States are trying to tax millionaires and billionaires. Will their proposals be effective?

To address budget gaps, states are relying on a familiar rallying cry: Tax the rich.

Loopholes and deductions in our federal tax system mean that wealthy Americans pay far less than they’re expected to. The 25 wealthiest Americans only paid a federal tax rate of 3.4% between 2014 and 2018, according to a 2021 ProPublic study. Meanwhile, the average income tax rate stood at 14.5% in 2022, according to the Internal Revenue Service.

Earlier this month, Democratic legislators in Washington state approved a bill that will place a 9.9% tax on those who earn more than $1 million. That bill now heads to the state governor’s desk.

Washington doesn’t have a state income tax and it relies heavily on sales and property taxes, which puts a heavy burden on low-income individuals, said Christina Lewellen, an associate professor of accounting at North Carolina State University. So Washington’s proposal is an attempt to make its tax system more equitable, she said.

Other states have also implemented “millionaire taxes,” including California, Massachusetts and New Jersey.

Some states, like California and Illinois, are now trying to propose a one-time “billionaire tax” on the unrealized gains of billionaires. Unrealized gains are the profits you’ve accrued in stocks or other investments that you have yet to sell. These taxes aim to address funding shortfalls in areas like transportation and health services.

While both millionaire and billionaire taxes could help reduce state budget deficits and fund state programs, they could cause some high-earning or high-net worth individuals to leave for other states, experts told Marketplace.

The experts that Marketplace spoke to have mixed views on which tax model would be more beneficial, with some saying that the best way to generate revenue is to reform our federal tax system instead of focusing on state taxes.

Do millionaire taxes work?

Cristobal Young, a Cornell professor who studies millionaire taxes, said that high-income individuals are not sensitive to taxes and tend to live where they live regardless of the tax rate.

But still, lobbying groups and Republican lawmakers have raised concerns that high-earning individuals will leave Washington due to the newly passed proposal.

There are established businesses in the state, which means it will be difficult for workers and their families to uproot and move, said Owen Zidar, a professor of economics and public affairs at Princeton University. “I could see a plausible scenario where not that much changes, and they raise more tax revenue,” Zidar said.

However, Washington’s 10% tax rate on millionaires will lead to a much bigger tax change than other states that have implemented millionaire taxes, Zidar pointed out. That means we can’t be sure what result it’ll have on migration, he said.

“My main concern is that a 10-percentage point increase is really big, and it's hitting people who are already kind of paying a high level of taxes when you include payroll taxes,” Zidar said.

Young said millionaire taxes help raise revenue and states with these taxes tend to have better services and greater investment in education and infrastructure. But at the same time, these states also have a higher cost of living.

Will a billionaire tax work?

When it comes to billionaire taxes, the California plan is expected to bring in $100 billion in revenue, according to United Healthcare Workers West, the group that proposed the tax.

The proposed tax will affect billionaires who reside in California as of Jan. 1, 2026, Six out of 214 billionaires in California left before the cutoff date in the proposal, including Google cofounders Larry Page and Sergey Brin and former Uber CEO Travis Kalanick. Those billionaires have taken $27 billion in potential revenue if the law passes, reported Fortune Magazine.

However, even if some billionaires are fleeing the state, a tax will still “bring in a substantial amount of revenue,” Lewellen said.

There are also a lot of advantages to remaining in California and doing business there, Zidar pointed out.

“It's a much better labor market. For a long time, there's been a corporate tax in California and zero corporate tax in neighboring Nevada, and still, many companies decided that they'd rather be in California,” Zidar said.

The case for why a billionaire tax might be better? Zidar said there are very wealthy individuals in the state who aren’t as productive anymore and they’re not paying high taxes, like heirs.

California’s middle class struggles with living costs, so a billionaire tax could be very successful if the state invests the money properly, Young said.

What should the ideal tax system look like?

Instead of implementing taxes at the state level, Zidar said he thinks we should reform our federal tax system. He and fellow economist Eric Zwick have proposed a “Party Like It’s 1997” plan, which would revert the tax code to what it looked like nearly 30 years ago.

That would entail changes like higher average tax rates on top incomes, a less generous exemption limit when it comes to the estate and gift tax, a higher capital gains tax rate and the end of certain deductions.

Zidar and Zwick’s analysis from 2020 estimated that this proposal would raise $5 trillion over a 10-year period.

Zidar said there are other ways we can reform our tax system, like addressing the payroll tax loophole for business owners. Some business owners treat a portion of their income as profits, instead of wages, allowing them to bypass payroll taxes on those profits.

“I'm sympathetic with the view that rising inequality and falling top tax burdens merits a reexamination,” Zidar said. “However, how we do that, I think, would be best done at the federal level rather than at the local level.”