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ARBOR OUTLOOK: The Golden State is killing the golden goose

By Margaret R. McDowell

"They're out there having fun

in that warm California sun."

 - From "Warm California Sun" as performed by The Rivieras

Since World War II, economic, political and cultural changes that occur in California inevitably find their way to the remainder of the U.S. Let's hope that Bill 1253 in the California state legislature is a trend that stays on the West Coast.

The recently proposed legislation would raise California's top personal state income tax rate from 13.3 to 16.8 percent. Three new surcharges would apply: a new 1 percent surcharge on adjusted gross income starting at $1 million, increasing to 3 percent if you earn more than $2 million and climbing to 3.5 percent for taxpayers with income over $5 million.

Say you're a business owner who finally makes a good profit after years of struggle. Figure a 15 percent state tax rate, plus a 33 percent effective federal tax rate. Now throw in business payroll taxes, property taxes, sales taxes... well, let's stop there.

Several years ago I wrote about pro golfer Phil Mickelson's objection to California raising the state's maximum personal income tax rate to 13.3 percent. Mickelson calculated that he was actually keeping only about 37 cents of each dollar he earned. Now Mickelson's 37 cents on each dollar earned represents substantially more than the average person's income, but at what point do we stop penalizing folks who are financially successful? California's progressive tax structure makes it especially onerous for big earners.

There's a widespread misconception that millionaires actually pay very little in taxes. In a vast majority of cases, they actually pay lots of taxes. In fact, millionaires currently contribute 40 percent of California's state tax revenues.

Naturally, there are a few exceptions. People who earn their income from investments, rather than from earned income, benefit by paying capital gains tax rates rather than paying at higher income tax levels. And general partners of private equity or hedge funds are typically compensated beyond a pre-arranged percentage fee through carried interest (beyond a specified hurdle rate), and are taxed at a rate less than earned income rates. But by and large, the more money you make, the more you pay in taxes.

California, with the world's fifth largest economy, provides an incredible array of services to its citizens. And these services are understandably costly. But passing that cost on to its more successful residents, who already pay high taxes and who employ many Californians in their businesses, will accelerate the exodus from the Golden State. High earners will simply find a new home state with friendlier tax laws.

The first axiom of wealth management is: It's not what you make, but what you get to keep that counts. Most smart investors and wealth managers begin with the tax component. Tax laws that discourage entrepreneurs and business owners will ultimately harm economic growth. With many of California's high earners working in the tech industry and capable of working from anywhere, California may be pushing their highest earners toward relocation plans. The Golden State is killing the golden goose.

Margaret R. McDowell, ChFC, AIF, author of the syndicated economic column “Arbor Outlook,” is founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a fiduciary, fee-only, registered investment advisory firm near Destin. This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.

Margaret McDowell