An Unlucky Proposition: A Policy Analysis of Prop 13

Executive Summary

California and its counties have faced continuous budget dysfunction and a major cause of this stems from proposition 13 limiting county’s property tax revenue, forcing the burden to be shifted to the state.  This paper ultimately recommends to remove/reform this policy.  While the new tax legislation from the republican congress may force California to abandon prop 13 by changing what deductions are available, this paper will recommend the pending ballot initiative of split rolling.  This would alter the way commercial properties are assessed for tax purposes.  A strategy that would not affect California’s residential property tax rates.  This is a middle of the road approach to this problem. 

Background

Prior to Proposition 13 California’s budget was growing exponentially.  As noted in the book Tax Revolt: Something for Nothing in California, spending by the California government had increased dramatically from 1973 to 1977.  California’s government expenditure was 8.2% higher than the national average with government jobs becoming 14.7% of all civilian workers by 1978 (Citrin).  In that time span, growth in California government jobs had outpaced the private sector for a number of reasons.   One notable reason was AB 80.  AB 80 was a bill passed in 1966 that standardized the assessment process in order to avoid selective assessment, which had been exploited by corrupt assessors in order to give their friends tax discounts.  The result of AB 80 was that properties began to be assessed at their actual market value resulting in tax increases for many California homeowners.  This then lead to increased revenue for the California public sector, which turned into budgetary growth. 

While this growth was occurring, the case of Serrano vs. Priest also concluded during this time.  Serrano vs. Priest was a class action lawsuit involving John Serrano, who was the parent of several children attending public schools, against Ivy Baker Priest, the California State Treasurer.  The suit contended that the school funding formula bred an inequity that caused a disparity between funding for schools in lower income areas in comparison to high-income areas.  At the time, property taxes were the revenue source for school funding and were kept within the jurisdiction they were collected from.  This ultimately meant that schools located in high property areas benefited from the high property values and therefore received more funding.  Serrano represented parents who saw this system as inherently discriminatory because it continued the cycle of economic inequality.  The courts ultimately ruled in Serrano’s favor forcing the state to equalize the funding between school districts and redistribute property tax income. 

(Howard Jarvis, image credit: Los Angeles Public Library)

With these elements in the background, the stage was set for proposition 13.  Enter Howard Jarvis, a former newspaperman from Utah who moved to California and began working for the Los Angeles Apartment Owners Association.  Jarvis began campaigning for proposition 13 in response to the changes caused by Serrano and AB 80.  Research by William Fischel suggests strongly that the Serrano decision was the direct cause for Prop 13’s rising popularity.  The basis of his supposition is that before Serrano, taxpayers had a direct connection between their taxes going to their local schools.  This is known as Tieabout theory, where two things being directly connected increases ones willingness to act.  Once Serrano was decided, taxpayers no longer saw the direct connection and therefore became less willing to pay taxes.  Fischel further supports this by pointing to the Watson initiative in 1972 that sought to limit property taxes.  This initiative failed by the same margin that Prop 13 passed.  What changed between the times of these two? Serrano.  In contrast to Fischel’s work, Isaac Martin produced a paper that questioned Fishel’s hypothesis. Martin claims that it was not Serrano but rather the foreclosure of elderly people in the face of readjusting property tax rates after AB 80 that rose beyond their fixed income levels.  Martin points to the ad campaign used by Proposition 13 proponents.  In their campaign, if the Serrano decision had been so key, they would have gone to higher value property owners and used the Serrano decision as a rallying cry.  Instead, Martin notes that the advertisements were built around the narrative of elderly losing their homes due to rising taxes.  The narrative then created a false dichotomy between over spending politicians and widows losing their home that was already paid off.  While both papers make strong arguments, they don’t have to be mutually exclusive.  That is to say that Fischel could be right on the how but not the why.  It is possible that Serrano created the framework for the perception of government overreach but the more effective narrative for campaign purposes was to appeal to voters’ empathy for vulnerable elder homeowners. 

A central claim for those in favor of Prop 13 is that it protected older homeowners from ever-growing property taxes due to rising market values. However, before prop 13, local government actually tended to decrease property tax rates as market values increased (Chu & Uhler)

Furthermore, there aren't any publicly reported cases of such foreclosures on homeowners, prior to Prop 13, although more research into that would be welcome.

This uproar around this combination of factors, which were the consequences of standardized assessment, created the perception that taxes were out of control.   Jarvis then lead what he called the Tax Revolt; a movement aimed at fighting taxes, specifically property taxes.  To accomplish this, his group introduced proposition 13, which would limit the ability of the board of equalization from easily editing the formula for property taxation.  It set the taxation to 1% of the property value at the time of purchase with no more than 2% increase per year.  Assessments would only be required at the time of sale, or acquisition value (hjta.org).  This meant that if someone purchased a house in 1980 for $100,000, they would pay $1000 in taxes.  As long as they maintained ownership of the property they would still be paying the same amount today.  Proposition 13 would be a huge boon for rental property in particular.  That is because they only pay a parcel tax. 

While property taxes were limited, rent could continue to rise with market value of the property.  This is a similar situation we see with commercial properties.

 

Passage of Prop 13 created several intended and unintended consequences.  These can be seen as beneficial or detrimental to the community.  On the positive side, the first impact was that it did lower taxes for homeowners and created an incentive to maintain long term home ownership as the home prices often increased faster than the 2% rise allowed by Prop 13.  This meant that if you owned a home for longer, you ultimately paid less and less in taxes as a percentage over time.  One example was noted by Warren Buffet who paid $14,410 on his $500,000 home in Omaha but only pays $2,264 on his $4 million dollar home in California (WSJ, 2003).   This was a major boon to homeowners.  A second positive impact was on new homes developments (take two).  This is because of two reasons.  The first was that it incentivized new housing developments because home ownership became longer term meaning there was less turnover and therefore more houses were needed to meet population demands (Fischel 1989 & Daily Beast).  Second, new home owners would bear more of the property tax burden, which they would be more likely to be able to do as newer generations tend to be more affluent that previous generations.  Lastly, for those who are skeptical of government’s efficacy with tax funds, this proposition would decrease overall tax revenue.  The result would be government would have less money to waste according to their viewpoint.  While there are some positive to proposition 13, there were also several negative externalities created by the policy whether unintentional or otherwise. 

The first negative impact is that Proposition 13 skewed the housing market in various ways.  As mentioned above, housing turnover greatly decreased as a result of the proposition.  While this may have helped current homeowners in 1978, it makes it more difficult for prospective new homeowners in the long term.  Homeowners keeping their houses longer artificially reduced the supply of houses that combined with increased demand drove housing prices up.  This make it more difficult for new owners to afford a house and additionally, meant that new homes were more expensive and therefore had to pay even more in property taxes (take 2).  This in effect created a divide between those who owned and those who wanted to own.  A second major consequence was that the decrease to tax revenue limited the ability of local municipalities to grow their budget and services.  This would not be problematic had government in California remained small.  However, California voters with prop 13 have tasked California’s government to do more with less by asking for more services with each passing year.  The gap between revenue and spending has consistently grown and has been a contributing factor to California’s budget shortfalls and deficit problems.  (McCubbins).  A third negative externality was that Proposition 13 mitigated the equity sought by the courts ruling in Serrano vs. Priest.  By limiting tax revenues this meant that there would be less funds to be distributed amongst school districts making it harder to evenly divide the funds, forcing counties to rely on the state.  Additionally, because homeowners were paying less in taxes, they could redirect those funds directly into the schools their children attended and therefore recreated the inequality that existed prior to Serrano.  The last major negative outcome was that Proposition 13 failed to deliver on the promise made by Howard Jarvis that renters would see lowered rents as landlords paid less in property taxes, despite Jarvis’s best effort (Christian Science Monitor).  Instead of seeing a trickle down effect, landlords pocketed the increased savings and kept rents inline with increased property values.  With the increased barrier to home ownership, more consumers were forced to rent which further increased rental prices (Daily Beast). 

 Fallout from Prop 13

After the passage of Proposition 13, there were many fiscal ramifications.  The first was that Prop 13 was supposed to limit tax revenue and therefore limit government spending.  While it was effective at the former, it failed at the later.  Research by McCubbins illustrates two major reasons for this.  First is that Proposition 13 had to be implemented by the same group it sought to limit, politicians.  This created an agency problem where they were not interested in punishing themselves for over spending.  The second reason was that while voters were happy to limit tax revenue, they did not want to see a reduction in services.  Rather, they wanted the opposite.  These two factors contributed to creating a massive and perennial budget dysfunction.  

 Figure one shows the impact of Prop 13 on property tax collection in California.  It is not unexpected that property taxes would dramatically fall due to the passage of a bill designed to limit them.  However, property taxes also make up a large portion of total tax revenue. 

As shown in Figure two, total tax revenue took a large cut due to the loss of property tax revenue.  So it is clear that while Prop 13 was effective in limiting total revenue, it still had no real impact on expenditures as evidenced by California’s continuously growing budget. 

In response to growing budgetary problems over time the state government began to look for alternatives to alleviate the burden caused by Prop 13.  Provisions within Prop 13 created the environment for the state government to establish Education Revenue Augmentation Funds (ERAFs).  ERAFs shifted the budgetary burden of paying for K-14 from state government to county, city and special districts.  The outcome of this policy had the effect of nullifying the Serrano decision, as the state was no longer responsible for paying for education and therefore no longer had to ensure an equal distribution of funding.  Yet again, due to the reduction in tax revenue from Prop 13, local governments are forced to do more with less.

Further more, the passage of Prop 218 was an extension of Prop 13’s aims to limit government’s ability to raise revenue.  Prop 218 made it mandatory for government to have voter approval on any revenue raising measure.   Effectively, if Prop 13 was the stabbing, 218 were the twisting of the dagger.  Similar to Prop 13, 218 exacerbates the problem of limiting revenue without limiting expenditures. 

The other major result of proposition 13 was a realignment of the residential dynamic in California by favoring long-term homeowners over newer ones, it created an incentive for perspective homeowners to become renters amid escalating rents. Even the OC Register noted that California has the second lowest homeownership in the country. The article also points out that the proposition's limits on taxation until a property is sold causes local governments to raise impact fees, which discourages homebuilding and creates a perpetuates a growing demand for rental property ultimately benefiting owners (Collins). It is perfectly reasonable to see why how Howard Jarvis, who worked for the Los Angeles Apartment Owners Association, would be compelled to write such a proposition into law, even if he did believe in it would benefit older homeowners. Coleman's research also shows that commercial and rental property owners reaped 40% of the financial benefit (Californiacityfinance.com). While it was effective at benefiting the wealthy and long-term property owners, it remains an unnecessary, ineffective, and ultimately outdated constitutional amendment that needs to be amended. 

Final Recommendation

         Public opinion of prop 13 remains relatively high despite Californian’s apparent willingness to tax themselves with targeted measures that raise revenue for key areas. Those who engage in litigation to defend prop 13 hail prop 13’s popularity. However, just because local government in California was able to adapt to the limitations of this, it seems counter intuitive to implement policy that caters to those who don’t believe in taxation in principal. Going a step further, repeal of prop 13 may be necessary due to the impact of the Tax Cuts and Jobs Act, which repeals the state and local deductions one in three Californians use, according to the LA Times.  By removing the SALT deductions for income taxes but allowing for sizable property tax, this sets the table for prop 13 to be phased out if even the most conservative Californians still support Prop 13 in principle, they will not want to give up the deduction.  However, a full repeal seems highly unlikely due to the entrenched Prop 13 support. 

         This leads to the next best solution and final recommendation of split rolling.  Split rolling is when the property value assessment rules are changed for commercial compared to residential properties.  This results in commercial properties absorbing a more proportional tax burden.  Since the passage of Prop 13, according to Chu and Uhler, the tax burden has shifted from commercial to residential property. Now, this is not out of step with other places in the U.S. entirely, but it is more pronounced in California.  While some companies may threaten to leave California in protest of higher taxes.  This threat though is often rhetorical, as businesses know that California is one of the largest economies in the world and they would be losing out on opportunity by leaving.  This leads to a low likelihood of businesses carrying out the threat.

         Ultimately, this paper’s final analysis has proven that Prop 13 is ineffective in its stated goals and has yielded negative externalities.  For the reasons of political viability and reducing externalities, split rolling should be adopted as policy.  Even though split rolling may not be fully effective in restoring government’s ability raise revenue given the available loopholes, it does represent a step towards eventual full repeal that is currently politically viable. 

Works Cited

- Collins, Jeff "Amending Prop 13 by raising property taxes could help solve housing

affordability crisis, expert says." The OC Register, The OC Register, 4 Apr. 2017, www.ocregister.com/2017/03/29/amending-prop-13-by-raising-property-taxes-could-help-solve-housing-affordability-crisis-expert-says/

- “Common Claims About Proposition 13.” Common Claims About Proposition 13, LAO

Report, 19 Sept. 2016, lao.ca.gov/Publications/Report/3497#Does_Proposition.A013_Increase_Homeownership.3F.

- Cox, Joel Kotkin Wendell. “Landless Americans Are the New Serf Class.” The Daily Beast,

The Daily Beast Company, 1 Apr. 2018, www.thedailybeast.com/landless-americans-are-the-new-serf-class-10.

- Dayen, David. “The GOP Tax Plan Could Be the Death of Prop. 13.” Los Angeles Times,

Los Angeles Times, 9 Nov. 2017, www.latimes.com/opinion/op-ed/la-oe-dayen-gop-tax-prop-13-20171109-story.html.

- “Did Prop 13 Cause LA’s Housing Crisis?” Take Two, KPCC, 29 Aug. 2017,

https://www.scpr.org/programs/take-two/2017/08/29/58859/was-the-housing-crisis-caused-by-prop-13/

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42, No 4 (1989), pp. 465-73.
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The California Journal of Politics & Policy, Vol. 2, No. 2 (2010)

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HUN?" The Christian Science Monitor, The Christian Science Monitor, 24 Jan. 1980, https://www.csmonitor.com/1980/0124/012460.html

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