The Tax Tidal Wave: High Taxes and the law of Unintended Consequences

Ah, taxes. Besides death, they’re the one thing that binds us all together. One of the most frequent and misguided assumptions about taxation is that increasing tax rates, especially on higher incomes, will automatically lead to increased revenue for governments. In reality, history shows that this may be one of the greatest fiscal fallacies of our time. Welcome to the phenomenon of "tax flight," where high taxes drive both people and corporations straight out the door, leading to an overall drop in tax collection as the effective rate and collection becomes zero. We’ve all been told the correlation between tax rates and tax revenues is positive. If true, it works only for a very brief period of time. Here’s the ugly truth:

1. California: The Golden State or the Golden Drain?

   
   

California has a graduated state individual income tax with a staggering 13.30% for the highest earners, and a corporate tax rate of 8.84%. Overall, it is amongst the five highest-tax states with an effective 11% burden. And burden it is! California has seen a decline in net tax revenue since 2020, largely due to an exodus of high-earning residents. California's population dropped by approximately 1.2 million from 2020 to 2024, driven primarily by high taxes and cost of living, with many moving to states like Texas (+875,000) and Florida (+750,000), both Republican led.

Democrats dominate California's political landscape, yet the high taxes meant to fund social programs have led to a reliance on the remaining middle-class and lower-income taxpayers, exacerbating fiscal challenges. The irony? Higher taxes have resulted in declining revenues and rising expenses, as wealthy individuals and corporations shift their investments out of state.

2. New York: The red apple or the rotting apple?

For all its vibrancy and economic opportunities, New York bears one of the highest tax burdens in the United States. The top earning bracket are punished with an eye-watering 10.90% income tax, and a net 13.6% overall tax burden, making it the runner up in tax-burden states. New York has experienced a troubling trend in tax revenue; personal income tax collections have fallen by approximately $17 billion since its FY2022 peak. Further projections indicate that tax revenue might decline by an additional billion in 2025 due to continued population loss and corporate relocation.

New York’s population has shrunk by approximately a million people since 2020 driven by factors including high taxes, high living costs, and an outflow of businesses seeking friendlier tax and regulatory environments in states like, again, Florida and Texas. The stat remains plagued by significant fiscal issues. The erosion of the tax base due to wealth flight and corporate relocations has led to a budget shortfall, projected to reach $5.1 billion by 2025. The state is struggling to balance its budget, and the reliance on high-income earners and large corporations to sustain its fiscal structure is becoming increasingly problematic.

3. France: The Land of High Taxes and Silent Retreats
   

This phenomena is not limited to the US. In France, the tax situation is equally telling. France has a top income tax rate of 52% and a corporate tax rate of 36% on very large corporations (>€3bn revenue) and 31% on large corporations (>€1bn revenue). Tax revenues as a percentage of GDP were among the highest in the world, yet the government continues to experience shortfalls and is expected to once again run war-time deficits of almost 6% of GDP for FY2025 while running a shocking 115% debt to GDP. France’s high taxes have led to historic deficits largely because many entrepreneurs and high earners have fled to more tax-friendly locales.

In recent years, France has experienced a notable outflow of wealthy individuals and businesses due to the high tax burden. The political landscape in France has been dominated by left-leaning policies (regardless of the governing party) aimed at maintaining high tax rates to fund expansive social services. However, these initiatives have resulted in significant capital flight, causing an overall decline in economic growth and tax revenue outflow.

The Unintended Consequences of High Taxes

Increased tax rates come with a host of unintended consequences impacting not just the wealthy but the broader economy:

Wealth Diversion: High-income earners often shift their investments into tax shelters, drastically reducing the potential tax revenue that policymakers were counting on. As Andrew Mellon, Treasury Secretary in the 1920s, famously noted, this leaves the burden to poorer taxpayers who can’t escape tax liabilities. The flight of wealthy earners leaves the remaining population to shoulder an increasingly heavy burden. Closing loopholes is not an alternative as high earners can relocate.

Discouragement of Investment: High tax rates can sap the motivation of entrepreneurs and investors alike. If the returns seem insufficient, capital will sit idle instead of being deployed to create jobs and innovation. Alternatively, driven businessmen and entrepreneurs are likely to flee high-tax states or countries in search for more business-friendly environments where their businesses can thrive.  

Political Misrepresentation: Politicians often mischaracterize tax cut proposals as “tax cuts for the rich.” What they overlook is that reducing rates can stimulate economic activity, leading to higher overall tax revenues—a concept that seems to elude the zero-sum mentality that dominates political discourse.

In conclusion, high taxes may appear to be a quick fix for funding government programs, but historical and empirical evidence reveal a sobering reality. States and nations burdened by high tax rates often find that their coffers run dry as their most productive citizens and businesses take their wealth elsewhere. It’s a classic case of “the law of unintended consequences,” where supposedly good intentions lead to poor outcomes. If policymakers truly want to increase tax revenues, they should consider lowering rates and creating a more favorable climate for business and investment. After all, a “rising tide lifts all boats”. Meaning, a thriving economy generates higher earnings leading to higher tax revenues. A state or nation that burdens its economy with high tax rates is in reality shooting itself in the foot as a broke business or individuals not only fail to contribute but will become a burden on the state’s finances, while fleeing corporations or people have an effective rate of 0% as they take their efforts and money elsewhere.