Anti-Business Policies Driving Innovation Out of California

It’s hard to say the word “innovation” and not think of California. Technology has paced the state’s growth in everything from agriculture and oil to housing, entertainment, and aerospace. California has always been the harbinger of the American future, the promise of ever-greater economic and social progress.

Yet increasingly, many of today’s innovators are fleeing the state. This past week, one half of the company arguably most symbolic of tech development in the state — Hewlett Packard Enterprises — one part of the now broken-up old Hewlett Packard and focused on lucrative areas like cloud computing and IT infrastructure — decided to leave for Houston. Within a week Elon Musk, the latest in the line of truly transformative California tech entrepreneurs, also announced that he would move to Texas, along with Oracle, a Fortune 100 company and global leader in database management. Other recent departures also include more traditional firms as Charles Schwab, McKesson, Bechtel, Parsons Engineering, and CB Richard Ellis.

The corporate exodus accompanies a human one. The state’s population, notes demographer Wendell Cox, is now virtually stagnant, with more people leaving and fewer people coming. Millennials, particularly as they ponder family formation (as we recently demonstrated in a report from Heartland Forward), are following a similar pattern. Today, suggests Cox, California, once the ultimate land of youth, is now aging far faster than the rest of nation.

Until the past year, Silicon Valley seemed immune to the economic stagnation or decline afflicting other key state industries such as aerospace, manufacturing, and energy. “We were fat and happy,” notes Jim Wunderman, president and CEO of the Bay Area Council, the region’s leading business group. “Now people are shaking their heads. HPE’s moving sends the message from one of the core founders of Silicon Valley. It’s very troubling.”

The appeal of Silicon Valley, as Wunderman is quick to add, has not disappeared: natural attractiveness and a congenial climate, leading universities, an unmatched pool of technical talent, and the preponderance of leading venture-capital funds. Even as the state suffers the nation’s highest poverty rate, the tech giants have ballooned in value, and new companies, including a set of IPOs, driven by the low cost of money and the pandemic disruption, are creating an enormous tax windfall—this year estimated at $26 billion.

California politicians, notably Governor Gavin Newsom, believe that this patten is immutable, and that even as companies leave, new ones will take their place. Yet the process is slowing. In recent years, according to figures developed by UCI business school professor Ken Murphy, California has been losing market share among the 11 states with high concentrations of innovation-oriented firms. Since 2005, California’s share of the nation’s innovation business has dropped 3 percentage points, while competitors like Florida, Oregon, Arizona, and Utah have expanded their share. The Bay Area has also seen an exodus of corporate headquarters, often to Texas.

California’s innovation industries, which include science and engineering services, are no longer adding jobs faster than those of several other states, notably Florida, Utah, Arizona, and Washington. California’s innovation economy, to be sure, remains a powerful one, with 27 percent of all innovation businesses nationally, but in a world of corporate mobility, for how long will businesspeople be willing to absorb the higher costs of the Golden State?

California’s business flight has been gaining momentum for years. State housing policies, including climate-related regulation, and extraordinarily high development fees, have made it hard to build on the periphery of the major metros, where most population and job growth takes place. One result has been that the state’s new house-building permits have fallen to barely half that of key competitor states like Texas, Tennessee, Florida, and Arizona. California also accounts for all three of the worst metros for first-time buyers, according to a recent AEI survey, and six of the top ten.

High housing costs affect employees and are one reason why so many firms with many mid-income office workers—McKesson, Toyota, Bechtel, Jacobs, Parsons, Nissan, Bank of America—have departed for places where these workers can afford to buy a house. High energy prices affect both consumers and industrial companies. Regulation against such things as fossil fuels has driven Occidental Petroleum, one of the largest home-grown firms, out of the state, and threatens the future of Southern California Gas and other remaining fossil fuel companies, not to mention the livelihoods of tens of thousands of people in both the Central Valley and Southern California who work in the industry.

Rivaling regulation as a negative is taxes. California already has the nation’s highest income tax—with a top marginal tax rate of 13.3 percent—and capital gains are taxed at that rate. A new proposal circulating in the legislature would add three new surcharges on seven-figure earners. It would add a 1 percent surcharge to gross income of more than $1 million, 3 percent on income over $2 million, and 3.5 percent on income above $5 million. That means a combined state and federal marginal tax rate of 54 percent for high earners. By contrast, Texas, Tennessee, Florida, and some other states attracting tech-industry firms have zero state income taxes.

The tax burden seems likely to get worse. This fall, state public employees pushed a ballot measure that sought to eliminate Proposition 13’s protection for commercial properties, a measure that failed by a small margin. Members of the majority in the state legislature have introduced AB 2088, designed to assess a 0.4 percent “wealth tax” on residents with net worth above $30 million. Approximately 30,400 taxpayers would be affected by this tax, estimated to generate $7.5 billion annually. Moreover, the tax would be assessed on people planning to leave the state for ten years after their exit—a clause of dubious constitutionality. “You get a wealth tax and people will leave in droves,” predicts Daniel Young, former president of the Irvine Company, and a long-time developer of multi-family housing in Silicon Valley.

Some cities, particularly San Francisco, seem determined to gore the golden goose entirely. Even in a year where most of California rejected new taxes, San Francisco enacted new wealth taxes and backed an expansion of rent control. The city’s stores remain closed, and rents are falling more than in any major metropolitan area; the city seems incapable of cleaning its streets or controlling rampant property crime and widespread homelessness.

Before the pandemic, California’s boosters and leaders could convince themselves that the state had developed a progressive and sustainable economic model. Covid-19 and the economic downturn have stripped away this illusion, as the state’s unemployment rates now surpass the national average, worse even than in the New York area, the epicenter of the coronavirus outbreak. It is particularly bad in Los Angeles, where less than half of residents now hold jobs. Los Angeles County has lost over 1 million jobs to the pandemic and suffers an unemployment rate higher than any of the major California urban counties.

Initially, the technology industry created lots of middle-class jobs. Hewlett Packard, founded in 1939, was an exemplar of enlightened management and employee benefits. Yet in recent years, Silicon Valley companies have become ever more virtual and digital, with fewer jobs for working- and even middle-class employees.

Today, the state’s economy is totally dominated by a handful of enormously powerful companies—Apple, Google, Facebook, Salesforce—none of which make tangible products, at least not in California. These firms, notes Robert Lapsley of the California Business Roundtable, see themselves as global first and foremost, not primarily as part of a state economy. “We need these people to step up and they are not doing it,” he suggests “That was not a problem when David Packard was around. We have lost that voice.” Many of these firms’ employees are overseas. Even in the Valley, close to half of tech employees—nearly twice the rate for the tech industry nationally— are non-citizens, working under HI-B visas. The federal government recently sued Facebook for discriminating against American workers in favor of foreign ones.

We have gone a long way from “the fire in the Valley” era, with its garage startups, homebrew computer clubs, and innovation by oddballs like Apple co-founder Steve Wozniak. Today, tech firms have become more concentrated. Back in 2006, notes Scott Galloway, author of The Four, a book examining the rise of the tech giants, only one, Microsoft, was in the top five in market cap; today, tech firms account for all five of the country’s top firms by market cap.

Ironically, these firms have done well in part because they have been largely unregulated. And when they object to taxes and regulations, they have the resources and technology to move operations elsewhere—as Musk, Uber, Lyft, Facebook, and Apple have done. Some new companies, such as Peter Thiel-backed Palantir, have chosen to move their headquarters elsewhere—in Palantir’s case, to Denver, in part to escape woke criticism for its work with the military and ICE. With two out of three tech workers now willing to leave San Francisco, big tech can get bigger while spreading talent and wealth around.

Mark Zuckerberg has claimed that he would never start Facebook in today’s California. Yet he seems unconcerned about the fate facing smaller firms. His foundation gave millions to Proposition 15, a measure that would have increased property taxes on businesses and opposed by most legacy businesses, and particularly by minority-owned firms. In a letter to Zuckerberg, the business owners noted: “Unlike Facebook, restaurants, dry cleaners, nail salons and other small businesses can’t operate right now and many may never open again. The last thing they need is a billionaire pushing higher taxes on them under the false flag of social justice.”

Jim Wunderman, head of the BAC, suggests that political pressure from both Washington and Brussels leads the tech mavens to adopt a progressive script—the firms are more concerned about privacy and monopoly issues than about higher taxes or even the most intrusive regulations. They also have to fend off their own left-leaning employees, by seeming to take progressive, pro-labor positions, even in an industry with virtually no unions and where the lower end of the wage spectrum offers little in the way of benefits. “A lot of their employees are progressives,” Wunderman suggests. “They are trying to be responsive to the people who work for them.”

One remarkable phenomenon has been the indifference of state government to big-name departures, even when signature companies such as McKesson—a firm with roots going back to the 1850s and now a “centralized distributor” for the Covid-19 vaccine—or Toyota, the world’s leading car company, shift out of state. Yet, notes Lapsley, the state makes virtually no effort to look out for companies that choose to stick around.

Kaitlin Lewis, Assistant Deputy Director of Communications for the Governor’s Office of Business and Economic Development (GO-Biz), suggests that the state is in “constant communication” with companies and also administers the California Competes Tax Credit program, a job-creation initiative begun in 2013 to help businesses grow and stay in California. In early November, California Competes had awarded $80 million in tax credits to a diverse set of businesses that are projected to create 6,535 new full-time jobs in California. The funding, Lewis says, will bring more than $400 million in new investments.

That may sound promising but consider some context: HP Enterprise is tracking full-year revenue of $27 billion in 2020. It has spent $7 billion in operating expenses in 2020, much of that related to the presence of its corporate headquarters, which will now move to Texas. The $80 million in tax credits that GO-Biz administers to retain businesses is not even close to adequate to retain a major employer like HPE, much less the other unhappy employers leaving or about to leave the state.

“Privately,” notes one top southern California business leader, “the sense is the state doesn’t care about the economy as long as money is coming in. Even Jerry Brown saw the importance of the broader economy outside a few tech firms and IPOs. Newsom’s people still think everyone wants to be us.”

In the past, to be sure, California evolved its remarkably diverse economy to meet new challenges. Yet as the critical mass of talent shifts elsewhere, and the regulatory burdens grow, one must question how long the Golden State’s economy can rely on a handful of firms and some IPOs, many of which will end up absorbed by larger firms. California’s future as a dynamic place for aspiration and innovation is far from guaranteed. Continual assertions of its greatness cannot obscure the likely long-term impact of the flight of the icons.

Joel Kotkin is the Presidential Fellow in Urban Futures at Chapman University and executive director of the Urban Reform Institute. His latest book is The Coming of Neo-Feudalism. You can follow him on Twitter @joelkotkin.

Marshall Toplansky is Clinical Assistant Professor of Management Science at Chapman University. He was formerly Managing Director of KPMG’s national center of excellence in data and analytics, and he is a co-founder of Wise Window, a pioneer in sentiment analysis and the use of big data for predictive models.