What Happens Next if Prop. 13 Is Overturned? : Taxes: Property owners who bought before 1978 fear financial calamity if measure is found unconstitutional.
Along North Clinton Street in Orange, the U.S. Supreme Court could turn the American dream into a financial nightmare.
On this block of modest homes, Ellis and Norma Judy have owned a four-bedroom house for 30 years. Social Security and Judy’s earnings as a semi-retired painting contractor provide a modest living. Their bills are few, the biggest of which is for property tax--$432.08 a year.
But if the U.S. Supreme Court throws out the guts of Proposition 13 in the weeks ahead, the Judys’ property tax could eventually go up three to five times--although the state Legislature hopes to cushion the potential blow with a two-year postponement of any reassessments.
“It would be a very large hardship,” said Norma L. Judy. “We might have to sell our home and move out of state. If not, we’d just barely exist. At our age we need our home. I have to trust in the Lord that things will just work out.”
In Orange County, roughly 30% of about 713,000 parcels of taxable real estate is assessed and taxed at pre-1978 market values, a large proportion of which belongs to businesses or people like the Judys, who pay relatively low property taxes courtesy of Prop. 13.
Should the nation’s highest court declare the controversial ballot measure unconstitutional, the consequences might be enormous for a state and local economy that has been reeling from the longest recession since the Great Depression.
Tax experts and academics speculate in worst-case scenarios that more homes and business property might be thrown on the still sluggish real estate market as rising property taxes become unaffordable for many. Those not forced to sell will place an additional drag on the economy because they will have less money to spend on goods and services.
The business community, already disenchanted with the state’s economic climate, would be affected as the owners of factories, warehouses, offices and stores try to pass on higher property taxes to increasingly cost-conscious customers in the form of higher prices and rents. Making matters worse, more businesses might leave the state, taking increasingly scarce jobs with them.
Despite the two-year reassessment moratorium passed in anticipation of possible Supreme Court action, long-term solutions to the tax situation might take longer than the grace period. The state’s political leadership, the bureaucracy and voters could be tied up for years trying to find consensus on a host of tax alternatives to maintain government revenue and prevent owners from losing their property.
More complications could show up in court, where county assessors, property owners and business people might challenge the moratorium or new tax proposals that result from the death of Prop. 13.
Although much of this is theory and conjecture, economists and tax experts say one thing is clear: A Supreme Court decision against Prop. 13 would throw the state into a lengthy period of uncertainty during a time of economic hardship.
“Would it be wise to subject California businesses and homeowners to an increased burden of this magnitude in the present weakened economic climate of the state?” asked Albin C. Koch, a prominent tax attorney and member of the State Bar Assn.’s taxation committee. “Many observers think that it could not come at a worse time.”
The matter before the Supreme Court is the brainchild of the late Howard Jarvis. Amid public outrage over rapidly rising property taxes in the mid-1970s, he led a revolt that established a method of taxing real estate unique among the states.
His ballot measure, which was overwhelmingly approved by California’s voters in 1978, decreed that property values would no longer be adjusted every year to reflect current market conditions, and that a tax-rate cap of 1% would be imposed. Those who bought real estate before 1978 would pay taxes based on the 1975 assessed value, while taxes for those who bought after 1978 would be based on the sale or acquisition price.
For all property owners, old and new, the assessed value can be adjusted upward by 2% a year to account for inflation. Because housing prices have soared by 25% or more in some years, some assessments have fallen far behind actual market prices over time. The result has been vast disparities in the property taxes people pay.
Real estate records show that in Orange County, owners of long-held ocean front property in tony Newport Beach sometimes have lower tax bills than people who recently bought $300,000 homes in landlocked Santa Ana or Mission Viejo. On Clinton Street in Orange, property taxes range from $417 a year to more than $2,000 a year for virtually the same type of home built in the early 1960s.
Perhaps nowhere are the differences better illustrated than in the 2400 block of Narbonne Street in Costa Mesa. There, property taxes vary widely on three near-identical condominiums that are next to each other and worth roughly the same amount at today’s prices.
One bought in 1977 has a tax bill of $727.22 a year. The condo next door, which was bought in 1983, has a tax bill of $1,368.20. Two doors away, the owner of a condominium bought in 1989 pays $2,011.16.
Overall, there are about 713,000 taxable real estate parcels in the county with a total value of at least $154 billion, according to the assessor’s office. Of the total, an estimated 30% have been assessed at pre-1978 market values for a total of about $24 billion; 30% are gauged at 1979-86 market values, or $50 billion; while another 40% are assessed at 1987-91 market values, representing about $80 billion.
From the statistics it is clear that taxpayers who bought property in the latter years bear a disproportionate share of the tax burden. Those vast differences are at the heart of the case the Supreme Court must decide.
The lawsuit which found its way to the nation’s highest court was brought by Stephanie Nordlinger, who sued Los Angeles County Assessor Kenneth P. Hahn in 1988 after buying a house for $170,000 in the Baldwin Hills area of southwest Los Angeles.
Under Proposition 13, her initial property tax assessment was about 1% of the sale price, or roughly $1,700. Her neighbors who bought similar homes before the ballot measure passed pay an average of $376 per year, less than a quarter of her property tax.
Carlyle W. Hall Jr., Nordlinger’s attorney, basically contends that Prop. 13 violates the equal protection clause of the U.S. Constitution by forcing new home owners to pay sharply higher taxes than longtime neighbors with similar homes. Hall argues that the 14th Amendment means that all property must be treated the same.
Attorneys for the Los Angeles County assessor say that basing property taxes on acquisition or sale price treats all property owners alike and permits them to predict in advance what their taxes will be based on actual rather than paper gains. They also claim that Prop. 13 protects homeowners from the threat of rapidly increasing property taxes that might force them out of their homes.
Oral arguments in the Nordlinger suit were held in February. A decision is expected by July.
Shortly after the case reached the U.S. Supreme Court last year, the state Legislature launched studies to look into alternative taxing methods and assess the potential impacts if Prop. 13 is declared unconstitutional.
Assuming the worst for property owners, county assessors would undertake the massive and difficult task of reappraising all taxable real estate at current market values. Because of the enormous appreciation of real estate in California since 1978, the state would gain a windfall of $12 billion to $15 billion. This would increase the total property tax levy to upward of $34 billion if tax rates remained unchanged--a scenario that some outraged property owners would definitely seek to alter.
But if the 1% tax rate did remain unchanged, tax bills for some people would drop while those for people who bought property before 1978 and perhaps a few years later would rise dramatically.
“It’s hard to say what will happen,” said Richard Johnson, a supervising property appraiser for the State Board of Equalization. “If everything just simply went to current market value, a lot of people would lose their homes or have their discretionary spending cut dramatically.”
But some doubt that the consequences would be that drastic because the Legislature would intervene. Already, the Statehouse has passed a bill calling for a two-year moratorium to give the leadership time to develop an alternative property tax if Prop. 13 is thrown out.
“I can’t imagine many homeowners losing their property,” said Assemblyman Johan Klehs (D-San Leandro), who sponsored the moratorium bill. “They shouldn’t worry about it. A substantial intent of the legislation is to protect property owners while a fair and stable system is set up.”
One plan under consideration by the Legislature calls for all property to be reassessed at current market value except for homes whose owners would elect to phase in their property tax increases over time. This would be coupled with a revenue limit on the state.
Another proposal calls for all property to be reassessed at current market value, but the homeowner’s exemption would be increased from the current $7,000 to $50,000 and indexed for inflation. The tax rate of 1% would be lowered to a level that would generate the same amount of revenue as in the prior year, but adjusted for inflation.
Under a third alternative, property would be reassessed at current market value, but the tax roll would be split so that homeowners pay a lower rate than business property owners. The tax rate for business property owners would be 1%, while homeowners would pay something less. It is estimated that business people would experience a $5.9-billion tax increase.
Considering that more than a dozen ideas have been proposed, the winnowing-out process could be a long and difficult one. There is the potential for lawsuits challenging the moratorium bill, and taxpayer groups are expected to mount ballot initiatives that would compete with any state legislation.
Complicating things further, state and county governments are experiencing financial difficulties from the sluggish economy. Last month, Gov. Pete Wilson announced a potential $11-billion shortfall in the state budget. A decision to increase state revenue from property taxes might have to be addressed by the Legislature, according to an Assembly report.
“It would be absolute chaos at a time when the Legislature can’t even deal with the issues now before it.” said Jonathan M. Coupal, director of legal affairs for the Howard Jarvis Taxpayers Assn., which fought for Prop. 13. “I can’t see any way to resolve the issues other than new statewide initiatives that would seek lower tax rates, homeowner exemptions and income tax credits for certain classes of people who might be tossed out of their homes.”
State business leaders say they will fight any effort to set up a split tax roll in which the owners of stores, rental property and commercial buildings are taxed at a higher rate than homeowners. They say such a plan would prolong the recession by raising prices for consumers and encourage more businesses to leave the state.
“We think a split roll would be a drastic blow to California’s economy,” said Fred Main, general counsel for the state Chamber of Commerce. “There could be a significant shift to the business community to provide homeowner protection. If the court overturns Prop. 13 and everything else stayed equal, it would take away the advantage of offering a stable property tax.”
Chamber leaders say that if Prop. 13 is overturned, the most equitable system would use assessments based on current market value, a tax rate cap that is the same for everyone and some kind of moratorium so the new methods can be set up properly.
“One thing should not be overlooked,” said Lucien D. Truhill, president and chief executive officer of the Orange County Chamber of Commerce. “The cost of doing business is passed along to the consumer in the form of higher prices. It could be another drag on the already weakened economy if Prop. 13 thrown out. Small businesses are having a tough time making it these days.”
Tax attorney Koch said the Legislature’s moratorium is of “dubious constitutionality” and might be vulnerable to lawsuits by county assessors who want to quickly proceed with reassessing real estate or property owners who might get a tax reduction under an alternative to Prop. 13.
“There is no question the state would have to readjust enormously, just like it had to adjust for Prop. 13,” he said. “There could be potential for more lawsuits. It would be like throwing Br’er Rabbit into the brier patch.”
Assemblyman Klehs doubts that any serious legal challenge would be made against the moratorium. Courts have favored grace periods, he said, and any lawsuit would take time, perhaps much longer than the moratorium.
Ultimately, tax experts and economists believe, some kind of plan in which property is reassessed at market value and the tax rate is lowered will probably be adopted. Using such a method, they estimate that the taxes for those who bought property before Prop. 13 would probably more than double overall, while the tax rate on the newest home buyers might fall by about half.
“Some of the people who would get tax increases live in mansions, and they can well afford them,” said Hall, Nordlinger’s attorney. “Not that many people would be adversely affected.”
A study by the Center for State and Local Taxation at UC Davis shows that if real estate were reassessed at current market values in Los Angeles County, revenue from property taxes would increase about 96% from roughly $4.6 billion to almost $9 billion. Total assessed value of all property in Los Angeles County is now about $459 billion.
Center director Steven M. Sheffrin says that Los Angeles County would have one of the largest percentage increases in property tax revenue in the state because of high appreciation and little new construction compared to other areas.
The county also has an unusually large portion of unimproved single-family homes assessed at 1975 market values--about 43% which have not changed ownership since then. Homeowners represent about a third of the property tax roll. If those homes were sold today, Sheffrin estimates, their market value would be slightly more than five times the 1975 value.
The additional tax revenue, Sheffrin says, could make it possible to cut the property tax rate from slightly more than 1% under Prop. 13 to .51% in Los Angeles County or .55% statewide. The same amount of revenue would be maintained while eliminating the enormous tax disparities that existed using the sale price method under Prop. 13.
Sheffrin said that if there was a statewide property tax rate, property owners in counties with lots of new construction could benefit because they would get a tax break if they bought property in the last few years.
“You could have some very different winners and losers,” Sheffrin said.
One of the losers might be Daniel Orona, a retired businessman who lives on North Clinton a few blocks from the Judys. For years, his family ran a flower and gift shop. Now, he lives on his savings and Social Security. His home, which he and his wife have owned for more than 20 years, is now worth about $250,000. Any large increase in his annual property tax of $452 a year could be a major blow.
“We would really be in trouble. I just could not afford it,” Orona said. “I’d have to go back to work.” Then he chuckles. “Or I’d have to ask my kids to move back in and support us.”
Taxing Inequities
Proposition 13 has resulted in significant disparities in the property taxes paid on similar real estate holdings. Illustrative of the inequities that have propelled the issue to the U.S. Supreme Court are the different property taxes levied against four adjoining condominiums on Narbonne Way in Costa Mesa. The owner of one unit who bought before Proposition 13 pays almost half the property tax of a next-door neighbor who bought in 1983, and almost a third of that paid by another neighbor who bought in 1989. The condos are almost identical.
1991 1991 Address Last Sold Sale Price Assessed Value Property Tax 2402 Narbonne Way 1983 $106,000 $126,351 $1,368.20 2404 Narbonne Way 1977 $ 64,000 $ 70,262 $727.22 2406 Narbonne Way 1977 $ 65,000 $ 70,262 $798.34 2408 Narbonne Way 1989 $188,500 $196,635 $2,011.16
Source: DAMAR Real Estate Information Service Researched by MARK LANDSBAUM / Los Angeles Times
Proposed Alternatives
After 14 years on the books, Proposition 13 is facing its toughest legal challenge, in the U.S. Supreme Court. In case the measure is declared unconstitutional this month or next, the state Legislature has drafted a number of alternatives that could replace the controversial ballot initiative advanced by the late Howard Jarvis.
1. Reasses but phase in higher taxes. Split the tax roll so all property would be assessed at current market value except for homes whose owners elect to phase in their property tax increases. This would be coupled with a revenue limit on the state, changeable only by a majority vote of the public.
2. Increase the homeowners exemption. All property would be reassessed at current market value, but the homeowner’s exemption would be increased from the current $7,000 to $50,000 and indexed for inflation. The tax rate of 1% would also be lowered to a level that would generate the same amount of revenue as in the prior year, adjusted for inflation.
3. Tax businesses at a higher rate. Assess all property at fair market value and split the tax roll so that homeowners pay a lower rate than business property owners. Business property taxes would be 1% of current market value, while homeowners would pay something less. Under this proposal business property owners could experience a $5.9-billion tax increase.
Other proposals that might be implemented separately, or in combination, include:
* Basing all property taxes on assessed fair market value.
* Reducing present property tax revenue and replacing them with another revenue source.
* Eliminating property taxes and establishing a new form of property tax, parcel tax, special assessment, or realty transfer tax that would mimic the change of ownership provisions of Prop. 13.
Source: state Senate and Assembly reports
