Sayonara, California

(A previous version of this article appeared in The Christian Science Monitor.)

Some people say California is one day going to break off and sink into the Pacific. In the literal sense, this is a myth. Figuratively speaking, however, it is an apt metaphor.

The state is known for its high taxes and myriad regulations. And with a budget passed in February that jacks up the top tax income rate to 10.56% and the sales tax to 8.5% (among numerous other taxes and surcharges), that reputation got driven home even further.

The inevitable result? Businesses will flee the state even faster. Fewer businesses will want to move there. And entrepreneurs won’t want to set up shop there.

California’s economy is larger than that of most countries of the world. But California is only a state, not a country. That makes it unable to get away with what countries can get away with. When the latter enact far-reaching social welfare measures, businesses grumble but almost all of them stay put; it is exceedingly difficult to relocate to another country. But if a U.S. state acts the same way, companies can move to another state with relative ease.

People and businesses vote with their feet – they pack up and move out. Given this reality, taxes and regulations have to be treated with even more delicacy at the state level than at the national level.

California’s social welfare measures are too numerous to mention here, but I’ll mention just a few. You’ve heard of family leave; California has paid family leave. Premiums that businesses pay for workers’ compensation have increased, as have unemployment insurance costs. And the statute of limitations for personal injury claims has been extended.

The state’s business-unfriendliness is borne out in surveys. Of all the states in the union, California’s business climate ranks dead last, according to a survey of 287 senior-level executives, conducted by Development Counsellors International. In the Small Business Survival Committee’s 2008 index, California ranks a dismal 49 out of 50.

The Census Bureau evidently does not keep figures on the rate of business out-migration, but one can get an idea of the trend by looking at net out-migration figures of U.S.-born people. More than 2 million of them left California during the 1990s, primarily resettling in neighboring states where the business climate is more favorable.

From 1997 to 2007, more than 1.4 million more Americans left the state than entered it, according the American Legislative Exchange Council. (This doesn’t include immigrants, who presumably view California’s quality of life as superior to the third-world country that most of them came from. But for how long?)

Of course, business out-migration is just fine with some Californians. Profit, in their eyes, is evil. As far as they’re concerned, the fewer businesses in the state, the better. Other more moderate Californians understand the benefits of having businesses around, but think their state’s quality of life will be enhanced by more generous social welfare benefits.

But what generally happens when businesses flee an area and/or fewer of them get established is the quality of life declines. Jobs get less abundant and incomes get lower (or at least don’t rise as quickly), and infrastructure tends to weaken. The environment may suffer as there is less money available to clean it up. The crime rate usually rises as well.

California won’t go downhill overnight. The perverse effects of excessive taxation and regulation typically manifest themselves over years or decades. To be sure, other things are keeping people and businesses in the state – e.g. a large market, good universities, beautiful landscapes, good weather – but more and more of them are deciding such attractions just aren’t worth it.

The state is caught in a vicious circle. Constituencies sympathetic to businesses are leaving California in increasing numbers. Meanwhile the state’s generous social welfare programs pull in lower-income people – both from the within and outside the United States. And they typically vote against the interests of businesses.

With fewer pro-business and more anti-business voters (i.e. fewer Republicans and more Democrats), the result is even more regulations and higher taxes, driving even more businesses out, and so on.

Californians have slipped from having the 3rd highest per capita income in the country in 1959, to the 13th highest now. What’s their solution to reverse the trend? Measures to make the state business-friendly again? No. Most of the state’s elected representatives are trying to remedy the situation with more tax increases; part of the vicious circle.

Occasionally, thanks to a quirk in California’s legislative process that enables a one-third minority to veto the majority’s wishes, the pro-business forces hold the line, such as this past summer when a budget was passed that cut spending and didn’t raise taxes. But it passed by the skin of its teeth.

It could be worse. California is one of only three states that require a two-thirds supermajority to pass tax laws. Were its constitution like that of most states which lack such a provision, taxes would be even higher, and businesses fewer.

Other states should take heed from California’s experience. It shows what happens when a U.S. state transforms itself into a welfare state.

Patrick Chisholm is editor of PolicyDynamics.

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