Democratic states seek to hike taxes on the wealthy

A version of this article originally appeared in CNBC’s Inside Wealth newsletter with Robert Frank, a weekly guide to high-net-worth investors and consumers. become a member to receive future editions straight to your inbox.

A new “blue wave” of tax increases on the wealthy is rippling through state legislatures as Virginia, Washington state, Rhode Island and others join California in calling for higher taxes on top earners and billionaires.

At a time when states face potential cuts in federal aid and Democratic lawmakers are emboldened by rising populism and a widening economic divide, lawmakers and governors in many blue states are preparing a series of new taxes on the wealthy. At the same time, many red states continue to reduce or eliminate income taxes to become more competitive.

“What you actually see is the difference,” said Lucy Dadayan, a state tax expert and principal research fellow at the Urban Institute Tax Policy Center. “On the one hand, some states are doubling down on rate cuts, deductions, and tax competition. On the other hand, some are turning to targeted surtaxes on high-income earners as a way to finance high-growth priorities without increasing broad-based taxes.”

While tax increases have been introduced by left-leaning state lawmakers almost every year, the latest moves have added momentum. Inflation has increased economic pressure on middle- and low-income earners and led to renewed calls for higher taxes on the wealthy to offset higher health and education costs. Government spending has continued to rise since Covid, renewing revenue needs.

Many Democratic leaders are also heralding a tax increase on high-income earners in Massachusetts as evidence that the wealthy will not flee. In 2022, Massachusetts voters approved the “Fair Share Amendment,” which calls for a 4% surtax on income over $1 million. The tax generated nearly $3 billion in annual revenue in its second fiscal year, more than double original estimates. Many Democratic leaders say the revenue shows that predictions of mass wealth flight in the face of higher taxes are misleading.

Like the Massachusetts amendment, the latest proposed tax increases target only the highest earners. Tax Foundation senior fellow Jared Walczak said efforts to separate millionaires and billionaires differ from previous tax increases that sought higher, incremental marginal rates on a broader population to raise revenue.

“There’s a sharper divide now,” Walczak said. “This doesn’t just mean that people should pay more and more as income increases. It’s an effort to apply taxes only to a certain subset of the population.”

California leads the way in taxing the rich. The state’s Billionaire Tax Act, which will be submitted to voters in November, would impose a one-time 5% tax on the total net worth of California residents worth $1 billion or more. This tax will be the first of its kind as it will tax assets rather than wealth. It will also be applied retroactively, effective from January 1, 2026.

Although its transition remains uncertain, some billionaires already moved out of state. Google co-founder Larry Page moved to Florida in December, leaving more than $170 million in Miami’s Coconut Grove neighborhood and moving his family office and various business records. David Sacks, the White House tech billionaire and artificial intelligence and crypto czar, said he is moving to Texas after 30 years in California. He told CNBC that the proposed Golden State tax amounts to an “asset seizure” and would likely become permanent once approved.

“This is not a one-off, this is the first time,” he said.

Because the proposal is a ballot measure, the billionaire tax would bypass the governor and the legislature. California Governor Gavin Newsom opposes the tax, saying it would direct the wealthy to states that impose lower taxes. But in other blue states, tax increases on the wealthy are coming from the top down.

In Virginia, the election of Governor Abigail Spanberger gave Democrats control of the state’s General Assembly and governorship. Lawmakers have proposed a new 10 percent tax bracket for those making more than $1 million a year. Currently, all income over $17,000 is taxed at 5.75%. A second proposal would add a state-level net investment income tax applied to capital gains, dividends and rental income for adjusted gross income over $500,000.

Meanwhile, Virginia’s neighbors are cutting taxes. While West Virginia lawmakers are in the process of phasing out income taxes, North Carolina’s flat tax dropped from 4.25% to 3.99% in January. North Carolina aims to reduce its income tax rate to 2.49% in the coming years.

Virginia House of Representatives member Elizabeth Bennett-Parker, who proposed the net investment income tax, said the revenue is needed to help working families better meet their health, education and food needs. He cited Massachusetts as an example of success.

“Other states have recently passed laws to ensure the ultra-rich pay their fair share and have not seen a significant impact on the population,” he said. “In the wake of the extreme Trump tax bill, which further skewed federal tax laws to the benefit of the wealthiest Americans, there is momentum across our country to rebalance state tax laws.”

In Washington state, lawmakers are making a bold bet on a possible millionaires tax. Washington is currently one of nine states that does not impose a statewide income tax. Opponents say the income tax would violate the state constitution and existing laws.

But in 2022, the state imposed a 7% tax on long-term capital gains over $250,000. The following year, Amazon founder Jeff Bezos, a longtime Seattle resident and one of the richest people in the world, announced that he was moving to Miami. Opponents said a capital gains tax in 2022 would open the door to a broader income tax.

Now this prediction is coming true. Washington state lawmakers are proposing a 9.9 percent tax on people making more than $1 million a year. They hope the state Supreme Court decision upholding the capital gains tax will offer a potential legislative path to a broader millionaires tax.

“It was very predictable that once you got a court decision allowing a capital gains tax, the dominoes would start falling,” Walczak said.

The “Invest in MI Kids” measure proposed in Michigan would amend the state constitution to impose a 9.25% cap rate on those with income over $500,000 for single filers and over $1 million for joint filers. Supporters say the new tax would bring $1.7 billion in additional revenue for education.

The new rate will also be on top for municipal taxes, giving Detroit residents a total rate of 11.65%. At the same time, Michigan’s neighbors Indiana and Ohio have flat individual income tax rates of 2.95 percent and 2.75 percent, respectively.

Fresh off last year’s “Taylor Swift Tax” on expensive vacation homes, Rhode Island is now considering a 3% surtax on incomes over $1 million. The top tax rates for an estimated 2,300 Rhode Island millionaires will rise from 5.99% to 8.99%, according to an analysis by the state budget office. It is estimated that 5,500 non-resident millionaires with tax liabilities in the state may also be affected.

In New York City, newly elected Mayor Zohran Mamdani continues to pressure Gov. Kathy Hochul to raise taxes on the wealthy to close what he says is a $12 billion budget deficit and pay for additional services. He proposed an additional 2 percent income tax on millionaire earners; this would bring the top city and state tax rate for New York City residents to 16.8 percent. When federal taxes are added, the top rate will be 53.8%.

While the fate of the tax proposals remains unclear, experts say the growing chorus of higher taxes in many blue states will cause business owners and top earners to consider moving to lower-tax states.

“Doubling down on high taxes in states like California, Washington and others makes them much less attractive, especially given how many other options are now available to businesses and individuals looking to relocate,” Walczak said. he said. “In California, you always wonder what’s going to happen next from a tax standpoint. In Texas, that’s not a concern.”