No accountability without choice

I went swimming this morning with a pro triathlete. It wasn't my intention, but there’s a triathlon in town tomorrow and a number of pro athletes are visiting and working out.

I got talking with her manager/trainer, who said they live in Florida. Because the triathlons are around the country (and the world), they can live anywhere they want. Like many athletes, they (and other triathletes) live in tax-free Florida, while others live in Texas.

The triathlon was invented in San Diego and popularized in Hawaii, and handful of professional triathletes still live here. But — between taxes and housing costs — most find it cheaper to live elsewhere and pay an accountant $5-10K a year to keep track of various state laws that require they pay the nonresident athlete tax for the days they work in high-tax states. The St. Louis Cardinals didn’t care whether the Tigers or Red Sox make the World Series, but clearly the Red Sox are better off playing three games in St. Louis (top rate 6%) than in Los Angeles (top rate 10.3%).

Pro athletes can arbitrage tax rates (for endorsements) and live where they want (off season). San Diego native Phil Mickelson was roundly criticized for the (factual) observation that he pays a 60%+ tax rate living in California and was considering living elsewhere.

Entertainers can also live anywhere also, and this should work well for musicians. However, it appears that actors still tend to cluster in Los Angeles and New York City, two of the highest tax jurisdictions in the country. I’d argue this is because while athletic performance is directly measurable, acting performance is not: do we care which 25-year-old starlet or 45-year-old aging acting star is cast in a big-budget movie? Probably not. Actors have to stay in the network, attending parties etc., so the decision-makers don’t forget them when casting the next movie, TV show or high-visibility stage production.

Still, other types of professionals and business owners lack job mobility. At one extreme, Silicon Valley is largely about access to venture capital (since it has no monopoly on smart people or good universities). At the other extreme, restaurants and dry cleaners can’t move to a low tax state and take their customers with them. With its unfavorable business climate, California will hold these two extremes and has been driving out the average business in the middle (such as manufacturing).

California is now a one-party system and the ruling party assumes it can charge what it wants. I have a fairly low salary for a b-school professor and I’m at the 9.3% marginal tax rate. This used to be the tops until they instituted two millionaire surcharges (bringing the maximum rate to 13.3%), the latest being including a retroactive tax increase passed last year to capture Facebook IPO gains.

Even worse, California taxes capital gains as regular income, and thus the long-term capital gains rate is higher than New York, France, Finland or Sweden (let alone notorious tax havens like Hawai‘i and D.C.) If you are a Google or Facebook founder, it isn’t going to change your standard of living, but trying to sell a $1-2 million business to retire would leave a lot less money to live on in your old age.

In a one-party system, there is no accountability for bad ideas — only for overt corruption. So if people can’t have a choice of economic policies, what remains is the option to vote with their feet ala Hirschman’s Exit, Voice and Loyalty†. Despite increasing centralization to the national government, the US — like Canada and to some degree Germany — has a Federal system that allows policy experimentation and competition of ideas.

New York and Massachusetts paid a price (in terms of employers and job growth) for their high tax policies — but apparently not enough of a price to cause them to rethink their policies. Like California, they have a small cluster of high end jobs (Wall Street and drug companies respectively), the immobile local jobs and have discouraged or driven away the jobs in the middle.

Since Hollywood’s business model is in decline, California’s ability to pay its bills seems tied to what fraction of the global tech economy remains in Silicon Valley. No matter how much you believe in Silicon Valley’s uniqueness, this is a bold (if not foolishly optimistic) bet on a small fraction of the state’s 38 million people. However, with term limits, politicians have a short-term mentality and are betting they will be long gone if something bad happens 5 or 10 years down the road.

† Writing in 1970, Hirschman (p. 84) assumed that a lack of voice would cause people to quit organizations but they cannot exit the “state” (i.e. national government). But this was before intra-EU job mobility and even the flight of jobs from the northeastern to the southeastern regions of the U.S.