By: Jacob Hartzler

On January 19, California Assemblymember Alex Lee, representing California’s 24th District, reintroduced a bill aimed at taxing California’s ultra-wealthy.  Assembly Bill 259 (“AB 259”) and an accompanying proposed constitutional amendment, ACA 3, were introduced as part of a “concerted effort” of wealth tax proposals in seven other states including Connecticut, Hawaii, Nevada, New York, Maryland, Illinois, and Washington.  While proponents of the bill argue that the bill will only tax the top 0.1% of Californians (while generating an estimated $21.6 billion in annual tax revenue), the imposition of such a tax may encourage tech entrepreneurs to flee California for jurisdictions that boast a lower tax burden.

Citing a release by ProPublica in 2021, Assemblymember Lee contends that the 25 wealthiest Americans pay a small fraction of their wealth in taxes by holding their fortune in assets such as stock and property while avoiding capital gains taxes by pledging these assets as security in order to borrow funds when in need of cash.  According to the Forbes’ annual list, the United States has the greatest number of billionaires, with over a quarter of them residing in California.  Assemblymember Lee contends that because wealthy Californians (such as Facebook’s Mark Zuckerberg) can avoid income tax so long as they do not sell their stocks, individuals like Zuckerberg “pay a lower effective tax rate than the bottom 99%”.  The new wealth tax would sustain investments in schools, tackle homelessness, maintain and expand needed services and “much more.”

The proposed wealth tax is paired with an amendment to the California Constitution and will apply a 1% tax on extreme wealth of $50 million or more per household as well as a 1.5% tax on wealth in excess of $1 billion.  According to estimates proffered by Assemblymember Lee, the new tax would affect about 23,000 households in California.  A constitutional amendment is critical to the implementation of the new tax as Section 2 of Article XIII of the California Constitution limits the tax rate on personal property to 0.4%.  To pass a constitutional amendment, ACA 3 will need to pass both houses of the California State Assembly by a two-thirds vote, and the amendment must thereafter be approved by the electorate in the next general election.

Currently, Section 2 of Article XIII of the California Constitution authorizes the legislature to impose a property tax on all forms of tangible personal property which cannot exceed 0.4%.  ACA 3 seeks to amend this section to authorize the legislature to tax all forms of personal property or wealth, whether tangible or intangible.  The amendment would also authorize the legislature to classify any form of personal property or wealth for differential taxation or exemption by a simple majority vote rather than by a two-thirds majority, as is currently required by Section 2 of Article XIII.

In addition, the California Constitution, as it currently stands, prohibits the total annual appropriations of the state and each local government from exceeding the appropriations limit of the entity of government for the prior fiscal year.  This figure is adjusted for changes in the cost of living and for changes in population size.  ACA 3 seeks to remove this limit for any given year unless two of the three following conditions have been met:

• The Director of Finance and the Superintendent of Public Instruction mutually determine California both ranks among the top 10 states in annual expenditures per student and ranks among the top 10 states with the lowest average class size;
• The Controller and the State Public Health Officer mutually determine that California is among the top 10 states with the lowest fraction of their population without health insurance; and
• Using information made available by the U.S. Census Bureau, the Controller and the Department of Housing and Community Development mutually determine that California is no longer among the top 10 states with the highest percentage of households whose housing costs exceed 50 percent of that household’s income.

If passed, ACA 3 and accompanying bill AB 259 will dramatically change the nature of personal property taxation in California by constitutionally guaranteeing the legislature the ability to levy taxes on an individual’s “wealth” and intangible property.  Moreover, the proposed amendment carefully adds that the legislature’s power to levy taxes on personal property includes but is not limited to certain enumerated forms of personal property such as capital stock.  No explicit language granting the legislature such broad discretion is currently present in Section 2 Article XIII.  Moreover, ACA 3 eliminates the requirement for a two-thirds majority of each house to classify personal property or wealth for differential taxation thus allowing the legislature to change the way personal property or wealth is taxed via a simple majority.

Furthermore, ACA 3 removes the solid limitation on appropriations set forth in Section 1 of Article XIII (b), which prevented the state and local governments from taking in more tax revenue than the previous year adjusted for inflation and population changes.  In its place, ACA 3 reallocates the power to determine whether such a limit has been reached (and thus whether Californians are owed a refund) in the discretion of the Director of Finance, Superintendent of Public Instruction, Controller, State Public Health Officer, and the Department of Housing and Community Development.  No limitations are explicitly placed on their discretion other than that they must “mutually determine” whether the conditions above have been satisfied.

Lastly, and perhaps most crucially, ACA 3 eliminates the 0.4% cap on the taxation of personal property.  No other cap is provided for, thus begging the question of when or if the legislature would increase the tax rate on personal property or wealth in the future.

In sum, ACA 3 greatly expands the legislature’s ability to tax intangible investment property and allows the legislature to tax such property at any rate they so choose while effectively eliminating the limitation on annual appropriations.

This is surely a dramatic change from Section 2 Article XIII and Section 1 of Article XIII (b) of the California Constitution, which currently limit the taxation of personal property to tangible personal property at a maximum rate of 0.4% and set a clearly defined limitation on annual appropriations.  A change of this magnitude is likely to garner the attention of the many uber wealthy Californians, particularly entrepreneurs in California’s technology industry who hold much of their wealth in intangible investment property.

Many technology companies have already begun to relocate outside of California.  For example, in 2020, Hewlett Packard Enterprises, Oracle, FileTrail, and DZS Inc. all announced plans to move their headquarters from San Jose to Texas.  Among other considerations, favorable tax policies in jurisdictions outside of California, such as Texas, are attractive to entrepreneurs and high-ranking officers in the highly profitable tech industry.  According to a recent blog by Jared Walczak, vice president of state projects at Tax Foundation, wealth taxes are destructive.  Many entrepreneurs hold much of their wealth in personal property, such as in their company’s stock.  High wage earners who hold their wealth in personal property is the exact demographic that AB 259 and ACA 3 seek to tax.  By taxing entrepreneurs with their wealth tied up in stock – an illiquid asset that may never actually materialize – California may see entrepreneurs look elsewhere to establish their business.  Legislators in California surely have a lot to consider.  They may either tax the wealthy investors and entrepreneurs who hold much of their wealth in illiquid assets in order to increase tax revenue and social spending ability, or allow uber wealthy entrepreneurs to continue to hold their wealth in investments, thus continuing Silicon Valley’s tradition of being the tech capital of the world.

 

Student Bio: Jacob Hartzler is a second-year law student at Suffolk University Law School pursuing a JD and an LLM in Taxation.  He is a staff member of the Journal of High Technology Law.  In May of 2021, Jacob received a Bachelor of Science Degree from Roger Williams University while completing a Double Major in Legal Studies and History, as well as a Minor in Economics.

Disclaimer: The views expressed in this blog are the views of the author alone and do not represent the views of JHTL or Suffolk University Law School.