Bill Fulton: How To Fix Proposition 13

It’s been 40 years since the voters of California passed Proposition 13—so long that hardly anybody who hasn’t reach retirement age remembers what life was like before the property-tax cap became the law of the state. It’s tempting simply to accept Prop. 13 as a typically oddball quirk in California governance – but it’s also important to remember the way in which it has distorted how California is run and financed and what some of the long-time effects have been.

There’s no doubt that, as advertised 40 years ago, Proposition 13 has helped many people on limited incomes—including older people—stay in their home when they otherwise would have had to move. But, in a fashion similar to rent control, Prop. 13 is a blunt instrument.

It helps anybody, rich or poor, who’s owned their property for a long time, and that clearly slows down the churn in the real estate market. And by the way, that includes not only homeowners but also owners of apartments and owners of commercial and industrial property—which creates perverse incentives for such property owners not to redevelop their property at a time when California’s policy is deeply committed to infill development.

So that’s Prop. 13’s legacy in the land use arena: lack of churn, disincentives for infill development and—lest we forget—a push by local governments to recoup their costs on housing projects by imposing high impact fees, creating Mello-Roos and assessment districts, favoring high-end residential development, and aggressively pursuing land uses that generate sales tax. Quite a legacy.

Indeed, Proposition 13 has been place so long it’s easy to forget what preceded it. In the old days, there was no upper limit on property taxes except the point at which politicians got pushback from their constituents. Every taxing entity imposed its own sales tax but nobody took responsibility for the overall bite, which meant that a property owner might pay 3% of assessed value each year in property taxes.

At the time of the first big run-up in California real estate prices, Proposition 13 was meant to cap property taxes in two ways: First, by capping the overall amount of property tax at 1% of assessed valuation; and, second, by permitting full reassessment only on sale and limiting increases in assessment for current property owners to 2% per year. This meant an immediate huge reduction in property taxes in the late ‘70s, but it also has meant that property owners who hold on to their property for a long time pay, over time, a very low effective tax rate. (Case in point: On my house in Ventura, purchased in 2005, I pay an effective property tax rate of about 0.5%. Without Proposition 13, I’d probably pay four to six times as much in property tax.)

The perverse incentives that Proposition 13 places on local governments have been well documented. The bottom line is that most cities—which, on average, receive 15% of the already-reduced amount of property tax available under Prop. 13—lose money providing services to housing developments. The results are pretty predictable: Many cities simply refuse to approve housing unless it’s very high-end, which will max out the property tax revenue. When they do approve housing, they approve the fewest number of units possible. They also impose high impact fees and/or get infrastructure money out of various special district options, such as Mello-Roos Districts, which are essentially an extra tax on people who own newer homes. Whenever possible, they don’t permit housing at all, but rather favor commercial and industrial property that has little service cost—and especially retail property that generates sales tax.

But the other two perversities I mentioned above are worth discussion, even if they don’t get as much publicity in local government planning circles.

The first is the decline in housing churn. By design, Prop. 13 was meant to reduce churn in the sense that it was supposed to make it easier for older homeowners to stay in their houses when their incomes stagnated and the value of the property rose. But a certain amount of churn is necessary for a healthy housing market, as people’s life circumstances change. Over time, more and more Californians have stayed in their homes for longer periods of time—often as empty-nesters—meaning that lots of housing that should turn over is held off the market and younger families looking to move up have been stifled.

The second is the perverse disincentive that discourages commercial and industrial property owners from selling or redeveloping their property. Business property owners are in many ways the real winners under Prop. 13, simply because these properties often stay under the same ownership for generations. A piece of real estate on a commercial strip—often near a transit station—may appear to be a prime spot for infill development. Then why does it have a Dollar General or a convenience store and a large parking lot on it? Because the property owner owns the land debt-free and pays very little in the way of taxes. Why take the risk of redeveloping your property—even if you could make more money—when you’re making a fine living cashing checks?

It’s often said that Proposition 13 is an immoveable object—that political support for it is so strong that there’s no way to change it. That’s really true only of the initiative’s two most basic tenants—the 1% cap and reassessment on sale.

So, of the three perverse effects above, really the only one that’s locked in by the two basic tenets is the lack of churn. So long as homeowners can sit on their house and pay very low property taxes, the churn will be slower than it should be.

The problem of local governments not getting enough money out of housing is—conceptually, at least—simple to solve: Give them more money if they approve more housing. This could be done a variety of ways—and in fact the problem may begin to solve itself with online retail sales, if jurisdictions are rewarded on a per-capita basis statewide, rather than being rewarded for hosting transactions.

As for the perverse anti-infill incentives for longtime business property owners, remember that split-roll initiative that’s been making the rounds? By taxing business property at market rates (splitting the assessor’s role between residential and non-residential property), the initiative would give those an incentive to do something more than cash checks.

So some parts of Prop. 13 are baked in California’s DNA. But if the state is going to attack the housing crisis, some of the initiative’s longtime effects can actually be mitigated.