California’s Prop. 40 Wealth Tax and the Economic Stakes

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0:33From the opinion pages of the Wall Street Journal, this is Potomac Watch. Bernie Sanders rallies California progressives to vote for the state's proposed wealth tax as Governor Gavin Newsom comes out in support of a competing ballot measure that would nullify it. Plus, the last inflation report before the election comes in hot, showing consumer prices up 3.7 % year over year. Welcome, I'm Kyle Peterson with The Wall Street Journal. We're joined today by my colleagues on the WSJ's opinion pages, columnists Alicia Finley and Joe Sternberg. Politicians and observers on both sides of the aisle are calling it one of the most important items on the November ballot.

1:16That's California's Proposition 40, a purported one-time 5 % tax on assets of residents over$1 billion. Let's start with a clip of Bernie Sanders making the trek out to California to argue in favor for it at a yes on 40 rally in my view proposition 40 the california billionaire tax act is the most important ballot initiative in the country because it deals with the most important issue facing this country.

1:55And that issue is, can the American people sustain democracy, take on the greed and power of the billionaire class, and create an economy and government that works for all, or are we destined to live in an oligarchic society where our economic and political lives are controlled by a handful of the wealthiest people in the world? Alicia, start with what exactly Prop 40 says it would do and your view of how this debate is shaping up. The polls are saying that it could be close. Right. So the polls right now show it running even. A small majority, depending on which poll you look at, it favors it, but it could go either way, depending on what the turnout is like and how few undecided voters cast their ballots.

2:57One problem, I think, even though the opponents have a lot of money that they are throwing at this and opponents as in a lot of business groups, as well as the so-called billionaires, the Google founder, especially Sergei Brin, are spending tens of millions of dollars to oppose this, while the SEIU, United Healthcare Workers West, which is the main sponsor of the initiative, and do not conflate the SEIU-UHW with the overall umbrella group, the SEIU, because the SEIU overall is not going all in on this. There was actually a little bit of a division within the union over this. But the SEIU-UHW, again, is spending heavily on this, and it's one of the more progressive factions of the labor movement.

3:41Because they see this as a test case, they want to sock it to billionaires. But they are also arguing, I think misleadingly, that 90 % of the money raised by the initiative will be required to go to health care programs and namely Medicaid. And this will raise some$100 billion,$90 billion of which would go to health care programs to supposedly offset the cuts from the Big Beautiful Bill. The reason why I say this is very misleading is because the Big Beautiful Bill actually didn't cut Medicaid. It did make some reforms, but that merely slowed the growth in the Medicaid spending to about the rate of inflation over the decade.

4:20California, the rate of growth in Medicaid spending is around 14 to 15 percent a year in terms of the growth, at least in federal payments, which means that California is continuing to see increases in federal payments, partly because it's figured out how to game the system. But I think that that reveals why the really real goal is, one, to hit or punish people who are successful, and two, just to increase the total amount of money that politicians can spend and throw around. And it seems like Bernie Sanders and companies see this as a test case, Joe. It's something that could be replicated elsewhere, other states or at the national level.

4:56And you take this up in your column on Friday. The headline is the California wealth tax French connection. This idea from some on the left that wealth taxes would make the United States more European and help fund the social welfare state. When the reality is that Europe funds that kind of stuff by taxing the middle class. And many countries in Europe have actually moved away from wealth taxes. You mentioned France as one because they're hard to value illiquid assets and they cause people to move to other countries. Yeah, Kyle, I think we've got a couple interrelated things going on here. One of which is this ambition among progressives in the U.S.

5:34to dramatically expand the role of the state in the economy, the government spending and the significance of that in the U.S. economy. And that inevitably is going to require generating more revenue. So, I mean, if you just look at a very top-line measure like government revenue as a percentage of GDP, in the U.S., that tends to be noticeably lower than it is in Europe. And for this crowd, that is a problem. And so the issue then becomes, well, what are you going to tax that is going to be politically feasible? In Europe, this revenue is often raised by consumption taxes, the VAT that falls very heavily on the middle class and lower income earners.

6:16I think that there's an accurate sense that that politically is a non-starter in the U.S. right now. So the next thing that you can go after is this enormous pool of wealth that exists partly as a function of American innovation. I mean, particularly in California and Silicon Valley specifically, what we are talking about here are the returns and rewards of entrepreneurship and innovation. And because America is an entrepreneurial and innovative economy, there are a lot of those returns out there. And it feeds into this very populist narrative that Bernie Sanders, in particular, has been pushing for a very long time.

6:57And, you know, this combines with the fact that Europe has been trying to do this kind of wealth tax for a long time. And if they thought they could get away with it, they would have. And as you point out, France has tried, a bunch of other European countries have tried over the years. And the main lesson that people on the left have extracted from that is they believe that those taxes failed because they were too easy to evade. In a world where the reality is that capital and labor are often mobile, you can get yourself out from under the tax if you can just do it in one place. So the prize for this crowd also is a certain universality for these sorts of taxes.

7:40And so from that perspective, I mean, at least getting the camel's nose under the tent by doing this in one U.S. state is a crucial start for that crew in terms of this broader project that they want to access this wealth, not just in the U.S., but in Europe as a source of funding for the expansive state. Hang tight. We'll be right back in a moment. weren't agents supposed to take things off your plate building another to handle the others is a bit much don't make more work out of work gemini is one agent that knows all parts of your business and actually gets stuff done you give it a project close your laptop and when you come back the job's finished no matter your industry or role your agent has the skills to help every team stay in their flow.

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9:22Welcome back. The way that the ballot initiative tries to get around this issue of capital and people being mobile, and we see that in Europe, but it's a lot easier to move from California to Florida than it is to move from Norway to Switzerland, for example. The way that the ballot initiative tries to handle that is it says it will tax people who are California residents as of January 1st, 2026, even if the tax itself is not passed on this ballot measure until November 2026. Alicia, do you have a sense, have analysts suggested how much capital flight this has already prompted people trying to get out of California before it passes?

10:03And the second part of the question, is there a potential legal problem, a legal vulnerability, what California is trying to do here? I mean, A, taxing people who have left the state, perhaps, before the tax itself passes, and B, one state trying to tax assets that really have no connection to it. I mean, commuters sometimes have complicated tax issues because if they live in Connecticut, for example, but they work in New York and New York taxes their income and they get a credit back sometimes. But what we're talking about here is California trying to tax things. Let's just make up something, a yacht in Florida that has never had any connection to Florida other than the owner.

10:41Right. So I think this points to one of the large legal vulnerabilities of the initiative. And I would recommend recent paper by the Hoover Institution's Joshua Rao on this that lays out the constitutional frailties. One issue is you point out residency. Well, how do states determine residency? Well, it's more of an art than a science. They look at various, you know, where you vote, where you have a driver's license, you know, where your dog is, where you have a gym. There are many factors that the states use to determine residency. But they also determine residency over the course of a year, not a single day.

11:22And so the question is, when the state taxized franchise board looks and tries to determine, were you a resident of California as of January 1st, 2026, versus were you a resident over that entire year of the 2026, or for that matter, 2025, it gets very, very murky. No state has ever done this before. And then you add in the complication is that you're not just taxing, as you point out, income, which is a stream. And there are actually precedents and systems for states to apportion income based on what share of the year a person spends in a given state or what share of their income they earn in a different state.

12:03For instance, in the sports arena, athletes pay income tax on their share of the games, like in a given state. Even if you're playing for the Tampa Bay Buccaneers, you'll still end up paying New Jersey taxes if you pay the Giants in New Jersey. The issue with residency or the issue with the wealth tax is you are specifically taxing assets that are outside of California. And as you point out, have no clear nexus to the state. If somebody owns a Renbrandt in a Miami penthouse, the state would be able to tax it. They aren't earning any income off of that in California. It has never been in California, so it's not clear why California could tax that.

12:45And this really opens the door to other states trying to tax assets outside of their boundaries, and not just in other states, but worldwide, right? So there's due process concerns under the Fifth Amendment, particularly, and, you know, a takings argument that they're confiscating essentially assets without just compensation in the way that they actually value some of these assets. They're not actually valuing them at the market rate in many cases. So I think there are a lot of legal vulnerabilities in how this initiative was drafted. And the reason why it was drafted in the way it was, was to try to deter tax avoidance.

13:23and just to punish these people. The issue of capital flight is one thing that Governor Gavin Newsom has cited, why he opposes Prop 40. Though, Joe, I'm not sure that he is really out there campaigning against it. I saw a recent interview. He was asked about his opposition and he, paraphrasing, basically said, you know, Bernie is one of the most important political figures in the country right now. We just happen to have a disagreement about this one. He's also suggested that the reason that he opposes the California wealth tax is because people would flee. And what we really need is a national wealth tax.

13:57But interestingly, last week, Governor Newsom also endorsed a competing proposition on the ballot in November. This is Prop 42. And it says that it would prohibit new taxes on individually owned assets, retirement holdings and so forth after January 1st, 2026. And it would also prohibit retroactive taxes that result in a tax liability based on conduct activities or status that occurred prior to the effective date of the tax. And so, Joe, this is one of those classic California situations, I think, according to the reporting, where you have competing ballot measures, both of them could pass in November.

14:36And my understanding is the one that goes into effect is the one that passes with a higher percentage of the vote. So if the wealth tax passes with, let's say, 52 percent and the ban on retroactive taxes passes with 53 percent, then I guess no wealth tax. It seems like a strange way to run a railroad. Yeah. I mean, look, Gavin Newsom is right. People can mark the state down because I don't often say that sentence. But in this case, the key insight is that this is such a bad idea that you have to do it nationally or not at all. And in fact, that is one of the key insights that's come out of Europe because, you know, to an important extent, I think that actually a lot of the features of the California Prop 40 are the way they are because of that European experience with the failure of European wealth taxes.

15:26And in fact, a bunch of the economists who were involved in drafting and laying the intellectual framework for Prop 40 are Europeans, particularly a bunch of French economists who think that they are applying the lessons that they claim to have learned from France's unhappy experience with that. And so that's how you end up with issues like making sure that you include business-related assets in the tax, because they have this theory that the fact that that kind of asset was exempted from the French version of the wealth tax was one reason that it failed. It's why you have this retroactivity because the retroactive aspect of this, because they felt that it was too easy for wealthy people to move their assets and their tax domicile elsewhere within the European Union to avoid paying the French tax.

16:16But the problem is the U.S. being what it is. On a practical level, unless you can include a retroactive provision, which is going to be very difficult to enforce constitutionally, I think, you are going to have this capital flight problem. So this would be something that has to happen nationally. And I'm going to go ahead and predict here that if the California wealth tax passes and it fails because there is capital flight, that is going to become the argument that you will hear from Democrats for applying this nationally. Because, you know, there isn't going to be any learning about any of the deeper economic problems with this.

16:59But, you know, I also just want to briefly pick up on the point Alicia made about some of the constitutional problems that this Prop 40 does raise, because I think that illustrates an important issue here. I mean, this is fundamentally a very European tax idea that sits very uncomfortably in America's tradition of how we think about property rights and taxation and sort of how you balance the relationship between the individual and the state via, you know, through the tax code. So I think that you have to understand that there is also a philosophical element to this Prop 40 debate, in addition to the really awful fiscal math of it and all of the other economic problems that it raises.

17:45Because what we're talking about, if this gets approved, is starting to graft into the U.S. a very different and unhelpfully European attitude toward taxation and the relationship between the private economy and the state. And I think that that opens a really damaging can of worms moving forward. Hang tight. We'll be right back after one more break. This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. Listen at schwab.com slash Washington Wise.

18:25Don't forget, you can reach the latest episode of Potomac Watch anytime. Just ask your smart speaker. Play the Opinion Potomac Watch podcast. From the Opinion pages of The Wall Street Journal, this is Potomac Watch. Welcome back. Let's turn to the latest inflation report and the last one that the public will get before the November election. the Bureau of Labor Statistics releasing numbers for September on Wednesday, showing that inflation, consumer prices of all items were up 0.6 % in the month of September. That is the highest monthly reading since April. And year over year, prices up 3.7%. Alicia, give us a sense of what you read in this inflation report.

19:13How much of that increase was energy costs, maybe related to the Strait of Hormuz and the Iran War or other items you would take away? Look, so about half of the monthly increase was related or was caused by an increase in energy prices, namely gasoline prices. There's also the way that they apportioned the formula, there's a small contribution from higher diesel prices, but it's mostly gasoline prices, right? And over the year, that 3.7%, it's about a third of the increase can be attributed to higher energy prices. Now, taking a step back, even if you were to exclude energy from the monthly or yearly increase, you're still looking at a increase well above the Federal Reserve's target goal.

20:00You're looking maybe at a 0.3 % increase for the month versus about a 2.4 % increase over the year. And one of the reasons why you're continuing to see inflation increase at above the rates of the Federal Reserve's 2 % goal, even though, you know, the inflation has come down from the peak of 9 .1 % several years ago, is because prices, namely on services, continue to increase in the range of around 3 % to 4 % a year. And if you look down at the break down the categories, you still see shelter increasing at about 0.4 percent. A lot of that is actually, interestingly, in the latest month was hotel costs.

20:45You see a steep increase in airline fares, 1.2 percent for the month. And yes, that probably is largely related to the higher jet fuel prices. But you've continued to see pretty strong increases in other areas, motor vehicle maintenance, hospital prices. You know, haircuts, veterinary services, things that really have no ostensible relationship to the higher fuel prices that many people and businesses are seeing. And so this suggests that inflation is proving somewhat stubborn. I have a theory, or I think some of this has to do with just a wealth effect that the consumers at the higher end continue to spend and splurge on vacations, eating out, all kinds of things, because they're feeling very flush from the buoyant stock market.

21:35and housing prices continue to remain quite elevated. So if you have a home and you locked in an interest rate below 3%, you're not looking to move, pretty settled, you're looking to keep your 401k and it's appreciated quite sizably over the last couple of years, you're probably pretty feeling good and you feel like you can go manage to take that vacation that you've been wanting or eat out or buy that Peloton bike, who knows. But that's, I think, one of the reasons why inflation hasn't come down as fast over the last couple of years as we've expected. But probably not the message that President Trump or Republicans wanted voters to be getting in the last weeks before they go turn in their ballots.

22:17The numbers showing again, Joe, that inflation is eroding wage gains. So most workers haven't had a raise over the course of a year. Where do you think that leaves the Fed, which does have one more meeting of its Monetary Policy Committee before the election? Well, I think that the Fed is sort of suffering from timing here in a bunch of ways. I mean, first off, remember, we've got still a relatively new chairman of the Federal Reserve, Kevin Warsh, who is an inflation hawk himself. I mean, all of his public statements, including his major speech at Jackson Hole, Wyoming, back in August, really hammered home that point.

22:56And I think that investors are starting to internalize the point that he's serious about that hawkishness. But he only was sworn in in May. It took him the first couple meetings of the Rate-Setting Federal Open Market Committee to start bringing along the other members of those committees who, remember, had been voting for rate cuts a year or so ago. So, you know, you kind of had that issue going on. We've now had one rate increase. And then the next meeting is less than a week before the election. It's going to be the last Wednesday of October. And I think that the Fed historically has been a bit skittish about making rate decisions in that last meeting before an election.

23:39It's relatively unusual for them to do that. In fact, this was one of the more unhelpful things that Orsha's predecessor, Jerome Powell, did was pre-election rate moves because you just can't win. One or the other party will always assume that the Fed has done what it's done to advantage or disadvantage someone. So I think that you're trapped in this situation where the Fed understands that inflation is its problem. I think Kevin Warsh has signaled pretty convincingly that he is determined to do something about it. The timing is not currently working in their favor. Warsh's timescale is very long.

24:19He's got years after this midterm election. Politicians contesting the midterm have a time horizon that's measured in weeks at this point. So I think that the key issue is the latest data are not a surprise to voters because, remember, this is backward-looking data. So what you're actually describing is something that people have been experiencing around their kitchen table for a month already. And I think that a lot of that is already baked into the election result for good or ill because my sense is that people have already decided what they think about the economy. and have decided the extent to which that is going to influence their voting decision.

25:03So here we are going into the remaining weeks of this midterm campaign, and that bit of it is probably baked into the cake. Thank you, Joe and Alicia. Thank you all for listening. You can email us at pwpodcast at wsj.com. If you like the show, please hit that subscribe button, and we'll be back next week with another edition of Potomac Watch. weren't agents supposed to take things off your plate building another to handle the others is a bit much don't make more work out of work gemini is one agent that knows all parts of your business and actually gets stuff done you give it a project close your laptop and when you come back the job's finished no matter your industry or role your agent has the skills to help every team stay in their flow.

25:49Seriously. Make work less work with Gemini on Google Cloud. Check response. Subscription required.