Low Taxes for Some, Chaos for All

Twenty-five years ago this week, California voters ushered in a new era in government and taxation by passing Proposition 13, a citizen-driven initiative that reduced property taxes dramatically and touched off a national tax revolt. Proposition 13 profoundly changed how we pay for government services like police, fire, streets, parks, water and sewers. But it didn’t change our expectations about what we get in return.

Many recent trends and crises in governing California can be traced to this disconnect. Heavy state funding of education, a huge obstacle to a balanced state budget today, is a result partly of Proposition 13. So are development-impact fees, Mello-Roos taxes, auto malls, parcel taxes and elections on utility-user levies and assessment districts.

Championed by tax-cut crusaders Howard Jarvis and Paul Gann, Proposition 13 cut property taxes by more than half and has permanently kept them low. And it made government more complicated, more desperate and, ironically, more concentrated on the remote, inside-the-Beltway world of state politics in Sacramento. After 25 years of post-Proposition 13 Band-Aids, there is almost nobody in the state who understands how we finance government, or who can trace the connection between what we pay and what we get.

The evasions pile on every year, but neither political leaders nor voters have much motivation to change the situation. The reason: Proposition 13 has created a self-perpetuating base of support -- at least as long as most voters also own houses.

Proposition 13 contains two provisions that are politically inviolate. One is the overall property tax rate of 1% on assessed value, which creates a much lower property tax rate for California homeowners than for homeowners in other states. The second -- more important in maintaining the initiative’s popularity -- is the “reassessment on sale” clause, which says that property is reassessed only when it is sold. If the value of a property goes up after you buy it, you aren’t ever taxed on the new wealth (except for a nominal 2% annual boost in assessments).

This essentially amounts to a huge tax exemption for people whose property has greatly appreciated in value since they bought their house. This “buy-in” occurs quickly. If you bought your house for $200,000 in 1999, and it’s worth $350,000 now (not an unusual scenario at all these days), you’re already a big winner. You’re paying $2,000 and change in property tax, whereas your neighbor who buys today, only four years later, pays at least $3,500. It’s not just the little old ladies who bought their houses in 1960 who win. It’s all people whose houses have appreciated significantly since they bought them, no matter when they bought them. This is most people, or -- more to the point -- most voters.

Is it unfair to give a tax break to people who happen to buy their houses right before a big run-up in home prices? Sure it is. But the U.S. Supreme Court upheld the constitutionality of this system more than a decade ago. And the unfairness leads to a self-perpetuating cycle of political support, because if you own a house in an up market, you’re a winner.

Then there’s the legacy of unintended consequences: the cumulative effect of Band-Aid after Band-Aid after Band-Aid, and the desperate efforts of the state and local governments to deal with these consequences.

Part of Proposition 13’s intent was to reduce the size of government by reducing the amount of tax revenue available. But it is not government’s basic impulse to cut its size. Rather, local governments have gone into survival mode in several ways that have made the system almost impossible for average voters to understand.

They first tried to find loopholes in the proposition. Many cities turned to utility taxes, which are not property taxes and thus are not covered by the initiative. This strategy was blocked by Proposition 62, which requires a vote on all taxes that might be used to replace revenue lost under Proposition 13. This, in turn, encouraged local governments to start creating more assessment districts, which were not covered by Proposition 13. But the boom in assessment districts led to Proposition 218, which requires a vote of property owners (many of whom are not registered voters or even residents of California) before an assessment district can be created.

Then there are the inventive ways to lay off the costs of expanding communities onto developers and new homeowners. Assessment districts were part of this trend, as are Mello-Roos taxes, development-impact fees and any number of financial techniques. This has created a two-tiered taxation system -- one for longtime homeowners, consisting primarily of low property taxes, and another for newer residents, which includes a dizzying array of special taxes, assessments and fees.

Beyond these unintended consequences lies the sales tax shell game. Because Proposition 13 robs local governments of their ability to raise property taxes, cities and counties must compete for sales tax revenue. They do this by targeting and subsidizing anything that generates retail sales -- shopping malls, department stores, big boxes, auto dealerships, even (if they’re smart) industrial parks with lots of business-to-business sales. At the same time, locals will frown on any development that generates only property tax, especially if the development requires a lot of public services. Houses, for example.

The most important -- and peculiar -- side effect of Proposition 13 has been to tether local governments to Sacramento, turning them into lobbyists and dragging them into the annual budget debate. Proposition 13 was intended to empower the people against tax abuse by the government. But, paradoxically, it also took the power to determine what to do with the property taxes away from local governments.

In the old days, property taxes were high, but at least you could have a debate at your local city hall about how much they would be increased and what the money would be used for. No more. Proposition 13 says that the allocation of the property taxes among local government entities is a decision to be made by the governor and the Legislature.

Combined with other state policies, this requirement means that cities, counties and special districts must lobby in Sacramento every year to protect their share of the property tax pie. In bad years, such as this year, the state tends to shift property taxes away from counties and cities to pay for the state’s financial obligation to schools. In good years, such as the previous few, the state tends to forget about returning the money to counties and cities.

Not surprisingly, this consequence of Proposition 13 has broken the bond of trust between Sacramento and local government, making it virtually impossible for them to work together to address or solve any problem in the state. Name the issue -- crime, potholes, stray dogs, welfare, health -- and if it requires the state and local governments to work together, it almost certainly will not get done.

Proposition 13 might be changed eventually. The system may become so complicated that even experts can’t figure it out. Or houses might become so expensive that only rich people can afford them -- meaning the voting middle class won’t benefit and could turn against it.

But none of this is likely to happen in the foreseeable future. The system continues to churn out platoons of experts who have learned how to manipulate it. And thanks to plummeting interest rates (and low property taxes), California’s emerging population groups are becoming home buyers so rapidly that the homeownership rate in the state is actually going up.

As economist John Maynard Keynes once said, in the long run, we’re all dead. Having survived Jarvis, Gann and the original generation of homeowning tax-cut crusaders, Proposition 13 now seems likely to outlast all of us.