If California undid its ‘original sin’ and matched Texas on taxing property, it would raise more revenue than the billionaire tax, economists say | Fortune

The 1978 Revolution and the Path to Volatility

To understand the current fiscal crisis, one must look back to the political climate of the late 1970s. In 1978, California voters, weary of rising property taxes and the escalating cost of living, passed Proposition 13 with overwhelming support. The initiative fundamentally altered the state’s fiscal landscape by capping property taxes at 1% of assessed value, limiting annual increases to 2%, and restricting reassessments to market value only upon the sale or substantial renovation of a property.

This measure did more than just provide tax relief; it signaled the beginning of a nationwide "tax revolt" that paved the way for the conservative shift in federal governance during the 1980s. However, the structural impact on California was profound. As local property tax revenue plummeted, the state government was forced to rely increasingly on volatile income tax receipts to fund public services. Today, California operates with the most progressive income-tax structure in the nation, featuring a top marginal rate of 13.3%. When federal obligations are layered on top, the total tax burden on high earners can exceed 50%.

The reliance on this model has created a "boom-bust" cycle for state coffers. The top 1% of earners now account for nearly half of all state income tax revenue. While this generates massive surpluses during bull markets and AI-driven tech booms, it leaves the state budget dangerously susceptible to stock market corrections and fluctuations in capital gains, which are notoriously unpredictable.

Proposition 40: The Billionaire Wealth Tax Proposal

Against this backdrop, Proposition 40 has emerged as a proposed solution to stabilize state revenue and fund essential services, such as healthcare and education. The measure, backed by powerful labor unions and progressive advocacy groups, calls for a one-time 5% levy on the assets of residents with a net worth exceeding $1 billion. Proponents argue that the tax could generate up to $100 billion in revenue, providing a much-needed buffer against federal spending cuts and addressing the widening chasm of wealth inequality within the state.

Supporters emphasize that given the explosive growth in the artificial intelligence sector and the concentration of tech wealth in Silicon Valley, California’s ultra-wealthy are uniquely positioned to contribute more to the public good without compromising their lifestyle. They contend that even after paying such a tax, these individuals would remain among the wealthiest in the world.

Economic Concerns and the Flight of Capital

The proposal has drawn fierce opposition from business leaders, venture capitalists, and economists who warn of significant unintended consequences. Critics argue that a wealth tax is fundamentally different from an income tax because it targets stagnant assets—including business equity and company shares—rather than liquid cash.

The primary concern is "capital flight." If California imposes a tax that requires founders and executives to liquidate large portions of their company holdings to satisfy tax liabilities, they may choose to relocate their residency and operations to lower-tax jurisdictions like Texas, Florida, or Nevada.

Data from the state’s recent history suggests this fear is not purely speculative. According to reports from former economic advisors, at least six billionaires—who collectively would have been responsible for approximately 25% of the projected revenue from Proposition 40—departed California in the months leading up to the ballot measure’s effective date. Furthermore, a Stanford University study projected that the long-term impact of such a tax could result in a net loss of revenue for the state, as the departure of these high-net-worth individuals shrinks the long-term income and corporate tax base.

The "Everywhere Millionaire" Argument: A Better Target?

As the debate intensifies, some experts are suggesting that the focus on billionaires is misplaced. Princeton economist Owen Zidar and University of Chicago professor Eric Zwick, authors of The Everywhere Millionaire, argue that California’s fiscal problems are not caused by a lack of billionaires, but by the "original sin" of its 1978 property tax regime.

Zidar and Zwick contend that while Proposition 40 targets a few hundred individuals, a much larger, more sustainable source of revenue lies in reforming the property tax system. Because Proposition 13 prevents property taxes from rising in tandem with property values, California homeowners currently pay an average effective tax rate of just 0.8%. By comparison, Texas homeowners pay an average of 2%.

The economists estimate that if California were to transition toward a property tax system more closely aligned with other states, the revenue generated could exceed $100 billion in a single fiscal year. Furthermore, they argue that removing the artificial constraints on property tax assessments could cool the overheated housing market by approximately 13%, potentially increasing housing affordability for the middle class.

The Political and Practical Hurdles

Despite the potential revenue, dismantling Proposition 13 remains a political third rail. Generations of Californians have structured their financial lives around the stability of low property taxes. Any attempt to eliminate the measure would likely trigger a massive voter backlash, as middle-class homeowners would face significant tax increases that could threaten their ability to remain in their homes.

Moreover, the implementation of a wealth tax like Proposition 40 faces a separate set of legal challenges. Because it relies on a new, untested method of valuing non-liquid assets for tax purposes, legal experts predict a "tidal wave of litigation." Opponents argue that this uncertainty would render the promised $100 billion in revenue speculative at best, as courts would likely tie up the collection process for years.

Alternative Paths to Fiscal Stability

Rather than pursuing a wealth tax, some former government officials suggest a more conventional approach to broadening the tax base. Laura Tyson, a former White House economic advisor, and Lenny Mendonca, a former chief economic advisor to Governor Gavin Newsom, have argued that California should focus on closing existing loopholes in capital gains and corporate taxation.

Their proposed alternatives include:

• Increasing Corporate Tax Rates: Strengthening the state’s share of corporate earnings.
• Closing Carried Interest Loopholes: Eliminating tax preferences for private equity and hedge fund managers.
• Reforming Estate Taxes: Strengthening the taxation of inherited wealth to prevent the permanent entrenchment of dynastic assets.
• Taxing Unrealized Capital Gains: Implementing a more targeted approach to taxing the growth of assets before they are sold.

Looking Toward the Future

As the election approaches, the state faces a stark reality. With an annual budget now reaching $540 billion, the current reliance on a narrow base of top earners is increasingly untenable. The volatility of the tech market, combined with the structural limitations imposed by 1978-era policies, has left California in a position where it must choose between radical new tax measures or deep-seated systemic reform.

Proposition 40 serves as a litmus test for the state’s political direction. Should it pass, California will enter uncharted territory, potentially setting a precedent for other states to follow. Should it fail, the pressure to address the underlying issues of the property tax system will only grow. Ultimately, as economists like Zwick and Zidar have noted, it is impossible to fund the modern needs of a state as large as California by leaning on a few hundred individuals. Whether through wealth taxes, property tax reform, or a total overhaul of the income tax code, the state is rapidly approaching a moment where its 20th-century tax structure must finally confront the 21st-century economy.