Key Prop 13 supporter Howard Jarvis, image from Los Angeles Public Library

Key Prop 13 supporter Howard Jarvis, image from Los Angeles Public Library

A while back I started a series of posts on how California could reform some of its key regulatory systems and institutions to become a more pro-housing state.  

Let’s continue this walk through significant institutions, looking today at California’s property tax rules. It is a little longer than the earlier set of posts- but hopefully worth it, because taxes have big impacts- hence the ! in the title.

Taxes impact housing in a number of ways. Taxation influences decisions made by residents, property owners, investors, developers, and government decision makers. For example, tax codes can make it more or less advantageous to own and rent real estate. In the 1950s and 60s, moderately wealthy people like dentists and accountants built small apartments in large numbers in California, spurring the state’s ‘dingbat’ boom , partly for the income from rents, but partly to reduce their tax bills.

Tax rules can also partly explain what types of homes get built where. This analysis from the Sightline institute suggests that tax laws are one of the main reasons why the vast majority of new multifamily homes in Seattle are apartments while developers overwhelmingly build condos in Vancouver.

The federal and state mortgage interest deduction for income tax contributes to inequality because the majority of benefits go to wealthier (and white) taxpayers with more expensive homes. On the other hand, the largest source of funding for deed-restricted affordable housing in the United States is the Federal Low-Income Housing Tax Credits program

This post focuses on how the 1978 initiative Proposition 13 and its sequels have affected housing supply and affordability in California ans how we might reform these rules.

The text of and arguments for and against Prop 13 are in this voters’ guide. It capped general property taxes at 1 percent of a property’s value. (Taxes associated with debt passed by voters, such as bonds to pay for schools or other purposes, could add to that so that rates could rise above 1 percent.) Prop 13 also set a property’s value for tax purposes at the 1975-76 assessed level, and limited increases in assessed value to 2 percent per year. It also raised the threshold to pass local special taxes to a 2/3rd vote.

Prop 13 was widely considered to be an influential, populist tax revolt. Its passage landed its key sponsor Howard Jarvis on the cover of Time magazine. It was spurred partly by concern over rising property tax assessments. With high inflation and a range of factors slowing home construction, values were rising fast. A typical headline, from in the LA Times in May 1978, when homeowners in West Los Angeles County were finding out how much their property values had risen since 1975, read: “New Assessments Shock Homeowners.”

Prop 13 also tapped into conservative beliefs that much government spending was wasteful.  So even though California cities, counties, and school districts received 27%, 40% and 47% of their funding respectively from property tax, voters were willing to take a gamble on the impact on services to reduce and partly cap their tax rates.  

After Prop 13 came into effect, its supporters pressed for a series of follow up ballot measures.  . Props 218 and 62 broadened the requirement that local taxes need 2/3 voter approval. Props 58 and 193 allowed parents and grandparents to pass on the assessed value of their home to their heirs.

Passage of the proposition had a major impact on how governments at all levels in California raise and spend money and carry out programs . For the purpose of this post, let’s look at how it impacted housing in the state. In 2016, the State Legislative Analysts Office issued a report looking a number of impacts of Prop 13. Their analysis suggests that Prop 13:

1. Primarily benefited wealthier homeowners and led to disparities between older and long time owners and newer home owners. The chart below from the LAO report shows the patchwork of valuation in part of Mid-City Los Angeles. Analysis by Trulia futher showed that homeowners in affluent cities often pay a lower property tax rate than residents in lower-income cities.

prop 13 patchwork of assessment.png

 

2. May not have significantly impacted approval of new homes by local governments. There is a widely held theory that Prop 13 contributed to the ‘fiscalization of land use’ because lower property taxes would cause local jurisdictions to favor commercial developments that brought new sales taxes or hotels (hotels can be taxed above and beyond their property value). The LAO analysis did not find that cities relying more heavily on sales tax revenue approved fewer new homes. However, there are clearly some cases in which the tax impacts of development do lead cities to favor non-residential projects.

3. Did contribute to residents selling homes less frequently and to lower-home ownership rates for younger California residents.

4. Did reduce new development because long-time property owners with lower assessments have less incentive to sell or build upon underused land. (See the chart below that shows a stark difference  between adjacent properties based on length of ownership).

prop 13 long time property owners less likely to develop.png

 

5. Did contribute to rising fees on new homes. Due to Props 13 and 218, raising local taxes requires a 2/3 vote by voters, while impact fees on development only need a nexus study and a majority vote by a city council or county supervisors. On this point, my Abundant Housing LA colleague Matt Dixon compared new home costs in the Inland Empire (San Bernardino and Riverside counties) with similar parts of the Phoenix metro area. Starter homes in the greater LA exurbs were $100,000 more than comparable homes in Arizona. While there are a range of factors contributing to the price difference, such as more expensive labor, Matt suggests that much higher development fees (up to $75,000 per home in the IE versus $20,000 or less in Maricopa County) was a major factor.  A 2014 report on housing costs in San Diego County calculated that development fees averaging  $54,000 per new home across 7 jurisdictions accounted for 11.75% of the average new home home.

One factor that the LAO report didn’t try to measure was how Prop 13 impacted resident’s attitude towards new home construction. By allowing homeowners to reap the economic benefits of scarce supply and rising home values without having to pay more in taxes, Prop 13 arguably increased residents’ incentives to oppose residential development. This is related to William Fischel’s “home voter”  hypothesis. As I suggested in the first post in this series, there was already slow-growth, anti-housing sentiment in many places before 1978 , but it may be that locking in lower property taxes for long-time property owners strengthened and sustained anti-development politics.

A second-level impact of Prop 13 was that its passage helped spur adoption of rent control ordinances in a number of California cities. Prop 13 supporters had argued that apartment owners would pass on savings in property taxes to renters. When rents didn’t go down, rent control was promoted as granting tenants similar limits on price spikes that owners had received via Prop 13. (I’ll write more about rent control in a follow-up post.)

Pro-housing tax reform

What kinds of changes to taxes in California might help increase housing construction and tackle high costs? Prop 13 has long been considered a political ’third-rail.’ But its impacts on state revenues, especially education spending and other social services, as well as its differential treatment of owners based on date of purchase, have also made it a target for reform.

1. If we are concerned about fairness, then a basic reform would be to eliminate the inheritance exemption to the reassessment of properties upon transfer. This loophole, which applies to around ten percent of property transfers each year, means that primary residences inherited by children or grandchildren are exempt from being revalued to their current worth. The exemption also applies to an additional $1 million in second homes or business properties. These semi-feudal transfers of a lower tax valuation between generations results in lower revenues ($250 million per year in LA County alone) as well as increased inequities in the amount of property tax residents pay. Since children of homeowners tend to be more affluent than Californians whose parents do not own a home (average income of $70,000 vs. $50,000), the exemption also helps residents who would more likely be able to afford property tax on a reassessed home. This exemption should be eliminated.

2. Another loophole from reassessment upon transfer applies to corporate owned properties. Property may only be reassessed if a single person or entity acquires more than 50 percent of the voting stock of a corporation or a majority interest in a partnership or LLC changes hands. This allows owners to buy property using multiple companies without triggering reassessment. For example, in 2006 investors bought a hotel in Santa Monica with one family member purchasing 49 percent with a trust, another family member buying 42.5 percent with a company they fully controlled and the remaining 8.5 percent with a second company in which they were majority stockholder. The LA County Assessor tried to reassess the value of the hotel for tax purposes but courts blocked the reassessment because neither family member owned 50% of the property. Changing this loophole so that all sales result in reassessments would raise billions of dollars in revenue for the state.

3. The Make it Fair Campaign, which is currently the best-organized movement addressing Prop 13, would go one step further and require most commercial properties to be regularly reassessed.   This approach is called a split-roll approach, because it would maintain Prop 13 for residential and agricultural properties. Half of increased revenues from updated assessment on larger commercial properties would be dedicated to schools and community colleges. The other half would go to ‘community services,’ and it is unclear if that would include affordable housing or housing-related services.

4. Going after commercial assessments is politically smart because it would not raise homeowners’ property taxes. Another potential  Prop 13 (and sequels) reform that wouldn’t touch home tax assessments would be to eliminate the requirement for a 2/3 vote on local taxes, or lower the threshold for these votes. In 2000, the threshold for school bonds meeting certain requirements was lowered to 55%. Recent efforts to set the threshold at 55% for local transportation, affordable housing, water and parks taxes, however, have so far stalled. It is possible that a California Supreme Court decision earlier this year lowered the threshold for all general taxes by citizen-initiated ballot measures (as opposed to government initiated votes.) but there isn’t consensus yet on how the decision will be interpreted.

5. Political difficulty aside, it is probably worth pursuing tax reform for residential properties, because current rules do contribute to restraints on housing supply and mainly benefit wealthier residents. If Prop 13 was repealed or altered, it would still be possible to avoid sudden increases in property taxes by phasing in increased assessments; by having policy “circuit-breakers’ that limit the amount of increase in any year (which could be linked to residents’ income or wealth to avoid tax burdens to those who cannot afford to pay more) ; or by only collecting taxes on the higher valuation when a property is sold. (Although this last option might reduce home sales and increase prices).

6. To raise more money for affordable housing and improve fairness, California should eliminate mortgage tax deductions for second homes. A bill to do this failed in the legislature last year, but it makes sense from the perspective or targeting funds where they are most needed. As the bill’s sponsor, Assemblyman David Chiu said, “We need to ensure everyone has a roof over their head before we spend tax dollars to help a small group of people have two roofs.”

7. California should also set upper limits on local development fees for new home construction. Development fees place the burden of needed public investments in affordable housing and infrastructure upgrades on just the small portion of pieces of land where homes are built (and the residents of these new units.) Property or parcel taxes spread the burden more broadly
While reforming prop 13 might tend to slow jurisdiction’s reliance on these fees by increasing revenue from property taxes, it may be worth also directly controlling fees by setting a maximum per home fee, possibly as a percent of local new home costs rather than a flat rate.

8. To spur construction of new homes, California could expand tax incentives for construction of multi-family housing. The state’s tax-increment financing for infrastructure districts (a partial replacement for redevelopment agencies) is too new to have been used widely yet, but recent changes may make it a more attractive option and could raise funds for affordable housing   California could also provide a tax break to all types of multi-family home construction. This approach is widely used in New York and has also proved successful in Seattle

9. The gold standard of pro-housing tax reform would be a full repeal of Prop 13 plus shifting of taxes from buildings to land. Prop 13 could be repealed but replaced with some type of income-linked circuit-breakers so that those who truly could not afford immediate increases in property tax would see a lower or phased-in raise. The repeal of Prop 13 would also open space for the state or local governments to implement a land value tax. LVTs are a potentially useful pro-housing policy because: “Conventional property tax pays people not to build things on their land, since doing so will mean having to pay more tax. But the Henry George Tax—which would replace conventional property taxes—makes buildings and other productive structures tax-free, thus encouraging landowners to build more of them.” Noah Smith calls a LVT a “Henry George Tax” in the linked piece after the idea's leading 19 century proponent. Henry George was a California resident for many years, so taxing land rather than housing would also honor one of our state’s most influential thinkers.