The Economic and Constitutional Vices of California’s “Once-only” Wealth Tax

Right now, there is an extensive war of words over the “one-time” five percent wealth tax on all the property of billionaires resident in the state of California, even those assets held personally or in trust outside California. The debate is intense. On the one side are the state’s unions, including public unions, who have mounted a powerful public relations campaign to get this measure on the state ballot this coming November. The proposal’s tough language announces that it will apply to all persons resident in the state as of January 1, 2026, even if they leave the state before the bill passes — if it passes — this November. Yet the bill contains no enforceable contractual promises to those who pay the tax this time that they will not be caught the next time, if the tax is reimposed, given the general rule, as announced in United States v. Carlton (1994), that the legislature is free to reverse its general tax waivers.  

The union backers of the bill make this an “us v. them” issue when they claim that the entire health care system within the state will falter if that tax is not imposed on the 200 or so billionaires now living the state, who are asked to bear the brunt of the one-time tax, while being exposed to other potential tax increases at the same time. Many of these persons, such as Sergei Brin, Larry Page, and Peter Thiel, have moved out, taking with them not only their personal wealth but also the various partnerships and trusts, thereby denuding the base. How many billionaires will follow suit is somewhat uncertain. The head of Nvidia, Jensen Huang, has announced that he was “perfectly fine” with the tax that could cost him $8 billion. Others are likely to follow the lead of those who have picked up stakes. But the economic logic is unassailable. As Jon Hartley and Arthur Laffer point out: “To collect $6,000 a year [under the wealth tax], the state destroys about $75,000 in private wealth.”

Faced with that grim prospect, the wealth tax will not only cause exit, but also block entry, for no current billionaire will move into the state so long as this threat hovers over his or her head. In addition, individuals who think of themselves as potential billionaires may well leave the state before they get close to that mark, thinking that the so-called one-time promise, even if kept for prior payors, will not protect these newbies, given that they escaped the first round of taxation. This combination of threats has led to one critical defection from the progressive ranks — Governor Gavin Newsom, widely regarded as a strong contender for the Democratic presidential nomination, has unambiguously cast his lot with the billionaires, given his concern about the exit damage, which he fears will not be contained. He may have looked at the recent projections for the change in electoral votes after 2030, where California (-4), New York (-2), and Illinois (-2) are expected to lose a total of eight seats in Congress, as Texas and Florida each gain four seats. Differential tax rates in general, not only the wealth tax, are a powerful determinant of that rising red shift, and Newson knows that if he caves now, his chances of taking the White House could easily go up in a ball of smoke.

What makes the matter even worse is the implicit premise behind the new claims: namely, that the wealth tax is needed to fix a system that needs no other repair. But that argument ignores the simple point that the state already has the largest crop of billionaires subject to high income taxes, yet it still cannot make ends meet with such a large tax base. And the explanation is that these unions know full well that whether the interest group is teachers, police officers, firefighters, or prison guards, the current system of collective bargaining allows them to use their political clout. The early opposition to public unions, when they were excluded from the Wagner Act of 1935, was that they sat on both sides of the bargaining table and could thus effectively control wages, contract terms, and pensions. So the thought experiment here is to ask what the deficit would look like if the state curbed union monopoly power, requiring them to accept competitive wages like other workers in the economy. No one has run these numbers, but the correct form of political reform is to undo that power and ask for additional revenue only then.  

That point is not only an economic imperative, but also a constitutional one. The basic maxim is that a public office is a public trust that, in turn, imposes on these legislative fiduciaries the same duties that are imposed on all private fiduciaries — loyalty and care. They can do neither if they cut sweetheart deals with the unions with whom they have an adverse interest, which is why Franklin Roosevelt strongly opposed public unions where the union is on both sides of the deal, an alignment that does not arise with private unions. That position was largely reversed by John F. Kennedy’s disastrous 1962 Executive Order 10988, which gave limited collective bargaining rights to federal public unions, which then quickly spread to the states. The net effect of the union support of the wealth tax has little to do with the public good. The revenue needs could also be raised through traditional means, which will not be used here because the public would rebel. But that is precisely why income taxes, especially flat ones, are a tool to control public unions. Yet the key contrast is this. The reviled billionaires made their money by making ordinary people rich, because the out-of-pocket cost of each useful product generates substantial consumer surplus at low prices. The poorer unions make other people poorer still, because their monopolistic activities shrink others' opportunities. A vote for the wealth tax is a vote for public decline.

But now suppose that this bill is passed in its current form; what happens next? The first point is that it will be challenged legally, first as illegal confiscation and then as retroactive legislation. The Sixteenth Amendment allows for taxation of “incomes from whatever source derived.” That broad mandate, however, does not allow for a tax on wealth unless one wants to make the dubious claim that all wealth is derived from income and therefore covered by the Sixteenth Amendment. That position is wrong, first, as a matter of fact, because wealth derived from a gift or inheritance is not earned by the recipient and is thus outside the income tax under Section 102 of the Income Tax Code.  

More fundamentally, income and wealth are contrasting notions. Income involves the change in wealth (including consumption, which is notoriously difficult to tax) between two points in time, and wealth is measured solely at a given point in time. There is therefore no authorization to tax wealth as such under the Constitution. The estate and gift taxes, moreover, are not wealth taxes because they are tied to the transfer of wealth either during life or at death and are thus excise taxes. Those taxes are exceedingly difficult to value because they cover all assets, including nonliquid assets, as does the proposed California tax. The valuation problems with these taxes are acute, and they often take years to determine.  

The once-only wealth tax will also take much time and money to evaluate, and those uncertainties will increase the tax’s implicit economic burden. Indeed, part of the initial challenge to the California tax will target its extraterritorial reach, arguing that, under the due process clause, such wealth is properly taxed by the state in which it resides, which usually does not allow for this tax. There are also significant valuation questions about intangible assets and contingent liabilities that must be resolved under regulations that will not be ready the day the bill passes.

Finally, there is a nasty retroactive hook in this tax, which is said to apply to property owned by people who left the state before the bill's passage. That nasty provision is meant to tie up wealth in the state, whether the bill passes, to give extra leverage against the exit right, a key check on state abuse. At this point, it is for a year, but nothing says that if the bill fails this year, it may pass next year with the same holding effect. That gimmick should also be eliminated.

These wealth taxes have failed pretty much wherever they have been tried, and this time is unlikely to be any different. There are learned economists like Emmanuel Saez and Gabriel Zucman who think that a wealth tax is a needed antidote to increasing wealth inequality. If you think so, I have a bridge in Brooklyn that I can sell to you for a cheap price.

Richard Epstein is a Senior Research Fellow at the Civitas Institute at the University of Texas at Austin.