Does California Really Subsidize Other States?

This is the work of independent journalism. It is not sponsored by any organization.

Often, people claim that California subsidizes other states.

Is this true?

In a word, if we define a subsidy to exist when there is a net transfer of money to other states, then the answer is NO.

The claim that California subsidizes other states is based on statistics that report California paying more in federal taxes then it directly receives in benefits.

The word ‘directly’ is important here. It refers federal tax dollars being spent inside the state of California.

When we look at subsidies, we need to consider not just direct expenditures, but net economic benefit, which consists of the difference between money out and money in – including not just federal spending within California, bu also all benefits that accrue to California from federal spending outside the state.

Relatively speaking, an entity that receives more than it spends is getting a subsidy, not giving one.

What we find is that when California tax dollars end up in other states in the form of federal spending, California is actually receiving more dollar value in return than it is losing.

Hence, California is not giving a subsidy to any other state, it’s actually getting subsidized from many other states. Many of the effects here flow from the high cost of living in California, in ways that will become apparent when we look at the details.

So the claim that California subsidizes other states is a myth. Let’s examine the details by considering a few key topics.

But before we go there, let me point out that many people in my family either live or have lived in California – we have deep connections going back there a long time. I have been there many times and I love California: it’s a beautiful state with lots of fantastic things to see or do. Like most, I’m not so fond of the over-population and often problematic government. But this article isn’t be written as some sort of ‘Hate California’ piece, because that’s not at all what I feel. I’m writing this article because I see that a lot of people have major holes in their education when it comes to thinking about some California issues and I’d like to help correct that problem.

Note also that I’m not doing a red vs. blue article here: the whole concept of red states vs blue states is very misleading and not a reliable basis for analysis, for reasons that many people have already covered so I won’t repeat them at this time.

Retirement

Consider the following fact: California has the largest population of any state in the USA – so it is ranked #1 in population – but the percentage of retirees in California is ranked #45 in the USA.

Question: What does this tell us?

Answer: It tells us that extremely large numbers of people leave California and go to other states in the USA when they retire from their jobs in California.

They may or may not leave the state immediately after retirement, but they do tend to leave at some point.

What are the consequences of this? These people that leave are typically receiving Social Security and Medi-Care payments from the federal government. This shows up as federal funds being spent in other states – funds that might have been going to California before these people moved.

But is this really a subsidy for other states? The answer is a definitive no.

Retirees are generally on a fixed income and tend to be very frugal. This means they aren’t spending much money in the local economy, so while they create or sustain some jobs through their spending, they aren’t affecting that many jobs as job counts tend to be proportional to spending. Also, because they are frugal, the government doesn’t get much in the form of sales taxes from them, simply because they aren’t buying much. They also likely get senior citizen discounts.

Also retirees tend to not pay much in property taxes, because they are shielded from property tax increases over time – under current California law – because of long residency in the same location, or because of age (there is a Senior Citizen benefit in California tax law).

For example, my uncle had a small house in Los Angeles that he bought many decades ago on a postman’s salary (with some help from his brother) and lived in for the rest of his life. He wasn’t an executive or manager or anybody important to anyone outside the family, so his salary wasn’t very high – and so his pension wasn’t very high either. During the lengthy period he lived in this house, he was paying hardly any property taxes on it because of his long residency – and that was fortunate because he couldn’t have afforded to pay much on a low-level postman’s retirement pension.

In any event, that small house sold recently for a couple million dollars. Had my uncle been taxed on the value of the house, he and his wife would have been forced to move long ago.

While government in the USA usually seems to work to the benefit of the wealthy, this example is one of the cases where government policy actually worked to the benefit of an ordinary person (where I mean ‘ordinary’ in an economic sense). Maybe that’s more of an accident than anything else, but it does show that not everything government does is bad.

The new residents will typically be paying much higher property taxes due to various quirks of California law.

So when people leave California to go to other states, they take their Social Security and Medi-Care with them, which means federal tax dollars are now going to other states. But in return, the retirees leaving opens up housing which can now be used by people who are still working. Those new residents – who often come from other states or even other countries – are directly contributing to the total dollar value of the California economy though their work, they pay higher property taxes than the former residents, and they tend to spend a lot more in the local economy because they aren’t on a pension.

Of course, the ‘new’ residents might already be California residents, but that simply moves things a bit (a Domino Effect). Their former residence will be sold, and someone else will buy it, and so on until you finally end up with a non-California resident or somebody not previously contributing to the California economy moving in (such as a group of recent graduates from California schools who were previously full time students).

Further, the process of selling a typical house gives work to people such as painters, landscapers, handymen, real estate agents, lawyers, inspectors, plumbers, roofers, title insurance providers, and others – and likely will also lead to associated purchases in the local economy of goods such as paint, wood, nails, etc plus government fees such as ‘transfer fees’ (government ‘fees’, like ‘tolls’, are usually just yet another form of regressive tax disguised as something else so people won’t notice how badly they are being screwed by their government).

The extra housing freed up by retirees leaving is especially important due to the large number of houses destroyed by wildfires each year. California has ridiculously high prices in part because there is a housing crunch in key areas: this situation would only get worse if the retirees were not leaving.

We can look at a few numbers to help illustrate the point. The average person gets about $35k each year in federal funds from Social Security and Medi-Care. Just the commission alone for a real estate agent in California (at 5% of 775k average house value it’s about $38k) more than covers that federal tax for the first year if only one person is moving. This isn’t even looking at all the other money spent when a typical house is sold, which can easily add up to as much as the real estate agent is making – though it’s probably only half that in most cases depending upon factors such as the age and condition of the home – so figure 8.5% or about $65k is added to the California economy for one house sale.

In other words, the California economy gains more than it loses – just from a single house sale alone – over the first year when a single retiree leaves. If two houses end up being sold (by the Domino Effect) it’s not only in the green, but well into the green for a single retiree leaving, or it’s in the green for two members of the same household leaving. We’ll assume a couple gets $70k in Social Security and Medi-Care – that may not actually be the case, depending upon various variables, but it seems like a good ballpark number.

Beyond that, the average household in California makes about $75k, so a new person added to the workforce adds more to the economy than the federal taxes lost for two retirees from the same household leaving California. This is a recurring gain that is added to the fixed gains associated with the house sales – and it typically gets larger over time as people get raises and other benefits, which likely outrun Social Security and Medicare by a lot!

Probably a lot of the people moving to California will actually be making a lot more than 75k, but I don’t have any research done yet to better clarify that detail.

At this point, California is already ahead – probably well ahead – and all the other benefits such as getting higher property taxes and more spending in the economy from the new resident(s) are just icing on the cake.

Hence, the fact that a enormous numbers of retirees move from California to other states is a good thing for the California economy overall (whether or not it’s a good thing in non-economic respects or in terms of sub-sectors of the economy is not something I’m going to consider here). The net benefits to the California economy exceed the amounts associated with paying federal taxes that end up in other states to cover the Social Security and Medicare payments those people receive. The fact that other states can absorb these retirees is a net economic benefit to California: instead of California subsidizing these other states, these other states are actually subsidizing California by providing someplace with a lower cost of living where retirees can move.

Military

Consider the following fact: California has the largest population of any state in the USA – so it is ranked #1 in population – but the percentage of military veterans per capita in California is ranked #48 in the USA. Only about 17% of the military stays in long enough to retire, so when we talk about veterans we’re generally not talking about retirees.

Question: What does this tell us?

Answer: It tells us that either a) extremely large numbers of military veterans leave California and go to other states in the USA when they leave military service, or b) the military is shifting a lot of people elsewhere in such a manner that when people’s enlistments run out, they have been stationed somewhere else for a while and are no longer located in California. In practice, I think it’s a mix of the two, but I haven’t found any good data one way or the other.

If you do a search on poverty and the military in California, you’ll find there’s a big problem. The pay of large numbers of military personnel is just not high enough to support them in California. So when people finish their enlistments or their careers they tend to move somewhere else – or they might already be ‘somewhere else’ if the military has relocated then.

I won’t look at the details at the moment, but the average military pay is about 10k less than the average civilian pay, so military personnel moving to another state and being replaced by civilians works out even more in California’s favour over the long term than is the case with retirees leaving the state, just from that consideration alone. For veterans that are not retirees, some can do well enough to make it in California, but most know that they will do far better in another state with a lower cost of living. The average income in California places it about 8th in US states, but the ratio of income to cost of living places California in 42nd place in US states (using numbers from 2017). That’s an enormous difference: it means that lots of people with marketable skills are nevertheless going to be far better off in some other state.

Because of the problems caused by the high cost of living in California, the military has been trying to downsize in California for a long time – and moving operations to other states. For both strategic and political reasons, they can’t do as much of this as they would like, but what they can do, they have been doing, for a long time now.

Consider, for example, the case of the Presidio in San Francisco. It was an US military base from 1846 to 1994 – over a century – and it was built largely on land that was considered completely worthless for most of its history. But as San Francisco grew, that formerly worthless land started to become enormously valuable. By the 1990’s the land was estimated to be worth over twenty billion dollars. Over 5000 military personnel and dependents lived on the base, but on the whole they didn’t contribute all that much to the California economy – they weren’t paying property taxes since it was federal land, and they didn’t spend all that much in the local economy because they didn’t have much to spend. Also, a lot of military spending happens in the informal economy between military personnel, so there is even less spending in the local economy than you might otherwise expect. For example, military personnel change posts frequently, so they move a lot. Often the people that are leaving will sell a lot of their stuff (such as furniture) to incoming or newly arrived folks, so the local economy doesn’t get involved.

There were certainly some civilians working on base, and the base doubtless had some spending in the local economy, but overall it wasn’t that much compared to what you might expect a twenty billion dollar piece of property located in the heart of a major city to produce.

The Presidio base was closed in 1994. All the federal tax dollars that were going to support it went to other purposes, and some of those tax dollars ended up in other states since the function formerly provided by the base had to go somewhere else (the base was primary occupied by elements of the 6th Army – the current organization with that name is now located in Texas).

So we have federal tax dollars being spent to support military units and personnel in other states that were formerly in California as a result of closing the Presidio military base. But what did the state get in return?

The answer is, a lot.

Some of the land that was formerly a military base is now being run as a park and a tourist attraction – it has a spectacular view of the Golden Gate Bridge, the ocean, and the city. Economists recognize that parks provide economic benefits, though they are sometimes hard to quantify. Further, the park is being run by the federal government, so California doesn’t have to pay for it’s maintenance.

Also, many of the former buildings are now being leased by over 200 different organizations – and some are also available for rent by the public for events like weddings. One example of a business now located at the Presidio is Industrial Light and Magic, a 1 billion dollar business that is a major player in the movie industry.

So now, instead of military personnel that aren’t spending much in the local economy, the Presidio provides both locations for businesses to operate, and housing for civilian renters. Those civilians are often working in the California economy, and as such they contribute directly to the dollar value of the California economy, plus they are spending a lot more in the local economy than the former military personnel did. In addition to helping keep jobs in the local economy, the new civilian occupants are paying more in sales taxes and probably a lot more in income taxes than the former military residents.

Some of this income was probably already going to California, since many of those organizations were already part of the California economy. But that opens up the spaces formerly occupied by those organizations, which in turn get occupied by other organizations, and so forth in a Domino Effect. This process tends to happen quickly given the high demand for space in California’s most economically active areas. Sooner or later some new business that wasn’t previously part of the California economy will be added to the mix, and that business will provide an entirely new economic benefit to California.

Just as with selling personal houses, selling a business property may provide some one-time benefits to the economy. Even changing renters is likely to have beneficial economic consequences as the owner will often take the opportunity to redo the carpets, repaint the walls, update old systems, and so forth before the new business moves in.

Those businesses located at the Presidio are also paying income taxes, but (perhaps surprisingly!) that probably isn’t a great benefit to California. Business taxes tend to result in a transfer of money from the middle class to the wealthy (for reasons that we can discuss in detail on another day) and that means lower total consumer spending, which in the overall economy will offset some or all of the money gained from the tax. For maximum economic benefit, all those business taxes should be converted into a) Income taxes on the individuals owning the business, and b) income taxes with withholding on overseas transfers (to ensure we include foreign ‘owners’ as well as US owners – and catch any shenanigans such as using overseas transfers to hide income from taxation). But that’s a topic for another day.

While the income taxes on the businesses are not necessarily ideal, these businesses are producing goods and services and providing jobs that are very much contributing to the California economy.

Overall, there is a net economic benefit to California of having this former military base be closed and converted to civilian use.

Military bases in rural or poorly developed areas or on the edge of an urban area tend to be an economic asset, but having military bases deep in a major urban area tends to be a liability from an economic perspective. Along with the Presidio, a number of other former military bases in the San Francisco Bay Area are now shut down and are likely to eventually become economic assets that contribute far more to the total California economy than the bases ever did. Other bases in the Bay Area have been downsized, such as Moffett Field Naval Air Station. In other cases California bases have had full time units redeployed to other states and replaced with part time Guard or Reserve units.

Note that California has a large and very active group of representatives in Congress. They ensure that the military doesn’t get to move anything away from California if it’s going to be a net economic problem for the state. It’s one thing to move away low paid personnel who are not contributing all that much to the economy anyway, but it’s another thing altogether to lose lucrative military programs that are bringing in lots of money and keeping lots of civilians employed – such as some civilian defense contracts. You have to consider all sorts of political wheeling and dealing to determine what actually constitutes the ‘net benefit’ so working out details is really hard and I won’t attempt that here, but the trend is clear. I don’t know of a single example of California’s representatives failing in that regard.

The result is a significant net economic gain for California. The large numbers of both active duty military personnel and veterans leaving California and going to other states is a good thing for the California economy. The net benefits to the California economy far exceed the relatively small amounts associated with federal tax movement away from California that went to pay salaries, GI benefits, VA spending, etc. The fact that other states can absorb these moves is a net economic benefit to California: instead of California subsidizing these other states, these other states are actually subsidizing California as California is getting the Lion’s Share of the economic benefit.

Agriculture

People claiming that California subsidizes other states often include a statement that California produces some enormous percentage of the nation’s agricultural products, either with the express or implied claim that the federal agricultural subsidies going to other states are a complete waste of California taxpayer dollars and represent corruption on the part of politicians from other states who are stealing Californian’s hard-earned dollars.

Is this true?

Well, there probably is a lot of corruption – but it’s just as likely to be present in California politicians as those in other states. California has a large and extremely powerful group of Congressional representatives – who often work as a team against frequently divided groups from other states that often end up working at cross-purposes – so it’s pretty unlikely that there are going to be any policies unfavorable to California on a net basis.

Let’s look at the details.

In 2017, California farms produced ~$45.2 billion dollars in sales, over $16 billion more than the #2 state.

Question: Does this mean that California is producing a massively disproportionate share of the nations food?

The answer is a definitive NO. The statistic above is enormously misleading because it shows a dollar value across all crops, whether they are staples or luxuries. Anyone with a decent education in economics or business (something that should be part of the normal high school curriculum, but no high school does that as far I know) can tell that you that in general the profits from luxury products tend to be enormously larger than the profits from non-luxury products.

Where are the staple agricultural products primarily produced? For many the answer is not California, with a few important exceptions. The top producers of some key various agricultural products are:

Note that – at the moment – I am considering oranges and cotton to be staple crops – most people drink orange juice or eat oranges, and most non-synthetic clothing and related products (e.g. towels, bedding) involves cotton. I am also looking at chicken and pork and beef as staples, which could be argued either way, but it seems useful to have the data here in either case. Probably I should be more formal about this and actually look at return per acre to distinguish staples from luxuries – perhaps I’ll do that at some future date.

A lot of adults don’t drink milk, but children do, and adults eat yogurt and cheese so I decided to include dairy as a key item. I included ‘peanuts’ as a separate item due to their enormous popularity, especially among children, often in the form of peanut butter. I could probably break out the vegetables a bit more, perhaps I’ll do that at some future date.

For now, I’m considering most fruit to be luxuries, and not listing them: California does produce a lot of this fruit but for now I’m not going to break things out that much. I think the general trend is fairly clear from what I have included here, and adding that information can be put off for another day.

Take these numbers with a grain of salt: the relative ordering does change from year to year.

Since California is not a top producer of many staple crops, what is it actually importing?

It turns out that California is (perhaps surprisingly) self-sufficient in many areas of agriculture.

However, is a big importer of several staple crops. For example, according to the California Wheat Commission, the average annual California wheat production is 400,000 tons while the mills in California grinds approximately 1.9 – 2.0 million tons per year of wheat (2017). So California is importing 5x as much wheat as it grows.

This means that field space that could be devoted to wheat is instead available for use in growing luxuries. California pays federal taxes that go to other states to support the growth and import of staple products such as wheat, so that California can make enormous profits on luxury crops.

Similarly, California imports large amounts of corn. For example, according to a 2001 study by the California Grains Commission, in the central valley California imported ~68 million bushels of corn, while California only produced 27 million bushels (2003).

Note that the USA imports fruits and vegetables from 125 countries, so the role of California in supplying fruit and vegetables is somewhat over-stated if you just look only at production in US states.

To produce it’s crops, California also imports an enormous amount of water, mostly from the Colorado River system and hence from Wyoming, Utah, Nevada, Arizona, Colorado, and New Mexico. A smaller watershed in Oregon also supplies water to California. There are enormous fights over this water, on a frequent basis – all the other states would be happy to use this water for their own purposes and not let California have any (they still have to let Mexico have some, by treaty).

California also imports 25% of it’s electricity supply, some of which goes to agricultural production.

We could also look at manufacturing of agricultural equipment and tools, and oil/gasoline as well, but I won’t do that for now.

There are some hidden subsidies in agriculture from the federal government that are not reflected in federal spending: a number of Western states receive water for agricultural purposes from federal sources without paying anywhere near the full market value of that water (a point made in Cadillac Desert, Marc Reisner). For now, I haven’t done any research into the details.

Some of the water used for California agriculture comes from underground aquifers that take tens of thousands of years to re-fill, so they are not sustainable resources. I haven’t tried to account for this here, but note the problem exists and will eventually place a serious limit on California agriculture unless we can find other sources of water.

What agricultural products does California export? The top money earners are here:

Note that some of the exports may represent goods first imported into California, then processed, then exported out again, such as happens with Wheat.

Notice the large number of luxury crops being exported here. It follows that California is using agricultural space that would otherwise need to be used for staples to produce luxury products, and this accounts for a large portion of the dollar value of California’s agricultural sector. It can do this because lots of other states are producing those staple crops. Thus, federal funds that go to agricultural subsidies or research or transportation infrastructure in other states actually allow California to make higher profits on its agricultural sector, by allowing the import of staples at a lower cost.

The fact that California can export it’s goods also depends in part on federal spending in other states to construct and maintain the transportation infrastructure. There’s no point growing extra heads of lettuce in California to ship to New York if you have no way of moving the lettuce from California to New York.

So, in conclusion, California actually gets a big return on a significant chunk of federal spending in other states, both in terms of supporting the transportation infrastructure needed to export California agricultural products, and also by allowing California to grow luxury agricultural products instead of staples through the import of enormous quantities of staple agricultural crops from other states. California Wins.

Cost of Living

The effect of cost of living is often neglected in comparisons of taxing and spending. For example, suppose your employer moves you from a mid-western state to California, but you are still doing exactly the same job. They will likely give you a cost of living increase to your pay. A dollar just doesn’t buy as much in California. You will now pay higher taxes, because you have a higher income – but at the end of each year, if your employer has done a good job calculating things, it’s not a real income change: your standard of life and yearly take home pay haven’t changed – and since you are doing the same job, the real contribution of your work to the economy hasn’t changed.

So the apparent total taxes paid by California are very misleading from the perspective of what a dollar is actually worth from year to year and from place to place. We should expect California to pay higher taxes than most other states just from cost-of-living effects – and so we can’t directly compare the taxes paid from state to state without some sort of cost-of-living adjustment.

It’s tricky to account for this because the tax code is non-linear. Hence if you move into a different tax bracket, and your employer hasn’t accounted for that in the COL adjustment they give you, then you are actually losing money at the end of the year as a result of changing location. On the other hand, if they have taken that into account, then you will make exactly the same amount you did before at the end of the year – the federal government is making more money from you in taxes, so the total taxes paid by Californians has gone up disproportionately due to your move, but the burden on you hasn’t changed.

This works both ways, of course: a federal dollar spent in California just doesn’t buy as much. In practice, cost-of-living effects vary enormously from one class of products to another, so the degree to which federal spending is affect by this depends on what they buying and how much. For example, construction costs have significantly gone up relative to other products in recent years (perhaps due to the large number of wildfires?), so if the federal government is doing a lot of construction, then it’s dollars will not buy as much as they did in the past.

Do these two effects cancel each other out? I don’t have enough data to know, so for now I’m going to have to ignore them.

The major point here is that the numbers other people are so blithely relying on in making their politically-motivated comparisons are highly suspect. Since I’m not making politically motivated comparisons, all I can do is acknowledge the problem: I’m not going to pull an “Emperor’s New Clothes” and pretend the problem doesn’t exist, something that happens all too often when political agendas control research or journalism.

Summary

In conclusion, California is not subsidizing other states, but is in fact receiving a net economic benefit from the federal tax dollars that are being spent in other states. In a curious and perhaps unexpected way the other states are actually subsidizing California – allowing the California economy to keep running at far higher levels than would otherwise be the case given the extraordinarily high cost of living in the most economically active regions of California.

Some people like the idea that California should just leave the USA and become it’s own country. Among other things, they claim that this would be economically beneficial.

This would not work out as these people expect. As with other states, the cities of California tend to have very different political views than the rest of the state (the NY Times has some nice maps that show how people vote during Presidential elections, and these maps really illustrate this point), and if California tried to secede it’s likely most of the non-urban areas would pull a ‘West Virginia’ and refuse to secede, following the example of West Virginia in the US Civil War *.

But even if that wasn’t the case, the considerations presented here show that California would take a significant economic loss if it were to become it’s own country, as they would lose the large net economic benefit they are currently getting from other US states.

Jumping to Conclusions: A Quote Selection

Here are some examples of the kinds of incorrect things various people (I won’t list any names) are saying about this and closely related issues, quotes that show the ways in which people jump to conclusions without ever engaging their brain to think through the issues.

Overall, the US education system does quite poorly at teaching people critical thinking and reading skills – probably a reflection of the fact that we have a poor student-teacher ratio. Everybody learns a little bit differently. Teaching people to use their brains requires a small class size so an instructor will have the time to work with each student individually many times over the course of the school year, in order to fit the learning process to each student.

• It seems all of California’s problems are because of being part of the US. With control of its own borders it can enact immigrant friendly laws. And wont have to subsidize the red states anymore. Its already running a budget surplus but if needed it could also print its own currency and run a deficit.
• Point is California manages to grow enough food to feed itself and export food while also hosting Silicon Valley , Hollywood and Lockheed Martin. The lazy bums aka farmers in IOWA just grow govt subsidized corn. Thats why its flyover country. All the smart folks leave for either coast and only the lazy bums are left behind – bums who would starve without govt subsidies.
• Isn’t red state wealth based on blue states taxation?
• Without a doubt. California is a donor state to the federal Treasury. We always, as taxpayers in the state of California, pay more in taxes than we get back to our state. And so we’re going to fight where we need to to make sure that we get the resources that we provided to the federal Treasury.
• Nine states sent more to the federal government than they received — seven of these were Democrat-voting and had higher per capita GDPs than many of the red states that received the most.
• Who really benefits from government spending? … As it turns out, it is red states that are overwhelmingly the Welfare Queen States. Yes, that’s right. Red States—the ones governed by folks who think government is too big and spending needs to be cut—are a net drain on the economy, taking in more federal spending than they pay out in federal taxes. They talk a good game, but stick Blue States with the bill.
• it is clear that some states receive a far higher return on their federal income-tax contributions than others

* Here’s a little historical background for those who are interested and don’t know much about the 19th century:

West Virginia was not the only region to refuse to secede, but it’s the best known. Delaware, Kentucky, Maryland, and Missouri all had legal slavery but did not secede, though in at least one case it may have been only the presence of the Union Army that prevented succession. Another region that stayed loyal was the Ozark Mountains region in Arkansas, which actually raised five regiments to fight for the Union.