other states. However, the top one percent, which typically pays between 40 to 50 percent of the state’s personal income tax revenue, is being asked to contribute more.

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The dip in the state’s population over the last three years has shown that the ultra-wealthy may be looking for states with lower tax burdens.

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The Rich Move to “Tax-Friendly” States

This recent 14.4 percent income tax increase has become a significant financial burden for high earners in California. Many of these top income earners are moving to states with lower tax rates.

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According to the Census data, Texas and Florida had the highest population growth in 2023, with gains of 473,452 people and 365,205 people, respectively. These states are attractive to affluent people because they have no personal income tax.

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The Exact Reason Why the Rich Are Leaving

“I’m seeing anywhere from two to five clients a month calling me and saying ‘We’re leaving,’” Todd Litman, an estate planning attorney told Sky News.

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Litman continued: “They have $1 million to $2 million sitting in their IRA and they’re saying: ‘When I retire and start pulling that IRA out, I’m going to be paying 13 percent state income tax, so I don’t want to do that.’ So, they’re heading out because of that reason.”

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California’s Plan to Squeeze Money From Rich Runaways 

Knowing that they are losing their highest taxpayers, California is considering a wealth tax on those who leave the state. This legislation proposes a significant financial burden for people relocating, despite not being formally called an exit tax.

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In response to losing wealthy residents, lawmakers are faced with a choice: either incentivize them to stay or attempt to recoup tax revenue through measures like this proposed wealth tax.

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What Is California’s “Exit” Tax?

The “exit” tax rate is 1.5 percent for net worths exceeding $1 billion. That tax rate will adjust in 2026 to 1 percent for net worths over $50 million.

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Luckily, not everyone will have to suffer from the “exit” tax when they decide to leave the state. The policy targets only those already subjected to the wealth tax.

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The Legality of the “Exit” Tax

Many critics have questioned whether or not the wealth and exit taxes are legal, debating whether they violate the Due Process or Commerce Clause of the Constitution.

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Critics believe that the taxation of individuals no longer residing in California or discriminating against interstate commerce may not be legal. But California might have other problems to handle beyond the legality of these taxes.

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The Consequences of These Taxes 

The real-life impact of these tax policies could cause California’s real estate market to undergo massive changes. Williams suggests that the declining property values and increasing taxes will create a significant financial risk for any homeowner.

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This risk underscores the broader economic consequences plaguing the Golden State as it increases residents’ taxes.

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Explaining the "Exit" Tax Mechanism

The “Exit” Tax is designed as a 0.4% tax on incomes, business revenues, or investment gains for those who meet certain wealth thresholds upon leaving California (via FLC Law).

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This tax is intended as a one-time levy to recapture investments the state has made in its residents and businesses, particularly in infrastructure and tax incentives aimed at fostering economic growth.

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The Residency Requirement for Exit Tax

Determining residency for the Exit Tax involves several factors evaluated by the California Franchise Tax Board, including where your largest residential property is located, where your family lives, and whether your children attend school in the state.

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These criteria help establish a taxpayer’s residency status, which is crucial for the application of the Exit Tax.

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Impact on High Net-Worth Professionals

Professionals like doctors and lawyers, who often have high earnings but not necessarily high liquid assets, could find themselves disproportionately impacted by California’s wealth and exit taxes.

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These taxes could force such professionals to reassess their financial and professional ties to the state, influencing decisions on where to live and practice.

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California’s Economic Future

There is growing concern that the wealth and exit tax policies will disproportionately impact California’s shrinking middle class, making it more difficult for them to maintain their financial security. These changes could shake the state’s economic landscape for better or worse.

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As California introduces more taxes aimed at raising revenue, the state’s economic future remains uncertain. Only time will tell if these new taxes will achieve their intended goals.

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The Role of Tax Attorneys and Financial Advisors

With the complexity of the new tax laws, tax attorneys and financial advisors are crucial in helping California’s wealthy navigate these changes.

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They provide strategies for tax planning and residency considerations to minimize liabilities, ensuring that clients are not unfairly penalized by the wealth and exit taxes.

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Effects on California's Real Estate Market

The proposed wealth and exit taxes are likely to have a profound impact on California’s real estate market. Concerns about decreased property values are surfacing as wealthier residents sell off large properties and relocate to more tax-favorable states (via MoneyGeek).

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This trend could lead to a softer real estate market, affecting property taxes and ultimately state revenue.

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Future Legal Challenges

Legal experts predict that the wealth and exit taxes could face significant challenges in the courts (via CNBC). Critics argue these taxes may infringe on constitutional rights related to interstate commerce and due process.

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These anticipated legal battles could shape the future and enforceability of California’s tax policies.

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Alternative Revenue Strategies

As backlash grows against the wealth and exit taxes, California might consider alternative revenue-generating strategies that do not solely target the ultra-wealthy (via Bloomberg).

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Options could include broadening the tax base, improving tax compliance, and innovating in economic sectors that attract businesses and therefore increase the tax revenue without heavy reliance on high net-worth individuals.

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Other Strategies to Retain High Earners

California may need to reconsider its approach to retaining its wealthiest residents. This could involve restructuring tax incentives, improving economic conditions, and enhancing quality of life aspects that make staying in California appealing despite the higher taxes.

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Such strategies are crucial to prevent further erosion of the tax base and to maintain the state’s financial stability and innovative spirit.

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Public Perception and Social Impact

The wealth and exit taxes are reshaping public perception of California as a bastion for innovation and entrepreneurship.

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There’s growing concern that these policies might deter new talent and businesses from settling in the state, potentially stifling the dynamic economic culture that has defined California’s global economic stance.

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Weighing the Costs and Benefits

California’s approach to addressing its fiscal challenges through wealth and exit taxes is a high-stakes strategy that balances immediate revenue needs against long-term economic health.

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While these taxes aim to stabilize state finances, they must be weighed against potential adverse effects on economic growth and public sentiment.

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