When California had a Magnetic Tax System
GroundSwell, May-June 2010]
(The following is excerpted from "Opportunities for
International Financial Centres in the 21st Century", Dr.
Gaffney's keynote banquet address at the Conference on the
Fundamentals of International Legal Business Practice, hosted by The
Bahamas Bar Association, in association with The International Bar
Association, The Bahamas Financial Services Board, The Organization
of Commonwealth Caribbean Bar Associations, and The Inter-American
Bar Association. Superclub Breezes, Nassau, July 16, 1999.)
The OECD says a "harmful tax regime" is one that "attracts
mobile activities." Many of us see that, rather, as a mark of a
good system, but I'll return to that. First, let's follow them along
a way. Right away we think of low taxes, and that is what the OECD
means - on p. 27 they specify low income taxes. They, and allied
international organizations like the EU, also have a history of
jumping nations whose VAT is too low to suit them.
That view is too simple by far. Mexico, for example, has very low
taxes, but repels both capital and labor anyway. A nation may also
attract mobile activities and factors in two other ways. One is by
offering superior public services. That, for example, is how many of
us became Californians, lured by the State University. The other is
by a tax structure that favors mobile activities without stinting on
public services. This may be done simply by targeting taxes on
IMmobile resources. Let's inspect those points closer.
B. Magnetic tax structures
The U.S.A. is a great laboratory for testing tax structures. It
contains 51 or more separate systems, with free migration of labor
and capital guaranteed by The Constitution.
The extraordinary growth of California from about 1900 to 1978
shook and recast the economy of the U.S.A., and parts of the whole
world. It was not done with low taxes and skimpy public services. It
was in part the product of a tax structure that was Magnetic
(compared with other states). California's natural advantages (a
mixed bag) did not promote much growth after the 1849 Gold Rush and
the Civil War, when California growth lagged badly for 20 years or
more. Neither did the transcontinental rail connection, completed in
1867, promote much growth. Eventually, though, INTERNAL
growth-oriented forces prevailed. California provided superior
public services of many kinds: water supply, schools and free public
universities, health and mental health services, transportation,
parks and recreation, and others. It held down utility rates by
regulation, coupled with resisting the temptation to overtax
That all required tax revenues. California had oil, but did not
tax severing it, and still doesn't. Its wine industry went virtually
untaxed. There was and is hardly any tax on its magnificent redwood
timber, either for cutting it or letting it stand. There was no
charge for using falling water for power, or withdrawing water to
irrigate its deserts. Most of those are good ideas, but they are not
what California did.
Its main tax source was another kind of immobile resource:
ordinary real estate. Its tax valuers focused their attention on the
most immobile part of that, the land, such that by 1918, land value
comprised 72% of the property tax base - and on top of that there
were special assessments on land.
People and capital flooded in, for they are mobile in response to
opportunities. California became the largest state, and a major or
the largest producer of many things, from farm products up to the "tertiary"
services of banking, finance and insurance.
C. Was this tax competition "harmful"?
California became the largest producer of cotton, for example,
displacing a good deal of eastern cotton. The damage to eastern
producers was offset by an equal gain to cotton processors and
consumers, with a net gain from higher usage due to the lower price.
Eastern cotton lands were released for other uses, like
reforestation of lands marginal for cotton. (To the extent this was
due to subsidies, and racing for cotton quotas during the Korean
War, I do not vaunt it - but there are few pure examples of anything
in this complex world.)
California attracted eastern workers, tending to draw up eastern
wage rates. The damage to eastern employers was offset by an equal
gain to their workers, with large net gains from two sources. One is
a more equal distribution of wealth; the other is a drop in welfare
costs and social problems like crime that would have ensued had the
"Okies," for example, had to remain in the Dust Bowl
instead of finding new lives in California. Even the braceros, the
Hispanic "guest-workers" who toil in the fields, send
money home, relieving problems in their homelands. It would be
better yet if they could become small landowners and work their own
farms, but in this imperfect world we observe what is, without
denying that it might and should be better. What is involved here,
in spite of its well-publicized abuses, and glaring shortfalls, is
turning useless and even criminal people into productive people.
As to capital, California offered a higher return on that, too.
There emerged what people called "the continental tilt of
interest rates," higher in the west, to overcome the frictions
of space and draw eastern capital to where it was more welcome. Over
time, buildings that wore out in the east were replaced in
Did California's vigor seem too ambitious, so as to damage others?
If so, as Shakespeare had Marc Antony say, "it were a grievous
fault," worthy of suppression by an OECD. Most economists
believe, however, that investing is the motor that drives
prosperity, and raising investment opportunities is the key to the
ignition. I certainly agree.
Basically, California's remarkable 20th Century growth extended
the American and the Canadian tradition of the western frontier, in
the spirit of Thomas Jefferson, as a "safety-valve" for
mobile resources oppressed in the older states. It limited the power
of the haves over the have-nots, with net gains all around.
Was California growth the product of untaxing wealth, and dumping
taxes on poor workers and consumers? The OECD says competition is
harmful because it limits the power of OECD nations to tax "wealth,"
thus more-than-intimating that they are upholding the interests of
labor, like good continental European social democrats. In this, I
suggest they have misstated the issue, setting an agenda for a false
and futile debate, fooling both their friends and their critics, and
possibly even themselves (although I am cynical as to the last
point). Their premise, at least the one they state, is that "wealth"
is more mobile than labor. Some wealth is, of course, but California
relied on the property tax, and, to repeat, 70% of this tax base was
land, pure land, totally immobile. The OECD treats land like one of
those four-letter words that is unmentionable. So do its academic
retainers, who are well-trained to believe that land is just as
mobile as capital. This makes them completely useless to analyze the
OECD allegation that a nation's tax regime is "harmful" if
it attracts mobile resources.
Was California growth the product of southwestern pioneer vigor?
Compare if with New Mexico, not far away. New Mexico has made itself
little more than a Third World Nation masquerading as an American
state. Since before statehood, an oligarchy of giant landowners, in
the million-acre class, have dominated everything, and kept taxes
off their vast lands. New Mexico raises a lower fraction of its
state and local revenues from the property tax than any other state.
Its economic base, such as it is, is mainly the product of what
Senator Albert Beveridge of Indiana called "the free coinage of
western Senators." New Mexico gets more federal spending per
capita than almost any state, but that and scenery are about it. It
is picturesque: its boosters call it "The Land of Enchantment,"
but The Enchanter has cast a sleeping spell on its local enterprise.
It has the highest poverty rate in the U.S., and, in its wide open
spaces, nearly the highest rate of violent death in the U.S. -
itself a violent nation.
D. Recent changes.
In 1978, California took a giant step backwards by enacting its "Proposition
13," capping property tax rates at about 1/3 of their previous
level. The national ranking of its services began a precipitous
fall; so did its per capita income. Struggling to maintain itself,
the State has raised sales and income and business taxes to
unprecedented levels. These are taxes that "shoot anything that
moves," and spare immobile resources that don't. The result has
been the rapid "Alabamization" of California, as we have
fallen to join Alabama with the worst school system in the nation.
Inmigration has changed to outmigration, and of those who stay,
California has by far the largest prison population of any state, so
large that the union of prison guards is now our most powerful
lobby, and building prisons is our fastest-growing construction
industry. None of these people, prisoners or prison-builders or
guards, are producing goods and services for others, but are not
counted as unemployed, and our unemployment rate is above the
national average even without them.
Today if we look for a new frontier we find it in, of all places,
one of the original 13 colonies, New Hampshire, with its poor soils,
marshy peneplains, harsh climate, impassable mountains, and lack of
natural urban confluences. What New Hampshire has now is the least
repellent tax structure in the nation: it does not tax personal
income or sales, while 2/3 of all its state and local revenues come
from the property tax. It has bucked the national trend toward
taxing income and sales, and IT HAS PROSPERED! (Details are in a
Chapter by Richard Noyes and the speaker in Fred Harrison (ed.),
1998, The Losses of Nations.)