Proposition 13, the constitutional amendment enacted in 1978, transfers wealth from young to old, from poor and middle-class to rich, from black and Latino to white, and from renter to owner. As the "third rail" of California politics, reforming the law will be challenging. But there are realistic, workable solutions to the problems posed by Prop 13, and reform has the potential to provide incredible benefits for the majority of California's residents.
If there's one reason I don't stay in California long-term it will be because of a law that many state residents have never even heard of: Proposition 13. It's something only a planner could think, I know. But despite its lack of notoriety outside urban planning circles, Prop 13 is among the most regressive, destructive tax structures in the nation—and a great reason to choose somewhere else to live if you don't already own property here.
BACKGROUND
Prop 13, also known as "People's Initiative to Limit Property Taxation," was a ballot initiative approved by California voters in 1978, and was one of the earliest manifestations of the tax revolt that swept through the nation. It included several key provisions, including a cap on property tax rates, limits on the frequency and scope of property value reassessments, and the two-thirds requirement for raising taxes that Californians are all familiar with. It's viewed by many as the "third rail" of California politics, much like Social Security or Medicare at the federal level. Unlike these federal programs, however, it has a very limited moral or economic rationale.
For our purposes, the most important provision in the law is the one that limits annual increases in taxable property value to two percent each year. Since actual property values have increased by an average of much more than two percent per year, this effectively means that the longer a homeowner or landlord retains majority ownership of their property, the greater the difference between the actual value of their home and the value that home is assessed at. For someone who bought a home in LA in 1980, that's very good news: over the past 35 years home values in the city have increased by approximately 450 percent, while the taxable value of their home—assuming they held onto it for that entire period—would have increased just 100 percent. A home bought for $100,000 in 1980 could now sell for $550,000 (and possibly much more), but the owner's property taxes would be the same as for someone who bought a $200,000 home today—if such a thing still existed in California.
The upside to Prop 13, and one of the primary reasons it was voted into law nearly 40 years ago, is that it protects residents from displacement when their home increases in value faster than their income. Consider an elderly homeowner in San Francisco or Santa Monica that purchased their house before their neighborhood gentrified: if their home had increased in value from $100,000 to $800,000 over the past few decades (an entirely plausible story in neighborhoods throughout coastal California), they might genuinely struggle to afford $8,000+ per year in property taxes on a fixed income—Proposition 13 protects them from losing their home and their community to this cold financial calculus.
In order to protect this narrow set of vulnerable Californians from displacement—a protection we generally don't extend to renters, who tend to be much less financially stable, by the way—Prop 13 restructured the housing market in a way that dramatically impacts every person in the state. There are numerous drawbacks to this restructuring; below are a few of the most serious:
- The greatest tax breaks accrue to those least in need of housing assistance. Generally speaking, the longer you've lived in your home and the faster your neighborhood has appreciated in value, the bigger your tax break from Prop 13. In LA and probably elsewhere, most of the increases in home value are happening in whiter, more affluent neighborhoods. There are real people that rely on Prop 13 to protect them, but much like with the mortgage interest tax deduction, the tax breaks tend to accrue to households that are at no risk of displacement or financial hardship. Further, while rent control in Los Angeles (for example) only applies to multifamily units built before 1979—leaving all other renters out in the cold—all property owners are protected from property tax increases, regardless of when their buildings were built or whether the owner even lives in them.
It's believed that the growth in wealth inequality across the world may be driven by increasing housing costs, and Prop 13's transfer of wealth to older, wealthier property owners exacerbates this. Image source: Matthew Rognlie, Brookings Institute.
Less tax revenue from property taxes means more must be raised elsewhere. When we arbitrarily depress property tax revenues we're forced to make up the difference elsewhere, often with less desirable and/or more regressive taxes. Today income taxes make up the largest share of state revenues (about $69 billion in 2014, compared to roughly $50-55 billion in property tax revenues), and while income taxes in California are fairly progressive, it's best to minimize taxes on activities we want to encourage, like work. Worse are sales taxes, which tend to suck up a larger share of poorer residents' incomes than they do for those that earn more. The state collects over $20 billion in sales taxes each year. If we boosted property tax revenue, we could cut these other taxes.
Local governments have less control over their budgets, and are more dependent on state support. Property taxes are collected and spent locally, by cities, counties, and school districts—the state doesn't get any of it. Because of Prop 13, though, local jurisdictions can't collect enough to fund their school districts. The state has to step in to provide support, leaving local governments more fully at the mercy of the state and its funding decisions. Relatedly, this encourages poor planning decisions that favor sales tax-producing uses such as big box retail outlets and discourages residential uses that rely solely on property tax revenues to support government services.
- The greatest tax burden falls on young and first-time home buyers. The longer you've owned your home, the lower your effective tax rate. As a result, first-time homebuyers will always bear the highest effective property tax, even though they're earning less than their more established neighbors. It's entirely plausible to have a couple in their 30s earning $80k and paying $5,000 a year in property taxes, living next door to a couple in their 50s earning $150k and paying $3,000 a year in property taxes on essentially the same home. There's something fundamentally unfair about this.
It discourages people from moving, even when it's in their best interest to do so. Staying in your home longer means you pay a lower effective tax rate, and this provides a strong disincentive for moving to a new home. If you've owned a home in Santa Monica for 25 years and get a new job that transfers you to Long Beach, 35 miles across heavily congested LA County roadways, it's probably in your best interest to move nearer to your new place of employment—or it would be, if not for Prop 13. If that Santa Monica home was purchased for $400,000 and it's worth $1 million today, its taxable value is just $650,000. To keep the same tax bill you'll need to find a new, considerably less desirable home at that new price point. People who move take a serious financial hit. Maybe it's just better to stay where you're at and deal with the commute (to the detriment of the region's traffic and your sanity), or maybe you convince yourself that the job's not so great after all. The same goes for seniors looking to downsize their homes or move closer to family, and just about anyone else who's been in their home for more than a few years. These differences in tax treatment mean that homes are worth more to the current owner than to any potential buyer, leaving fewer homes on the market and forcing younger residents to rent later into their lives.
- It fails to recognize that, even without Prop 13's tax limitations, homeowners win big when their homes increase in value. With a one-percent statutory limit on property tax rates, every time your home value increases by $100,000 you owe an extra $1,000 to the government each year. That is an outstandingly great deal, and homeowners whose homes rapidly appreciate are still coming out way ahead—why are we protecting people against increases in tax payments that literally amount to just one percent of their increase in wealth, especially when household wealth for the median black and Latino household is less than $10,000? An outright abolition of Prop 13 would put some "house-rich and cash-poor" residents at risk, but their problems could easily be solved by a payment deferral system that allows property owners to delay some payments until their home is sold.
Source: Survey of Income and Program Participation (SIPP), 2008 Panel Wave 10, 2011.
In short, Proposition 13 represents a massive transfer of wealth away from the young, poor, and people of color to the old, prosperous, and white; skews power away from local governments toward the state; and influences decision-making in destructive ways at every level, from personal choices about where to live, to political/planning decisions about how our cities should grow and evolve.
In Part 2, I'll look at how Prop 13 could be changed to improve the fairness of our state's tax system while still protecting the small number of people that are legitimately threatened by increasing property taxes. The reform discussed, if adopted, would help protect the much larger number of people that are threatened by high rents and high property values in general, and needn't increase California's total tax burden.
Click here to read Part 2: How to Fix California's Broken Property Tax System