California has the largest economy in the United States,
with a gross state product of over $4 trillion.
If it was its own country, it would have the world's 5th
largest economy, behind Japan and ahead of India.
California is home to some of the world's most valuable
technology companies. It's the center of the global
entertainment industry and its farms are amongst the most
productive in the world, growing over half of America's
vegetables, fruits and nuts. California's workers are hugely
productive too. The state has AGDP per capita of
$104,000, which would rank it as number six in the world if it
was a country. Tax havens, which California
definitely is not, often have distorted GDP as multinational
companies frequently transfer intellectual property assets to
tax havens like Ireland, which get counted as that country's
GDP. Income on foreign owned capital
held in tax havens also gets counted as GDP because the
income originates in that country, even if the financial
firm has nothing but APO box to show for it.
If we exclude tax havens from the list to remove these
distortions, California really stands out as the most
productive place in the world. Unfortunately, some of the shine
has started to come off the Golden State in recent years as
companies and workers have been leaving.
Elon Musk famously announced this summer that he would move
the headquarters of his companies from California to
Texas. He has long complained about
over regulation and excessive taxation in California, but said
that the final straw was a new law relating to parental rights.
Critics argued that Musk was attacking the state after years
of benefiting from its abundant government support, which was of
course paid for by the high taxes.
The president of the California Labour Federation told the LA
Times that California, through tax credits, electric vehicle
subsidies, and training grants, made Elon successful.
It's not just Elon Musk, however.
Companies like Chevron, Hewlett Packard, Palantir, and Charles
Schwab have all left the state in recent years.
According to the Financial Times, over 200 companies have
left California since 2019, with very few companies moving there
to replace them. This contrasts with states like
Texas and Florida where the exact opposite is happening.
This isn't all that new either. Research from the Hoover
Institution shows that this trend began well before the
pandemic and has been slowly picking up pace.
They point out that corporate relocation planning takes years,
giving the example of the NHRA who left California in 20/21
after a 12 year study. According to Joseph Politano at
the Bureau of Labor Statistics, the biggest beneficiaries of the
post pandemic move have been states like Texas and Florida,
whose economic growth has outstripped most emerging
markets in recent years with huge jobs growth too.
Now, it's worth noting that despite all of this negativity,
California has been growing faster than the United States
overall. And the United States has
experienced great economic growth in recent years.
But as Texas and Florida have grown, so have jobs.
But in California, there's been economic growth paired with very
weak jobs growth, which is a problem. the US unemployment
rate sits at 4.1%, which is not far off.
It's low, but in California, California, the unemployment
rate has risen to 5.3%, the highest of any US state.
The recent tech and AI boom has been good for California, but
not for Californians. According to the LA Times,
California's homelessness problem, which has always been
an issue, has grown by 40% over the last five years.
And half of all homeless people in the United States live in
California. So how is California different
from the rest of the United States?
How did they go from $100 billion budget surplus two years
ago to a budget crisis with a $73 billion deficit today?
And what explains the Californian exodus and lack of
new arrival? Early settlers mistakenly
believed that California was an island, entirely separated from
the United States by the Gulf of California.
In many ways it developed like an island too, with its major
population centres all on the coast as it was cut off from the
rest of the United States by huge mountain ranges and hard to
cross deserts. Before rail and good roads were
laid, the easiest route from the East Coast to California was by
sea. The states modern economic
history began with the Gold Rush in 1848 which attracted over
300,000 settlers, boosting the population and infrastructure
which led to statehood 2 years later in 1850.
The oil industry played a significant role in the state's
early economic development too. After oil was discovered in Los
Angeles in 1895, California quickly became the biggest oil
producing state up until 1936, after which reserves became
depleted. Today, oil and natural gas are
mostly imported into California from abroad, which partially
explains the state's high energy costs.
Agriculture has been a huge industry in the state too, with
Californian farmers focusing on the production of the highest
margin produce. The film industry is possibly
what California has been most famous for around the world, and
along with the tech sector, it contributes significantly to
California's global cultural influence, which has been huge.
The development of Silicon Valley in the late 1970s
transformed California into the global leader in technology and
innovation, which it remains to this day.
Given the size of the state economy, it's no surprise that
there's also a vibrant financial sector too.
Californias public universities are ranked amongst the best in
the world for academic excellence, research and
innovation. They attract top tier faculty
and focus on research and development, which has driven
advancements in technology, medicine and the arts.
The top Californian universities have policies in place that
encourage students to take ownership of their research.
Students are often given the opportunity to be named on
patents that they developed and are supported by the
universities in commercializing their work.
The UC system has resources like technology transfer offices and
entrepreneurship programs to help students navigate
intellectual property rights and develop their research into
marketable products or services. At other universities, the
ownership of research and IP might be more strictly
controlled by the institution itself.
Many universities retain ownership of all IP created by
students, faculty, and staff. The UC systems policies have
fostered a sense of ownership, empowerment and entrepreneurship
among students and can be given credit for a lot of the
innovation and business success that come out of the state.
California is famously America's most left-leaning state, earning
it the nickname the People's Republic of California and
making it the whipping boy of conservatives for whom
California has long been shorthand for everything wrong
in the country. The state is home to many of
America's most progressive policies.
It has the heaviest tax load in the country.
Criminal justice policies like decarceration, deprosecution and
policing, these are all new words to me, have led to a crime
problem that has damaged the state's image along with
residents feeling of safety. Energy prices, which are high to
begin with in California, are likely to only rise higher as
the state mandated transition to A0 carbon grid takes
conventional power offline and replaces it with more expensive
green sources. According to research from
George Mason University, California is the most regulated
state in the United States with more than 419,000 restrictions
in place, the majority of which cover industry, commerce and
development. This overall combination of high
taxes, high regulation, high crime, and an extreme
homelessness problem makes California an easy target for
right wing politicians. And as the situation gets worse,
outsiders rush to declare it a failed state or announced that
the California dream is turning into a nightmare.
I should probably use one of those as a video title or
something about checking out of the Hotel California.
You guys will click on that hopefully.
The cost of housing and energy are so high in California when
compared to the rest of the United States that even high
incomes look a lot less impressive once adjusted for
taxes and the overall higher cost of living.
The price to income ratio for buying homes is 25 times median
income in Newport Beach, 19 times median income in Palo
Alto, 12 times in San Jose, and 11 times in San Francisco.
This compares to a national average of 5.6 times for the
overall United States, according to researchers from Harvard.
According to the Hoover Institution headquarters,
migrations out of Santa Clara, Alameda and San Mateo counties
reflect high tech companies in the digital and social media
world opting for less expensive locations not only to control
business costs, but so that they can recruit workers who will
benefit from lower housing costs in other states.
California's 3 greatest challenges today are rising
unemployment, growing fiscal strains, and population
outflows, all of which relate to each other and don't have easy
solutions. In the United States, overall,
the unemployment situation is quite good, with an unemployment
rate near its long term lows and with 1.6 job openings per
unemployed person. In California, the situation is
a lot worse. Unemployment rose more than in
any other state since interest rates were hiked in 2022, and
there are just 0.8 job openings per unemployed person, the worst
ratio in the country. Big Tech, which had hired
aggressively during the 0 interest rate environment, began
laying off staff a few years ago as soon as they experienced a
slowdown. These layoffs affected the
overall Californian economy, not just tech, as when laid off tech
workers stopped spending, it affected retailers, restaurants,
transport and service workers too.
With the slowdown, California's income tax collection fell by
25% last year. A drop equivalent to decline
that happened during the bursting ofthe.com bubble in
2000 and the global financial crisis in 2008.
California's state constitution requires a balanced budget in
that if proposed spending exceeds estimated revenues, the
governor has to recommend the sources to make up the budget
shortfall. Governor Newsom projected a
deficit of $38 billion for this fiscal year, but the Legislative
Analyst's Office, a nonpartisan fiscal advisor for California's
legislature, has estimated that the state is on track to spend
$73 billion more than it brings in in taxes.
This is quite an about turn, as just two years ago the state had
a $100 billion budget surplus. The reason California's budget
fluctuates so wildly is that California has a very
progressive tax structure for higher earners pay a much larger
share of taxes. When the state's highest earners
do well, the state budget does well, like in 2022.
But during business slowdowns, tax revenues dry right up.
This volatility in tax collections explains why every
few years California has a major fiscal crisis.
Governor Newsom defends this set up, saying that it creates a
lower tax burden on low and middle income workers.
But the problem is that the policies are pro cyclical,
meaning that when the state needs to spend money during a
slowdown, it has no money to spend and instead needs to cut
back. It's not obvious that cutbacks
on government programs that are most relied on by low income
workers during downturns benefits them.
Solutions that have been put forth for dealing with the
current budget deficit include deferring promised funding for
universities, the homeless and the disabled.
In prior budget crises, Californian politicians have
played games like pushing payments out an extra day so
that they come out of next year's budget are paying IO us
to businesses, students and taxpayers to whom it owed money.
None of this fixes the core problem.
The LA Times writes that despite what people believe,
overspending is only a small part of California's problem.
They say that the state's fiscal headache is largely the result
of an unstable tax system that relies too heavily on the rich.
For decades, California's revenues have been heavily
dependent on capital gains taxes on the richest residents.
Thus, revenues spike in years when the stock market booms as a
lot of IPOs occur and investors sell stocks and other assets.
For example, Facebook's IPO in 2012 brought in an extra $1.3
billion in state taxes. The problem is that in years
with an IPO drought, insufficient taxes are collected
to keep government programs running.
As an example, in 2021, the top 110th of 1% of Californians paid
almost 30% of Allstate income tax.
The problem with relying on such a small number of people for
such a large percentage of state taxes is that if they choose to
leave the state, the tax revenue drives right up.
A famous example of over reliance on top earners was in
2016 when New Jerseys wealthiest resident moved to Florida,
throwing the New Jersey State budget into chaos as hundreds of
millions of expected revenues evaporated.
This is already a problem in California.
The state has been losing a growing number of high earning
residents, with the trend picking up pace during the
pandemic. In 2021, according to The
Economist, the state lost almost $30 billion in net taxpayer
income to other states as wealthy taxpayers relocated.
California was not always set up like this.
In the 1950s, income tax made-up only 10% of California.
California general fund and sales tax, which is much more
stable, was the main revenue source.
Since then, California has become much more of a services
based economy and is one of the few states that doesn't tax
services. Tim Hartford wrote an article
this week on some of the strange taxes that have been introduced
throughout history. Like Peter the Great's beard
tax, whose aim was to encourage Russian nobles to shave.
Or Argentina's bachelor tax, which brought about a new
profession, the Lady Rejecter, where women would charge men a
fee to write a letter stating that the man had proposed
marriage to her and that she had declined the offer.
The fact that the man had tried but failed made him exempt from
the tax. Hartford, who was writing about
the UK and not California, argued that it often works
better when a government needs to raise revenue to broaden the
tax base while lowering the tax rate at the same time, rather
than to single out small groups to tax.
This is possibly more the case for a state than a country, as
it's easier to move to a neighbouring state in the United
States than it is to move to another country.
The Economist points out that there's nothing new about more
Americans leaving California than move there.
They say that this has been going on for over 30 years, but
they point out that something else has changed.
California's population still grew over that period because of
foreign immigrants arriving there to work.
A slowdown in immigration to California from abroad that
started during the pandemic has sustained, and California has
now seen an outright decline in its population for three
straight years, the first sustained drop since becoming a
state in 1850. California's reliance on capital
gains taxes limits the state's flexibility to fix its budget
crisis, as hiking taxes further could just drive more rich
Californians to leave, exacerbating the problem.
According to the Hoover Institute, California has hit a
wall where the state can't bring in any more tax revenue without
significantly damaging the economy.
California's state income tax rate is amongst the steepest for
wealthy people in the United States, topping out at 13.3% for
millionaires, and it's gasoline tax of almost $0.60 per gallon
is the nation's highest. Well, California's taxes are
very progressive, hitting the wealthiest the hardest.
The Public Policy Institute of California reports that 70% of
Californians still feel that they are paying more than they
should in state and local taxes. Most taxpayers weigh up what
they get in terms of public services for their tax money.
And with high crime and extreme levels of homelessness, many
Californians don't feel that they get additional public
services that are not available in low tax states.
They simply feel that they're not getting value for their
money. The one area where the state's
tax collections are lower than in other states is property tax.
Proposition 13, which was adopted by California voters in
1978, requires that properties be assessed at market value at
the time of their sale, and after that, assessments can't
rise by more than 2% per year until the house is sold again.
This means that in a situation where property values increase
by more than 2% per year, which they have in California,
California home owners are incentivized to stay in their
original home rather than move, as their taxes are lower than
they would be in a different House of the exact same value.
This distorts the Californian real estate market, and the data
shows that Californians tend to move house a lot less than
Americans in other states. This rule benefits wealthier
older residents at the expense of new home buyers.
The people who have left California cite high taxes,
expensive real estate, crime, homelessness, and over
regulation as the reasons they decided to move to other states.
So how bad is the regulatory environment in California?
We saw earlier that California has the most regulation of any
state in the US by a significant margin.
But the same report showed that Texas, a state that people are
leaving California for, is number 5 on that list, which
doesn't seem a whole lot better. According to the Pacific
Research Institute, California doesn't just have more
regulations than other states, but the regulations themselves
are more restrictive than in other states, too.
The report argues that California's regulatory
environment is particularly difficult for small businesses
that lack the scale to efficiently manage the
administrative burdens and finance the higher costs created
by onerous regulations, according to the Bureau of Labor
Statistics. A big reason for the migrations
we've seen from states like New York and California to states
like Florida and Texas is that the pandemic weakened the
economic clusters that dominated pre pandemic America.
Pre pandemic, 19% of all tech jobs were based in California.
Today, only 16 1/2 percent are. It's not just tech jobs that are
moving out of state either. According to the LA Times, film
and TV workers are leaving, too. During the pandemic, when work
could be done remotely, people moved to more affordable
locations. This happened right as the tech
industry was booming, which just meant that California had a
smaller slice of a growing pie. Everything seemed fine once the
tech recession occurred. As interest rates rose,
California was just losing outright with a smaller slice of
a smaller pie. High technology stocks today
make up just under 1/3 of the value of the S&P 500 index.
If you add in communication services stocks, many of which
connect with the technology arena, the group represents more
than 40% of the overall stock market.
On top of this, there are lots of huge privately owned tech
firms too. The growth of the tech sector
has been a huge contributor to Californian growth over the last
60 years, but people are starting to question if these
companies can continue to grow from their already massive size
going forward. The tech sector is well suited
to California as it relies on small numbers of highly paid
workers to design products or software that are really
scalable. Unfortunately for the state, you
wouldn't really manufacture physical products there due to
the expense of real estate, high regulation, and high taxes.
There's a reason that every Apple product says designed in
California, made in China, and taxed in Ireland on the back of
it. If the tech industry stops
growing, the state might struggle.
Tech layoffs have been hitting California quite hard over the
last two years. I made a whole video about this
a few months ago, and while Californian tech workers
received the highest average tech pay of any US state, they
have not only been hit the hardest with layoffs, but also
withstood the largest year over year pay drop when they find new
jobs as demand for their skills has dried up since the gold
rush, California's economy has been built on ready access to
freshwater. The state's agriculture sector
faces significant water challenges today due to
prolonged droughts and over reliance on groundwater.
California's water reservoirs are often well below average
capacity today, leading to stringent water use
restrictions. This puts a lot of strain on the
agricultural sector, which is vital to California's economy.
And once again, there's no obvious solution to this
problem. California clearly faces a
number of challenges and it's economy today is suffering in
ways that the overall U.S. economy is not.
But California has had rough patches in the past, like in the
early 2000s and in the wake of the credit crunch.
But it's innovation LED growth model has managed to stand the
test of time. The state made-up 14% of
America's total output last year, up from 12 1/2% in the
late 1990s. There's no need to count the
state out yet. The biggest problems appear to
be unaffordable housing, excess regulation, and a pro cyclical
tax system that finds itself in crisis every few years.
The unaffordable housing problem is driven by a combination of
excessive regulation and Nimbyism, which combined make
California the most difficult part of the United States to
build new housing in. Fixing this problem would likely
fix a lot of California's other problems.
It's worth noting that the states that people have been
moving to, the ones experiencing the fastest growth, are also the
states with affordable housing, where it's easy to build.
Workers simply like living in places where they can afford a
comfortable home, and employers like hiring in these places as
workers with affordable homes are willing to accept lower pay.
You don't really benefit from high pay if it all goes out the
door, and housing costs. So can all of California's
problems just be blamed on progressivism?
After all, Californian refugees have been moving to states where
there are no state income taxes, to states with lower regulation
where it's easier to build, or to places where crime rates are
lower than in the Golden State. Janan Ganesh made an interesting
point in a recent FT article on the balance between the right
and left, arguing that the governing climate in which urban
life flourishes is a blend of progressive ideas such as
liberal immigration rules and infrastructure spending, with
conservative ideas like market incentives and toughness on
crime. He argues that while cities
might benefit from low taxes, less burdensome regulation, and
a business friendly atmosphere, they often vote for policies
that would harm them. California has been a hugely
successful economy because of its ability to attract the best
and brightest, and if these people are starting to move away
for greener pastures, it might be worthwhile mimicking some of
the qualities of the states that are attracting them away.
Thanks for tuning into this week's podcast, with a special
thanks to my supporters on Patreon who make it all happen.
If you'd like to support the podcast, there's a link in the
show notes. Talk to you again soon.
Bye.