(Editor's note: This column by Cal-Tax Chief Tax Consultant David R. Doerr originally ran in the December 15, 2009 issue of the Capitol Morning Report.)
Proposition 13 has been law in California for more than 31 years, meaning that most people alive today either were not around when it passed in 1978 or were not old enough to have owned property. Since they never experienced the changes it made, they may not fully comprehend how Proposition 13 affected property taxes and where those taxes would be without it.
Using the latest available tax rate and assessment averages, the property tax today on a $300,000 house in California is $1,850. Without Proposition 13, the tax would be $7,369. Prior to Proposition 13, the property tax took 5 percent of California's personal income. Today, it takes between 2 percent and 2.5 percent.
Proposition 13 made these changes in two steps. First, it set a maximum rate for the property tax; and second, it removed guesswork, opinion and chance from the determination of a property's assessed value – that is, the value upon which the tax rate is levied.
In 1977, the average property tax rate in California was 2.67 percent. Proposition 13 fixed the rate at 1 percent plus whatever additional rate is needed to cover voter-approved indebtedness, such as bonds. Although the additional rate varies around the state, it generally runs at about one-tenth of a percent, setting the overall Proposition 13 rate at 1.1 percent.
To understand how Proposition 13 removed guesswork, etc., from assessed values, some background is needed. Prior to Proposition 13, county tax assessors generally valued properties according to the theory of "highest and best use." Instead of valuing a property by its actual use (as a home, for instance), assessors made subjective judgments based upon their opinion of its best use (by a developer, for instance). Or, if a subdivision sprang up near an existing home, the assessor might raise the older home's value because it now sat in a more expensive neighborhood.
These practices often increased values astronomically, forcing owners to sell because the tax was simply unaffordable. Proposition 13 put a stop to all this by requiring that locally assessed property be assessed objectively; that is, by the price paid for it. If the market value of a property declines in later years, it must be reassessed accordingly.
Proposition 13 also dealt with the ups and downs of inflation. During the early 1970s, inflation rates were running in the 10 percent range and above, and assessors hiked property values accordingly. As a result, a property owner could see his or her tax bill double within one year. Proposition 13 removed that threat by allowing assessed values to increase by no more than 2 percent annually.
Prior to Proposition 13, property values were not only established subjectively, but also were established at various percentages of current market value. Board of Equalization data from the pre-13 period found some property in counties being assessed at 2 percent and others at 200 percent or more of current market value. An Assembly committee report found rural properties in El Dorado County being assessed at 10.7 percent and residential property at 23 percent.
Thus, assessed values told taxpayers nothing about the actual value of their property, nor could taxpayers know whether they were being assessed fairly in relation to others. But now, because Proposition 13 requires that all real property be assessed at its acquisition cost (except for railroad, utility and some other properties still assessed by the Board of Equalization), there is far more uniformity around the state.
A measure of assessment uniformity is the "coefficient of dispersion." Prior to Proposition 13, there was only one county under the now state maximum of 7.5 percent. Currently, all counties are below the maximum.
Because of Proposition 13's assessment reforms, similar properties, perhaps sitting side by side, may be appraised at vastly different amounts. Thanks to the 2 percent maximum on annual assessment increases, the property purchased years ago will be assessed at a much lower price than the one purchased recently, perhaps during the latest real estate boom.
Some say this is unfair, that equivalent properties should pay an equivalent tax. But in return for these tax disparities, the state's property owners are granted the comfort of certainty. The owner knows going in what the tax will be on his or her property (1 percent of the price) and that it will not increase outlandishly over the years.
In 1992, the US Supreme Court, in Nordlinger v Hahn, upheld Proposition 13 and the variation in assessments by an 8-1 vote that included a very strong opinion by Justice Harry Blackmun. He called the granting of certainty to a property owner an "exceedingly persuasive justification" for the disparities in assessed value.
And then there was Adam Smith, the father of modern economics, who wrote about taxes long ago: "The certainty of what each individual ought to pay is, in taxation, a matter of so great importance that a considerable degree of inequality ... is not near so great an evil as a very small degree of uncertainty."
Some say Proposition 13 decimated local revenues. This is not the case. Since the passage of Proposition 13, local property tax revenues have grown, on average, more than 8 percent per year, from $4.9 billion in 1978-79 to approximately $47 billion this year. This is outstanding growth for any revenue source.
Proposition 13 also protects local government from major cyclical swings in revenue. If the pre-13 system had been in place this year, property tax revenues would have plummeted 20 percent to 30 percent, reflecting the decline in property values. This would have decimated local budgets.
In short, Proposition 13 stabilized property tax revenues. Granted, if there had been no Proposition 13, the tax would have produced more revenue in the past. But given our political inability to save for rainy days, we would be seeing far more suffering today from cuts in social services, layoffs and other traumatic products of the need to reduce spending.
Proposition 13 has not shifted the property tax burden from business properties to homeowners, as some had predicted. Data from the State Board of Equalization show that in 1979-80, homeowners paid 41.8 percent of the tax on properties subject to Proposition 13. The percentage now is much the same, 40.4 percent in 2008-09.
Much of today's opposition to Proposition 13 is not directly related to the property tax. Supporters of the initiative feared that legislators would respond to its passage and its cutting of the property tax by simply raising other levies to balance the loss or perhaps raise even more. To reduce that possibility, they required that tax increases be approved by a two-thirds legislative majority, not the simple majority of before.
Although the two-thirds requirement made it harder to raise taxes, it did not make it impossible. Even with this higher vote threshold, there have been some massive state tax increases since 1978. In 1991, state taxes were increased by $7.1 billion. Just this year, they were raised by over $9 billion. What the requirement does is force a hard look at other ways to balance the budget, especially when revenue growth slows or declines.
(Historical note: the requirement that the state budget be approved by a two-thirds vote did not originate with Proposition 13. It was approved by voters in 1933 as part of the Riley-Stewart plan.)
Proposition 13's effects at the local level are clear: more and different taxes may be levied now than before, but voter approval is required for all. Prior to 13, charter cities could levy some local taxes, such as utility user and hotel taxes, by action of the city council, but general law cities and counties could not. None could raise the sales tax beyond the 1 percent level. Schools and other districts had no independent authority beyond voter-approved property taxes.
Now, all cities and counties can levy a wide variety of taxes, including local add-on sales taxes, with voter approval – a majority vote for general tax increases and a two-thirds vote for property-related taxes and special tax increases.
(Historical note: the vote requirement for qualified school bonds is lower now [55 percent] than it was prior to Proposition 13. The two-thirds requirement for local bonds did not originate with Proposition 13. It was adopted in 1879 as Section 18 of Article XI of the California Constitution.)
In conclusion, Californians still seemed pleased by their enactment of Proposition 13. Polls show that the initiative, despite its opponents, is as popular today as when it passed more than 31 years ago.
Cal-Taxletter, December 18, 2009
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