“Reassessing” California’s property tax

A failing policy

Are California’s communities getting the most they can out of their property taxes? A recent article in The Economist claims real estate is the best and most under-used source of potential tax revenue.

The average wealthy nation raises less than 5% of its total federal and local tax revenue from property taxes. Emerging middle-income economies collect even less — just 2% of total tax revenue comes from property taxes.

17% of all government revenue collected in the U.S. comes from property tax. Although near the top of the property-taxing ranks, this figure is still de minimis when one considers how much of America’s wealth is stored in real estate. Of course, local governments in the U.S. take nearly 70% of total property tax revenue.

Why not tax property more? Despite the volatility of the real estate market, property taxes have proved an incredibly stable source of revenue for local governments. During the financial crisis and Great Recession, U.S. state and local governments saw lesser declines in property taxes than in income and sales tax, which are immediately affected by job loss and a soft economy.

An across-the-board increase in property tax based on present value may also ward off real estate market bubbles. Market rates for property tax bases will render real estate speculation too expensive a game to play.

While there are many reasonable arguments for increasing property taxes, the greatest barrier to reform is political will. Property tax is one of the most visible forms of taxation, especially since homeowners pay them in annual lump sums. With so many real estate related industries motivated to keep home buying attractive, even the most firebrand politician wouldn’t touch such a proposal with a 10-foot pole.

Related article:

“Levying the land” from The Economist

Welcome stranger!

Proposition 13 is the holiest of all of California’s sacred cows. To propose reforming Prop 13 would be political suicide . Well, since we’re not politicians, allow us to once again make the unpopular claim: Prop 13 was bad for California in the 1970s, and it’s still bad for California now.

Prop 13 is a regressive and unequal tax regime. It allows the rich to take and keep a larger percentage of total incomes in California. In 1992, the U.S. Supreme Court upheld the constitutionality of Prop 13, finding that the tax conformed to the doctrine of equal taxation. We strongly believe the court erred in its decision, and history suggests the same. [Nordlinger v. Hahn (1992) 505 US 1]

There is a reason why Prop 13 has been deemed the “Welcome Stranger” law. New members to a community, who are also typically less wealthy than established community members, essentially subsidize community services by paying a disproportionately higher property tax than those sheltered by Prop 13.

Related articles:

Brokerage reminder: Proposition 13 transactions excluded from reassessment

Total assessed values, and taxes, drop in many counties

Economic consequences

Consider the vicious cycle this creates in the California real estate market. Rather than encouraging mobility, home sales and the best use of property, Prop 13 rewards those who stay put.  And the longer a homeowner owns his or her home, the more encouraged they are to remain there.

This says nothing of the Prop 13’s greater economic impact. It overburdens new homeowners, who are usually young families. This demographic already shoulders the bulk of the tax responsibility, and are most likely to contribute to our consumer economy. But backwards taxation under Prop 13 has them busy funding public education (a future payoff for the community) and paying for the street sweeper.

One of the most popular claims of Prop 13 proponents is that it encourages community stability and longevity. Unfortunately, our economy no longer favors workers who have set down deep roots. Rather, those with the greatest agility and adaptability are rewarded with the most high-paying jobs.

Our present property tax system discourages home sales and keeps homeowners fastened to their property for fear of upgrading their home and upgrading their tax bill. Thus a vast contingent of the labor force is rendered unable to compete in the homeownership game and all the more likely to rent!

Recall that the state and federal governments are the employer of last resort. If revenues fall too low, the state cannot hire workers to provide necessary social services that keep our standard of living in California so high. This is a type of safety net in recessionary times.  Creating these jobs sets off a virtuous cycle of employment, consumer spending and most likely, eventual homeownership. Prop 13 keeps this virtuous cycle from getting off the ground, pun intended.

Neighbors and equals

Prop 13 was passed during a moment in our economic history of soaring inflation and an out of control Federal Reserve — now 35 years past. One demographic in particular, homeowners over the age of 55 (who also happen to be the demographic that votes!), was getting hit hard by continually rising property values and property tax reassessments.

Rather than waging war against the boom/bust cycle in the real estate market, homeowners (apartment owners mostly) took it to the tax code. Thus, the demographic divide of inequality has continued to grow ever deeper since the ‘70s.

There are a multitude of legitimate justifications for differences in taxation, including:

• ability to pay;
• the type of property;
• the use of property; and
• whether the taxpayer is an individual or a business entity producing employment.

However it is decidedly arbitrary to determine taxation based on the date a person becomes a property owner. Prop 13 was tailor made to suit a particular demographic, subsidizing their standard of living at the cost of future real estate sales — a result of paying less annually for local services.

It’s quite simple, as property values increase in any given community, the cost to maintain the standard of living increases in turn. Under Prop 13, homeowners are expecting to maintain their standard of living at a continuously cheaper price — paying less for the same things from year to year — as their assets grow and their tax bill remains the same, but for a 2% increase.

As long as a property owner is equally enjoying the benefits of a community, they ought to be paying an equal share. Fair is fair. Right?

The only way to do this is to match property taxes to current fair market value (FMV) for all homeowners in California.