How Notes Could Help Make Changes to Prop. 13 Fairer

Don’t look now, but a major California sacred cow may be headed for the slaughterhouse.

The U.S. Supreme Court will hear arguments today in a case challenging the constitutionality of Proposition 13. Specifically, it will decide whether to overturn the provision that taxes pre-1978 property owners much less than people who bought later.

Nordlinger vs. Hahn, the case at hand, has a lot of people frantic. If Proposition 13 is struck down, it could throw California local government finances into disarray, cut property values and spark a huge political struggle over what to do next. Business fears that any shifting of the tax burden will be in its direction.

Drowned by the deafening sound of nail-biting are a couple of important concepts: Only one part of Proposition 13 is at stake, and that part is probably going to change sooner or later anyway. Other court rulings, an increasingly desperate revenue squeeze and declining numbers of pre-1978 homeowners make change inevitable. The only question is how.

Fortunately, there’s a way to eliminate the unfairest part of California’s famous tax-cutting law--the part that Nordlinger challenges--without “taxing people out of their homes” or sacrificing the funding California needs to invest in its future. It’s also just the thing should the Supreme Court find in favor of Nordlinger.

(Adopted in 1978, Proposition 13 limits California property taxes to 1% of purchase price, with no change until sale save for a 2% annual increase for inflation. But for those who bought before Proposition 13, property taxes were rolled back to 1975 levels.)

If the Supreme Court does overturn the relevant provision of Proposition 13, California would have a problem to solve. Pre-1978 business properties, which never should have been included in the rollback, probably would have to be reassessed at something resembling market value, perhaps with a phase-in period to ease the burden.

The question of single-family homes is tougher, but this political dynamite can be defused with a little financial creativity. All we have to do is levy the standard 1% California property tax on approximate market values across the board--except nobody has to pay any increase until he sells his home.

This is no mere transfer tax. Instead, it’s an annually occurring but indefinitely deferred property tax obligation, safely secured by residential real estate and collectible from the seller when the home changes hands. Unfortunately, that can take years; meanwhile it doesn’t bring in money for roads, schools, etc.

It can if we liquidate it, though, and that’s the key. Government need only pack up the deferred tax obligations of millions of California homeowners and take them to market. Sell them to the highest bidder, and suddenly we’re flush.

The securities markets should have no problem with this. California itself routinely issues short-term Tax Revenue Anticipation Notes to collect now on tax money the market is sure will come in later.

The same can be done for property taxes. All it would take is a little fancy actuarial footwork to estimate when people would be likely to sell their homes. A sale, remember, would redeem an individual obligation.

By bundling these securities and maybe dividing them into short-term and long-term groupings, or tranches, as is done with other bonds, a lot of the uncertainty could be ironed out. Money from the collective liquidation of millions of individual tax obligations could be used to service and eventually retire the debt in an orderly fashion.

A homeowner, meanwhile, would continue to enjoy fixed property taxes. Year after year, he or she would keep paying the same old 1% tax on the purchase price. But somewhere in a computer in Sacramento, that house would be tagged with a new market value annually--and tagged as well with a deferred tax obligation equal to 1% of the difference between that and the purchase price, plus some modest rate of interest.

(We might let frugal property owners pay the obligation annually; it is deductible from their income taxes, after all.)

When the house is sold, the tax collector is first in line, but the levy would come out of the likely appreciation, which wouldn’t hurt as much. Home prices might be dampened a little, but that’s supposedly what everybody wants.

Why bother with all this? Because Proposition 13 can’t stand unchanged. Oh, it may survive Stephanie Nordlinger, the Baldwin Hills attorney who is suing Los Angeles County Tax Assessor Kenneth Hahn because her property taxes are unfair.

But hers isn’t the only challenge to Proposition 13. Earlier this month, a Superior Court judge in San Diego ruled that the state’s formula for distributing property tax money unfairly penalized counties with low property taxes before Proposition 13. That ruling will probably take two or three years to work its way through the appeals process, but if it stands, it will have a wrenching effect. Los Angeles County, for example, could lose up to $400 million a year in property tax revenue.

In December, the state Supreme Court rejected a San Diego County ballot measure that levied a half-cent sales tax to build courts and jails. By holding that Proposition 13 required a two-thirds vote in that case, the court threw into question a whole array of special taxing programs all across the state.

Aside from the courts, California’s state and local governments need money badly. The counties are desperate. And California is way behind when it comes to its investment in infrastructure, which is vital for a growing economy.

The real problem is political: Making any change in Proposition 13 will be enormously difficult. Maybe the Supreme Court, later this year, will suddenly make it easy.