Landmark Property-Tax Suit: It’s All About Doing the Math

Nearly a quarter-century after California voters revolted against soaring property taxes by approving Proposition 13, a court battle over a single paragraph in the measure could mean thousands of dollars in tax refunds for individual homeowners and the loss of billions in revenue for the cash-strapped state.

An Orange County Superior Court judge has ruled that the method local tax assessors have used for years to set property-tax rates violated the 1978 landmark ballot initiative. If upheld on appeal, the decision could lead to the biggest property-tax break since the birth of Proposition 13.

The case boils down to a basic question: What exactly did Proposition 13 mean when it limited increases in property assessments to 2% a year?

County assessors around California have one interpretation. Tax attorney Robert Pool had another, and he filed a lawsuit against Orange County after the assessment on his $330,000 Seal Beach home jumped 4% in 1999. He argued the increase clearly violated the easy-to-understand language of Proposition 13, and in December 2001 Judge John M. Watson agreed. Last week, the judge turned the case into a class-action suit, potentially extending any tax refunds to millions of homeowners.

“A victory for Pool would be a victory for taxpayers statewide. It’s not the government’s money. It’s the people’s money,” said Jon Coupal, president of the Howard Jarvis Taxpayers Assn., the anti-tax organization founded by Proposition 13’s author, Howard Jarvis.

Still, Coupal and other tax experts said the potential effect of Pool’s lawsuit is muddied by legal complexities, and homeowners banking on an eventual tax refund may find themselves sorely disappointed. Even if Pool prevails on appeal, the state Legislature may decide how tax refunds would be dished out.

Before California voters approved Proposition 13 in June 1978, assessments were based on a property’s “fair market value, “ and the skyrocketing housing market was triggering mammoth property-tax increases.

Proposition 13 limited annual property-tax increases to 1% of the assessed property value and prohibited counties from increasing a property assessment more than 2% a year. The measure also mandated that all future tax increases would be added to a base value defined as the purchase price or, if in the hands of the same owner since Proposition 13 was approved, the property’s assessed value in the 1975-76 tax year.

A companion ballot initiative, Proposition 8, passed in November 1978. It refined Proposition 13 to allow property values to be reduced in a declining market.

The much-argued paragraph at the heart of the matter, now part of the state Constitution, reads: “The full cash value base may reflect from year to year the inflationary rate not to exceed 2 percent for any given year or reduction as shown in the consumer price index or comparable data for the area under taxing jurisdiction, or may be reduced to reflect substantial damage, destruction or other factors causing a decline in value.”

Under Scrutiny

This bureaucratic prose was put under the microscope in the Pool case.

Pool said the language in the Constitution is clear and must be followed: The county is prohibited from raising a resident’s property assessment by more than 2% above the previous year.

An example is what happened to Alan Lavallee of Buena Park. Though not involved in the Pool lawsuit, Lavallee is among those closely watching the issue. He complains his assessment jumped an average of more than 9% per year in the last five years.

“No one really understands what’s been happening, what the county has been doing,” said Lavallee, who believes his last property-tax bill overcharged him by about $1,600. “The county has really screwed up.”

Orange County Assessor Webster J. Guillory and state tax officials said the language can be interpreted differently. He said the Proposition 13 limit on a property-assessment increases at a rate of 2% every year from the time the property is purchased. That cap continues to rise, no matter what. And a county is allowed to increase assessments at any rate so long as the value remains under that cap, they contend.

For example, a $100,000 home purchased this year can have a maximum assessment of $102,000 in 2003; a maximum assessment of $104,040 in 2004; a maximum assessment of $106,120 in 2005; and a maximum assessment of $108,242 in 2006.

Even if a flat housing market forces the county to keep the home’s assessment at $100,000 until 2005, the county can increase the property assessment to $108,242 in 2006 if the market fully recovers -- even though that is more than an 8% increase, Guillory argues.

“All I’m doing is following the market, and I’m following the market back to cap,” he said.

Temporary Changes

Lowered assessments -- allowed by the passage of Proposition 8 -- are temporary, he said.

In effect, assessors treat a drop in property value the same way they treat homes damaged by a disaster. When a house is significantly damaged, the owner can apply to have the county lower the assessment on the property. When repairs are complete, the house is reassessed to the value of the property before the disaster -- even if the assessment increase is greater than 2%.

Under Pool’s interpretation of the law, Guillory argued, a homeowner whose house is gutted by a fire would only pay property taxes based on the assessed value of the remains, even after the home was restored.

The case, which is expected to head to the state 4th District Court of Appeal this winter, is being watched closely throughout the state. All 58 counties in California use the same method for determining property-tax assessments. Orange County tax officials said if the ruling is upheld and applies to all taxpayers, the county might have to refund up to $1 billion. Los Angeles County officials said the cost could be as high as $4 billion.

“There are two different readings of two different clauses in the Constitution. I don’t think this is a frivolous case at all,” said Paul Steinberg, senior tax counsel for the state Board of Equalization.

But legal opinions are far from unanimous. Though a judge ruled for the plaintiff in Orange County, a judge in Los Angeles County dismissed a similar case in April. “You’ve got a lot of uncertainties on this. We didn’t even attempt to assess the impact,” Steinberg said.

Even if courts find in favor of the plaintiffs, the ultimate effect is hard to predict. To begin with, California has a three-or four-year statute of limitations on claiming tax refunds. In the Orange County case, the judge has one final element of the case to decide. He is expected to rule Jan. 30 on how taxpayers should be notified that they could be due a refund. He said he will suspend his ruling to allow the case to move ahead on appeal.

Coupal said that if the courts uphold Pool’s court victory, then every assessor in California would be inundated with claims for property-tax refunds. To avoid that bureaucratic nightmare, the state Legislature would probably be forced to rush in with some sort of remedy to streamline the process, he said.