The Coming Blue State Collapse

Here’s a quick and dirty guess: Upper-middle-class families in blue states–those President Obama calls “the rich”–will soon be paying 20% more a year in state and federal taxes. If you pay $100,000 off
of a $300,000 income now, look for $120,000 in a couple of years.

Federal income taxes are going up, and deductions are going down. That much we know. What we don’t know yet–but I would bet money on it–is if the 7.65% Social Security and Medicare tax ceiling will be
lifted from $102,000 to $150,000 or so.

Taxes are headed up at the state and local level too. Residents in blue states like California and New York will be socked hardest.

Take California. Its top income tax rate is the nation’s highest at 9.3%. More appalling, it kicks in at only $47,056 a year. Make too much gold in the Golden State–a million a year–and you are pinched by a 1% surcharge. California also has a 7.25% sales tax, but that’s just a base.

Capital gains get no preference. They are taxed like ordinary income.

For all that, California spends more than it takes. The state is on the verge of bankruptcy and just passed a budget with $12 billion of new taxes.

The trend of higher taxes has not escaped California taxpayers. For each of the last five years, California has led the nation in the outflow of its residents to other states. Since 2004, California has lost about a million and a half people from taxpaying households. At the same time, the state has taken in two million people, mostly non- or minimal taxpayers who are newborns or immigrants, legal and illegal.

I focus on California because I live there. The same trend is at play in other high-tax, high-cost blue states such as Massachusetts, New York and New Jersey.

How will this play out? Well, consider:

1. Home prices are highest in the coastal blue states and remain that way despite the recent losses. In California, the percentage losses are uneven. Silicon Valley residential real estate is down only 15% to 20% from the peak–and less for those little sub-$2 million houses. I’m not kidding. A
modest three-bedroom, two-bathroom house of 2,500 square feet in Palo Alto still sells for $1.5 million to $2 million. The income it takes to buy such a house, which is a middle-class house by size and amenities, is what Obama and the tax collectors are now calling “rich.” Palo Alto may
be extreme in its home prices, but the same is true in all blue-state upper-middle-class suburbs. It takes a “rich” income (north of $250,000) to live a middle-class lifestyle if one is still raising children and paying a mortgage in these places.

2. Jumbo mortgage loans (more than $417,000 nationally and $625,000 in high-house-price counties) are often required to buy a house in urban blue states. Too bad for the blue-staters. Mortgage interest rates on jumbos are about 1.5% higher now than for regular conforming loans.

3. Inflation–when it restarts (likely five minutes after the economic recovery begins, as it did in the 1970s)–will push droves of upper-middle-income earners into higher tax brackets, as it did in the 1970s.

4. An upper-middle-class income–an income I would define as middle class but with the bonus of freedom from day-to-day worries about grocery and doctor bills, car and mortgage payments, and education and vacation costs–only begins at the point defined as rich by President
Obama in many urban blue states. On the other hand, $200,000 might be upper-middle-class in Atlanta or Denver, $150,000 will get it done in Des Moines and Spokane, and $120,000 should do the trick in Fargo or Fayetteville.

A reasonable conclusion is that America could see a huge outflow of educated, upper-middle-class families from the high-tax urban blue states to more congenial places. (I wrote about this in my 2004 book, Life 2.0 but I’m convinced today’s circumstances will accelerate this trend.)

If I were investing in real estate, I would look at Washington state (no state income taxes but a vibrant economy and educated populace), both around Seattle and Tacoma and in the east around Spokane; and Texas (no state income tax), particularly in the high-tech areas of Dallas and Austin.

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