Joel Fox: To Tax or Not to Tax, that is the Question

Against the background of the economically devastating coronavirus plague (not in any way to minimize the ultimate tragedy of lives lost), governments are trying to figure out how to handle their lifeblood–taxation. Government faces budget shortfalls to fulfill its responsibilities, yet the taxpayers who are the great source of government revenue suffer, too. Businesses are closed, workers are out of jobs, commerce is at a near standstill.

For government, to tax or not to tax, that is the question.

If taxes are placed before voters, which arguments prevail? Will the goal of capturing new taxes win out because they are necessary to fulfill public needs in response to the emergency such as medical supplies, hospital beds, homeless accommodations while also funding adequately traditional services such as education and public safety? Or will preventing new taxes capture the voters’ empathy because they believe new taxes could stymie recovery, permanently damage businesses and add a burden to individuals who are barely hanging on?

How to deal with this Catch-22 dilemma when a traditional solution to revenue loss is denied by circumstances inherent in the problem? 

On Friday, Gov. Gavin Newsom’s Department of Finance projected that the initial cost to the state to deal with COVID-19 will be $7 billion. While it is estimated that the federal government could cover up to three-quarters of that amount through the Federal Emergency Management Agency, the cost is just the tip of the fiscal iceberg threatening to rip an ever larger hole in the state budget. The Department of Finance projected that the coronavirus impact will continue through 2021.

Likewise, UCLA’s Anderson School of economic analysis projected double digit unemployment rates in the state through 2021 meaning businesses will be reduced and jobs will be lost. Before the virus struck California was enjoying a record low unemployment rate of 3.9%. According to a Chapman-Claremont McKenna College Consumer Sentiment Survey released last week consumer confidence has plummeted to record lows.

Prior to the full-blown economic emergency, local governments were considering placing many taxes on the November ballot for voters to approve.

Yet, even before the crisis, doubts were creeping in whether voters in Californians had reached a state of tax exhaustion. There were 240 measures on the primary election March ballot to raise money for public schools and local governments, and 146 failed; 94 passed, a 39% success rate. Compare that to the presidential election of 2016 in which 83% of the 430 city and county general taxes, general obligation bonds, special district taxes, and school parcel taxes and bonds passed. In the last statewide General Election of 2018, the success rate for local government tax and bond measures was 81% of 386 measures offered to the voters.

Couple an attitude shift from the voters toward taxation with the economic chaos caused by the coronavirus plague, it is doubtful that governments can solve fiscal woes through tax increases. It should be noted that a tax plan to relieve California of fiscal pressures caused by the Great Recession was defeated by a two-to-one margin in a May 2009 special election.

Yet, taxes will certainly be considered by California governments. It is not clear how many local tax measures under consideration will actually be on the ballot in November. Already, a business head tax in Palo Alto destined for the ballot, has been pulled because of the economic situation. 

However, there is one tax now scheduled for the statewide ballot that would raise taxes for local governments and schools.

The effort lead by public employee unions to raise property taxes on business property has already qualified a measure for November and a second version was circulated when proponents discovered problems with the first. Often labeled a split roll because it carries different rules for residential property and commercial property in assessing property taxes, the campaign turned in 1.7 million signatures for the new version, certainly enough to qualify. It is expected once the new measure is approved for the ballot the first one will be pulled.

The Yes side will argue schools need money because there will be funding cuts under reduced budgets and local governments need revenue to offset the public response confronting the coronavirus.

The No side will talk to people who lost paychecks under Covid-19 and who will face increased costs of food and goods and services if the property tax increase passes. Because of the collapse of businesses big and small, many will struggle to get back on their feet–some won’t survive–under an increase in property taxes.

Does either side of the debate have an advantage conducting a campaign in the shadow of a pandemic? I asked someone who has been following this issue for a number of years with his widely respected poll, Mark Baldassare, President and CEO of the Public Policy Institute of California. 

“It’s hard to say how the yes and no arguments for the split roll will be heard because we have entered unchartered territory with the coronavirus pandemic and its economic impacts,” Baldassare admitted in an email.   

“The burden of proof is always on the yes side in any initiative campaign and it will be especially challenging in the face a well-funded opposition,” Baldassare wrote. “The no side is capable of raising questions about the intended and unintended consequences.”  

Acknowledging that matters will be different (hopefully in a positive way) seven months from now when voters decide on the measure, government and citizens will still be feeling the after-effects of this stressful experience and that is bound to play out at the polls.

While Income taxes, sales taxes and corporate taxes, the three pillars holding up the state budget, are expected to fall precipitously, property taxes which fund local governments may not be reduced much, at least immediately, thanks to California’s Proposition 13.

The Proposition 13 property tax system requires properties to be assessed when they are purchased and that the tax can rise no more than 2% a year, depending on inflation. Under this acquisition property tax model, when property values increase over time, property owners are paying a controlled property tax that doesn’t rise as fast as the value of property.

When an economic downturn hits, assessors are required to reassess property downward for tax purposes. Under Proposition 13, because many properties are paying taxes on assessed values below even the recession-reduced market values, taxes on these properties are not lowered. 

This situation has allowed property tax-reliant local governments to weather severe economic storms in the past. During the recession of the early 1990s, one Los Angeles County official was quoted in the Los Angeles Daily News, “Thank goodness for Proposition 13,” because the system prevented a big drop in property taxes while other tax collections fell all around.

The same thing was repeated in the difficult budget days of 2002 after the dot com bust.  A December 10, 2002 Los Angeles Times article said that while tax revenue on income, capital gains, sales and other revenue sources were down, property taxes was an increasing revenue source for government.  As California officials wrestled with a budget deficit of more than $21 billion at the time, taxes on real estate, according to the then Ventura County Assessor, are “keeping it from being a disaster.” 

Property tax collection has dropped overall only twice in the 41 years that Proposition 13 has been the law. In fact, during that time, property taxes have been the most stable tax in California increasing about 7% a year, faster than inflation and population growth.  

However, a stable property tax would be put in jeopardy if the initiative to raise taxes on commercial property passes in November. 

The proposal is to raise property tax assessments at least once every three years on certain properties to full market value. When an economic downturn occurs, like the one that is occurring now, all those properties would have to be re-assessed to a new, lower value thus reducing tax collections for local governments and schools.  

The California tax most reliable for government will become as volatile as other state and local taxes if the property tax increase initiative passes.

Some pro-tax advocates, seeking a smoother avenue to raise taxes, hopefully look to the California Supreme Court to clarify a decision that had been interpreted to allow local voters to pass special purpose taxes with a simple majority vote if the tax proposal reaches the ballot by initiative.

The state constitution requires that local general taxes receive a majority vote from the voters but taxes earmarked for specific purposes—say fire services— must secure a two-thirds vote. In the case California Cannabis Coalition vs. City of Upland, the Supreme Court broadly declared that the two-thirds vote standard applied to taxes proposed by local government officials, not necessarily to initiatives brought to the ballot by voter petitions.

Immediately, some observers assumed that the requirement of a two-thirds vote for special taxes could be ignored. Since then a case in San Francisco upheld the notion that the special purpose taxes brought by initiative needs a simple majority vote to pass, while courts in Fresno and Oakland took the opposite view. The Supreme Court will have to clarify.

While the court action may come too late for any initiative proponents to qualify a measure for November, local governments in the long term may regret a favorable decision to make it easier to raise special purpose taxes with a majority vote.  The problem is that earmarked special taxes set for specific government functions ties local budgets into a knot and takes away needed discretionary decision-making powers from local elected officials to spend tax revenue where it is needed.

Beyond the debate over taxation, governments and citizens hope that the federal stimulus package has a positive effect and that the emergency regulations locking down the economy have a short life. If so, the economy could rebound and fill workers’ wallets along with government coffers. There is also ongoing debate in Washington to add a fiscal stimulus package to relieve pressure on the states backed by a bi-partisan group of state governors.

Local governments will also consider consolidating debt under today’s low interest rates and at the same time look to the federal government to pick up short-term notes from state and local jurisdictions. The process has already begun to the tune of $500 billion and could grow. The precedent for the federal government to bailout state debt was set by Alexander Hamilton, the first Secretary of the Treasury, who consolidated state debt at the federal level after the Revolutionary War. 

If local governments do go ahead with tax increase efforts, will they offer reforms to the way they do business to show the taxpayers that all will share the pain of recovering from the crisis? Pension reform is one standard concern with government budgets even before the crisis hit.

Considering we are in the throes of an economic tornado; governments should wait to see if the crisis eases; to see how deeply scarred the state’s businesses and taxpayers are. Wait to see how strongly and how swiftly the economy comes back. Don’t apply more burdens on the taxpayers in a time of crisis.

Joel Fox has spent over 40 years in the California political world serving as president of both the Howard Jarvis Taxpayers Association and the Small Business Action Committee, as a senior advisor to the gubernatorial campaigns of Richard Riordan and Arnold Schwarzenegger and as  founder, editor and co-publisher of the California political/business blog Fox and Hounds Daily, twice recognized by the Washington Post as a top state political blog,  in which portions of this article were previously published.  Disclosure, the author is a paid consultant by Californians to Save Prop 13 and Stop Higher Property Taxes, sponsored by California homeowners, taxpayers, and businesses.