The ‘Welcome Stranger’ Provision of Prop. 13 Clearly Is Unwelcome

A U.S. Supreme Court decision in a West Virginia tax case has reignited controversy about California’s Proposition 13. The court ruled that a property-tax assessment system, strikingly similar to one provision of Proposition 13, was unconstitutional. While the court carefully avoided ruling on the constitutionality of Proposition 13, the decision casts doubt on the California property-tax assessment system.

The court condemned a tax-assessment method that discriminates against newcomers and in favor of long-term landowners. Known as the “welcome stranger” method, the valuation approach reassesses property only when it changes hands. If property is retained by the same owner, the tax assessment does not increase.

For supporters of Proposition 13, this case raised difficult issues. Two major organizations that supported Proposition 13 filed friend-of-the-court briefs on different sides of the West Virginia case. The Howard Jarvis organization urged the court to uphold the “welcome stranger” practice in West Virginia, while the National Taxpayers Union concluded that the tax disparities that it created violated the equal-protection clause of the U.S. Constitution.

The problems of the “welcome stranger” method outweigh its benefits. As land values appreciate over time, the discrepancy between new and existing owners becomes more pronounced. In West Virginia, for example, some newly reassessed tracts were valued, for tax purposes, at8 to 35 times higher than neighboring properties. In California the estimated 1988 effective tax rate for recently sold residential properties is three times that of homes that have not been sold since Proposition 13’s enactment in 1978. In several areas in California the discrepancies approach the levels that existed in West Virginia.

Under the Proposition 13 system, identical homes are taxed at different levels just because of the date on which they were purchased. For example, consider two homes that were each worth $100,000 in 1975. One home has frequent turnovers while the other remains in the same ownership. Assuming that home prices increase 7% per year, the transferred house would have a taxable value of more than $750,000 in the year 2005. The assessed value of the other house, increasing at only 2% a year, would be listed on the assessment rolls at about $180,000.

As the discrepancy becomes more pronounced, it may discourage people from buying and selling real estate. A family moving from a home in which its members have resided for a number of years would be faced with a substantially higher taxburden in a new home, even if they purchase a house with exactly the same market value.

In determining whether inequalities in taxation are constitutional, courts will examine whether there is a rational reason for discriminating between taxpayers. For example, there is no question that state and local governments can legally charge newcomers or developers special fees or taxes if new residents generate additional expenses. The inequality in West Virginia arose because one local tax assessor simply failed to reassess property. This administrative dereliction was clearly not a sufficient reason for inequality. On the other hand, California has adopted the same policy deliberately. California’s system is grounded on the idea that taxes should be based on the original cost of property and that unrealized paper gains should not be taxed.

The major question arising in the wake of the Supreme Court’s decision is whether this justification is sufficient to save the Proposition 13 approach.

Discriminatory taxation interferes with the democratic process and encourages excessive government spending. It separates benefits from burdens so that some people can enjoy the benefits while others, the newcomers, bear heavier tax burdens. Those who will purchase homes in the future do not yet participate in local taxing decisions. The soon-to-be resident is excluded from the political process and thus cannot defend his interests.

How should Californians respond to this constitutional issue? The easy answer, to do nothing and let the court decide, poses substantial risks. On the one hand, the court could rule all of Proposition 13 invalid and open a Pandora’s box to a new round of uncontrolled property-tax increases. Or it might sever the “welcome stranger” provision from Proposition 13, causing large tax-base losses as thousands of taxpayers sought rollbacks in their assessments.

California taxpayers should give new urgency to solving the problems causedby the increasing disparity in property taxes paid by owners of similar properties. Until a permanent solution is found, eliminating reassessments at the time of sale for properties purchased after 1985 is one possibility. It would prevent the disparities from becoming worse, eventually eliminate the vast majority of the disparities and continue the essential goal of limiting the property-tax burden.