The myth of college for all

Starting in 2018, those who might die before 2026 can look forward to a per person amount of $11.18 million, indexed yearly for inflation, exempted from federal estate tax. This amount can also be gifted away, without paying a federal gift tax, and a like generation-skipping transfer tax amount is exempt.

While this exemption is projected to drop to about $6.5 million in 2026, the increased amount still seemingly offers some advantageous planning options. But now, a proposed California ballot initiative could amend our state constitution to establish a state-level estate tax to raise money for universal college tuition grants, providing less chance of escaping estate tax for many who had hoped to pass assets on to heirs.

In 1982, California voters banned state-level inheritance and estate taxes when they approved Proposition 6. Mitigating its short-term impact, the state received revenue from a pick-up tax through 2005. This lingering funding source used the federal credit for state-level estate taxes to claim a portion of Californians' federal estate tax payments which otherwise went to the federal government. The Economic Growth and Tax Relief Reconciliation Act of 2001 ended this credit.

Last year, Democratic Sen. Scott Wiener proposed a bill creating a constitutional amendment allowing a state-level estate tax. It was shelved later in the year when the federal estate tax survived tax reform. This new proposal will thus reverse prior voter decisions.

And this proposed state death tax is a bad idea. The College for All Act of 2018 is based on Sen. Bernie Sanders' proposal for free nationwide tuition and will impose (if passed) a tax on decedent estates over $3.5 million in value. Under the measure, taxable estates valued between $3.5 million and $4 million will be taxed at 12 percent, between $4 million and $4.5 million at 15 percent, between $4.5 million and $5 million at 17 percent, and between $5 million and $5.49 million at 20 percent. Estates valued over $5.49 million will be taxed at the maximum rate of 22 percent. Adding in the federal estate tax, those above the exemption amount will pay 62 percent on that added amount of estate value. Note, only an estimate 0.2 percent of Californians are worth over $3.5 million, or $7 million for married couples, so this proposal disproportionately taxes a very small percentage of state residents.

The proposal's backers, including the California Federation of Teachers and the University of California Student Association, project that this new tax will generate about $4 billion of revenue annually. Given that we cannot mandate that a certain number of high net worth individuals who have not done effective tax planning die each year, this estimate is problematically optimistic.

Interestingly, numbers for estate tax paid are easier to get on the national, not state level. In 2015, nationally 4,918 households paid a total of $17.1 billion on their estates valued at $88.2 billion, which was about the same as for 2014. The Center on Budget and Policy Priorities estimates that in California, 1,071 people, or 0.4 percent, might be subject to the (higher exemption amount federal) estate tax. Regardless, these numbers are somewhat meaningless as they are not taking into account tax planning and the greatly varying estate values at which an estate tax (federal or proposed state) might attach. Needless to say, the projected funds raised will not come close to funding "college for all." Especially when we delve more deeply into those numbers.

Optimistically, the bill aims to fund undergraduate tuition for all California resident students. Any excess revenue will be used to expand state assistance for student living expenses. Tiers of priority mandate where the money will go. Prioritized are first-year students attending a public institution and those who have recently graduated from a state high school and want to attend four years of higher education, including those students who otherwise would have been excluded due to not meeting (prior) GPA requirements. Part-time students seem to qualify. Any excess funds will be used to fund other educational needs. The provisions made for any shortfalls in funding allocate based on the type of school the student is attending. Thus, part-time students at community college will have priority over full-time students at the University of California (a perverse incentive, as no graduation or full-time attendance is required; arguably less "serious" students have priority over those in four-year programs).

Supporters of the current initiative say that California is not sufficiently funding higher education. Fees and tuition have materially increased, thus burdening students. Universal access to college would create "greater economic activity at the local and regional level, driving economic prosperity for all." Opponents disagree and believe that a state estate tax hurts small businesses and family farms, among others, by creating an almost immediate need for liquidity (to pay the estate tax) after a decedent's death. Heirs will be forced to liquidate assets, even if they are highly illiquid, such as a family business.

Backers must submit 585,407 registered voters' signatures by June 13 to qualify the initiative for the November ballot. If they get those signatures, the voters will decide. While the proposal is both deceptive and impractical, California voters seem increasingly not to do the math when making electoral decisions, so the initiative could pass.

Moreover, the state is already driving taxpayers out. In 2016, California had 142,932 more residents exit to live in other states than arrived, according to a report from the U.S. Census Bureau. This domestic net outmigration was the second-largest outflow nationally, behind New York and just ahead of Illinois and New Jersey. It was also up 11 percent (13,699 net departures) over 2015. About 143,000 estimated net Californians left in 2017.

Meanwhile, the wealthiest Californians pay nearly half of the state's income taxes, according to the state Franchise Tax Board. Their mobility is not desired if California wants to continue paying its bills.

To sum up the reality, we have a state heavily dependent on revenues from a small portion of the population, some of whom are already beginning to migrate out, and we now have a proposal to add an additional (double) tax on income already taxed. Small wonder that out-of-state trust companies are swarming to present their more favorable options for those (somewhat limited) assets that can be housed outside of California borders. Moving assets is by no means easy, and California has strict clawback provisions for those who attempt to do aggressive planning in this area. California also taxes any income that touches the state or its residents. But some people and assets are more liquid than others. Relying on enough rich people who don't do good tax planning to pay for "college education for all" is idealistic, and ignores the law of supply and demand.