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How much property tax did you and your clients pay last year?

Roughly 70% of California homeowners pay an effective tax rate of less than 1%, as of the 2015 tax year. 40% of California homeowners pay less than 0.5%, according to Trulia.

The piece of legislation behind California homeowners’ low property tax rates is Proposition 13 (Prop 13).

Prop 13, also known as the People’s Initiative to Limit Property Taxation, was voted into California’s Constitution in 1978. It caps the amount property taxes may increase each year.

Prop 13 limits property taxes to 1% of the property’s assessed value. The property’s assessed value equals the property’s base value (the property’s value at the time of purchase), plus an inflation factor determined by California’s consumer price index (CPI).

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Prop 13, explained

Places of the state with the highest home values have the lowest effective property tax rates. The lowest average property tax rate in 2015 — 0.42% — is in Palo Alto, where the median home value was over $2.2 million that same year, according to Trulia.

On the other hand, the highest effective tax rates are found in areas of the state with low home values. Beaumont has the highest average property tax rate — 1.37% — and here the median home value is just $260,000.

Average property tax rates are consistent with an area’s:

  • home value growth;
  • long-term resident population; and
  • new housing construction.

Therefore, a place with rapid home price growth, a large number of long-term residents and little new home construction — like Palo Alto — will have a lower effective tax rate.

California lost over $12.5 billion in 2015 to reduced property taxes. Is this a problem? It depends on who you ask.

The pitfalls of Prop 13

For wealthy homeowners who have lived in their homes for many years, Prop 13 is terrific. In fact, the very reason for Prop 13’s creation was to protect elderly homeowners living on fixed incomes from losing their homes due to escalating property values/taxes.

Over the past few decades, Prop 13 has accomplished this — and more — at the expense of new homeowners and renters.

Some of the negative effects spread by Prop 13 include:

  • reduced sales volume, as current homeowners are incentivized to stay in their current home to keep their low tax rate;
  • new homebuyers — typically young families with less wealth than their more established neighbors — pay higher tax rates than their neighbors, who benefit from the same government services their property taxes support;
  • local governments need to make up for the lost revenue from property taxes by requiring:
    • higher income tax rates;
    • higher sales taxes; and
    • more business taxes, according to the Tax Foundation;
  • major loopholes allow for investors and businesses to take advantage of reduced property taxes — not the law’s intention; and
  • all of this lost tax revenue leads to lower quality government services.

The thing is, the law could be changed to protect older homeowners from property tax increases, while eliminating the negative effects mentioned above. For instance, the law could cover only those in a certain income tax bracket, and/or those over a certain age.

But it’s extremely unlikely the law will ever change. Once people get used to a tax break, they won’t vote to eliminate it. Further, any changes to California tax law which result in an increase in taxes (of any kind) are required to be passed by a two-thirds majority in both legislative houses. [Calif. Constitution Article XIII Sec. 3(a)]

Finally, first tuesday is in no doubt of its readership’s feelings on the matter. A recent poll showed 82% of our readers were in favor of Prop 13.

We aren’t proposing California eliminate Prop 13. But reforming it to eliminate corporate loopholes is the least California can do to regain some of the lost revenue that harms local infrastructure. For example, consider the 2013 revelations that Michael Dell was able to avoid paying over $1 million in annual property taxes on a hotel purchase by using Prop 13’s corporate loophole.

Ought California homeowners and renters continue to subsidize large corporations? Tell us what you think in the comments.