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.
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Kotkin Wendell. “Landless Americans Are the New Serf Class.” The Daily Beast,
- Dayen, David. “The GOP Tax Plan
Could Be the Death of Prop. 13.” Los Angeles Times,
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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),
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