Property Tax

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Property Tax in California

Passed by voters in 1978, Prop. 13 kicked off a nationwide antitax crusade–and hog-tied public finance in California for a generation. In 2012, an aging group of reformers thinks the Legislature and the public are ready to fix Prop. 13’s unintended consequences.

The efforts of this group of graying activists to reform the California’s signature antitax initiative, Proposition 13, may be hard. For them, it’s been something of an obsession for more than three decades. But with polls showing an uptick in support for reform, the tide may finally be turning. One idea is to close legal loopholes that allow commercial real estate to be dramatically undertaxed. Another is to make it easier for local government entities to raise new taxes.

Prop. 13 Reform

By Sasha Abramsky, a Sacramento-based freelance writer.

Proposition 13 is the California’s totemic antitax initiative that has stood the test of time for 35 years.

Significant cracks in Prop. 13’s defenses appeared on election day last November: Voters passed Gov. Jerry Brown’s tax initiative to stave off nearly $6 billion in school funding cuts and supported enough Democrats to give the party a supermajority in both houses of the state Legislature. For Goldberg and other longtime opponents of Prop. 13, impossible things suddenly seemed to be within reach – maybe even by the next presidential election.
“In 2016 I’ll be 71 years old,” Goldberg says, anticipating a series of reforms that he hopes will unfold at the Capitol and the ballot box. “And this’ll be my swan song. [Amending] Prop. 13 is the Super Bowl – [capturing] as much as $12 billion in commercial property tax” that’s now off the rolls “is the Super Bowl.”

Getting this far in the Prop. 13 playoffs, however, has taken a very long time. On June 6, 1978, California homeowners – faced with rapidly rising property taxes on real estate assessed regularly at market value – switched to assessing real estate value at the time of acquisition. Grandly titled “People’s Initiative to Limit Property Taxation,” Prop. 13 promised to cut property taxes as well as cap future increases. It was promoted by Howard Jarvis and Paul Gann, two businessmen and would-be politicians who later led the Orange County-based Howard Jarvis Taxpayers Association (HJTA). The Jarvis-Gann Initiative, as it was known, won the support of nearly 65 percent of the voters and helped launch a nationwide tax revolt.

By limiting the maximum amount of ad valorem tax on real property to 1 percent of its 1975 assessed valuation, Prop. 13 slashed property taxes overnight by an average of 57 percent statewide. It capped the annual increase in valuation at 2 percent a year, except when the property is sold (or new construction added). It required a two-thirds majority in both the Assembly and the Senate to increase any state tax rates, including income tax rates. And it required a two-thirds vote in local elections for entities wishing to raise undefined “special” taxes. (See Cal. Const., Art. XIII A.)

Opponents immediately challenged the initiative’s provisions in court. But the state Supreme Court, exercising original jurisdiction later in 1978, found Prop. 13 to be a valid constitutional amendment. “Acknowledging as we must that Article XIII A in a number of particulars is imprecise and ambiguous, nonetheless we do not conclude that it is so vague as to be unenforceable,” Justice Frank K. Richardson wrote for the majority. Only Chief Justice Rose Bird dissented. (Amador Valley Joint Union High Sch. Dist. v. State Bd. of Equalization, 22 Cal. 3d 208, 244 (1978).)

A series of court rulings since then expanded Prop. 13’s impact on the state’s finances, in particular by permitting purchasers of commercial property to avoid reassessment at market value through the use of structured real estate transactions. This came on top of beneficial tax treatment common to residential homeowners. The result was a de facto alliance between big business and homeowners that made Prop. 13 the electric third rail of California politics.

Prop. 13 also spawned other antitax initiatives, and it set the stage for broad opposition to public spending in California. Three decades after Jarvis-Gann, voters passed Prop. 26, which further limited the ability of government entities to raise taxes by making any method of generating revenue – including levies and fees that exceed “the reasonable costs of government activity” – subject to two-thirds approval by the voters.

Clearly, California’s antitax forces remain formidable. “I may end up retiring without ever winning the Super Bowl,” Goldberg admits. “We’ll see.” But he does believe that, for the first time in a generation, there’s more than a fighting chance to break Prop. 13’s grip on the state’s public finances.

Goldberg’s optimism is shared by a small circle of longtime political colleagues, a graying group that includes state Sen. Loni Hancock (D-Berkeley); Tom Bates, the mayor of Berkeley and Hancock’s husband; Assemblymember Tom Ammiano (D-San Francisco); and younger activists in California Calls, a statewide alliance of community groups.

Another component of the group is a coalition of Silicon Valley business leaders concerned that Prop. 13 starves public education and impedes rebuilding the state’s crumbling infrastructure. Last year, for instance, Joint Venture Silicon Valley and the Silicon Valley Community Foundation together sponsored a special analysis of Prop. 13’s impact on local governments after the housing market crash.

“There are now glimmers of hope for reform,” says Ammiano, who has fought for changes to Prop. 13 since his days as a school teacher a generation ago. “The people are a lot more responsive, particularly [around school issues]. They’re hungry for sustainable funding for the public schools.”

Josh Pechthalt, president of the California Federation of Teachers and a key member of California Calls, says, “Income and tax inequality has become a major issue around the country. It was central to the debates in last year’s presidential campaign. For us, the conditions have changed for the public to support Prop. 13 reform.”

Of course, Prop. 13’s supporters disagree. Though Jarvis and Gann are both long deceased, the Howard Jarvis Taxpayers Association remains a powerful statewide organization. Claiming more than 200,000 members, it views Prop. 13 as a signal achievement that it argues has saved Californians more than $500 billion in taxes. HJTA’s efforts are supported by the California Taxpayers Association and the California Chamber of Commerce, and it has worked with the Pacific Legal Foundation and with legislators from both parties who defend Prop. 13 as a bulwark against voters suspicious that any changes to the initiative will invite tax hikes.

There’s a wonk-heaven quality to the Prop. 13 debate, as the two camps dig deeper into the minutiae of California tax policy. Their interactions entail a tense pas de deux between political veterans who distrust one another’s motives but still need each other to attract the spotlight.

The parties are so familiar with each other’s arguments they could make their presentations blindfolded. For every data point that Lenny Goldberg tosses out, the HJTA people counter with their own statistics. Both camps showed up in April with their data at a hearing before the Assembly’s Committee on Revenue and Taxation.

“California’s a high-tax state,” explains Jon Coupal, president of HJTA. “And we’re paying for that with businesses leaving California – businesses both large and small. With those losses comes the loss of skilled workers – an outflow to Texas, the Dakotas, and the Carolinas. There’s a good venture capital market in California, but a lot of people with those skills [to staff new enterprises] are now moving out of state.”

To Coupal, Goldberg is little more than a tired, 1960s-era lefty, a man beholden to “very powerful monied interests,” such as the state’s public employee unions. “Lenny Goldberg – of course – and the other Prop. 13 detractors would like to reassess commercial property more frequently,” Coupal claims. “The political left sees no connection between having the highest tax rates and having the highest unemployment.”

Moreover, he cites research showing that even after Prop. 13 passed, spending on education in California actually increased significantly. “We’re spending 30 percent more on a per-student, inflation-adjusted basis than we did pre-Prop. 13,” he says. When school construction dollars and in-classroom spending are factored in, Coupal argues, California is a midrange state for funding education – not at the bottom of the barrel, as Goldberg and the teachers’ unions contend.

“There’s nothing new here,” adds Kris Vosburgh, executive director of HJTA. “You have the general public overwhelmingly in support of Prop. 13. On the other side, you have politicians – who equate the ability to spend money with power – and the union and satellite groups, like those who contract with government.”

Vosburgh continues, “There’s only one goal in these so-called reforms: revenue. They’re not interested in fairness. We already have the highest income tax rate in the nation, the highest sales tax in the nation, the highest gasoline tax in the nation.” And, he adds sarcastically, “We’re way down at 14th in per capita property taxation.”

Loren Kaye, president of the California Chamber’s Foundation for Commerce and Education, says the current tax-reform proposals are “pretty broad and vague” – and possibly stalking horses for groups with an antibusiness agenda.

For HJTA and the chamber, any move to modify Prop. 13 simply encourages public entities around the state to overspend, and public employee unions to over-demand for pay and benefits. “The calls for changes to Prop. 13 are not coming from the grass roots,” Vosburgh says. “There are no demonstrations, no public demand for it. The discontent is being ginned up by politicians and some special interests in Sacramento.”

One reason Prop. 13 is back before the Legislature is that court challenges have been exhausted. The initiative has been tested repeatedly – both facially and as applied – since 1978. Opinions range from the U.S. Supreme Court’s Nordlinger v. Hahn (505 U.S. 1 (1992)) to the latest challenge, brought last year by former UCLA chancellor Charles Young. Plaintiffs attorney William A. Norris – a retired Ninth Circuit judge who represented plaintiffs 35 years ago in Amador – argued that Prop. 13’s supermajority vote requirement for tax increases is an unlawful constitutional revision. But the Second District Court of Appeal affirmed a lower court dismissal, citing Amador to find that the initiative measure was a permissible amendment to the state constitution. (Young v. Schmidt, 2012 WL 3013900 (review denied Nov. 20, 2012).)

With such durability, Prop. 13 has proved a useful weapon for antitax groups to wield in attacking other spending provisions in California. Most recently, the Pacific Legal Foundation rolled out a series of constitutional challenges to the cap-and-trade market for carbon emissions – set up under the rubric of AB 32. Revenues gained by selling emissions rights, the foundation’s attorneys argue, are in fact illegal taxes under Prop. 13.

For the current generation of tax reformers, Prop. 13’s unintended consequences are the point of attack. Granted, they concede that Prop. 13 did prevent long-term homeowners – especially elderly people and those on fixed incomes – from being taxed out of their homes. But it had damaging effects, too, taxing properties on the same block at grossly different levels and hobbling government across a range of issues.

Cleverly structured commercial real estate transactions have also denied the state revenue by permitting sellers to dodge property value reassessments. Existing tax law permits transfers of ownership involving a corporation, partnership, limited liability company, or other legal entity to avoid reassessment to market value if the buyer obtains less than a controlling interest in the entity. Courts have affirmed that buildings can change hands while the land under them is held in trust by the original owners, thus keeping assessed valuations artificially low for decades at a time.

Goldberg says one perverse result of this loophole is that homeowners currently shoulder a greater share of the local property tax burden compared to commercial property owners than they did prior to Prop. 13.

At the Assembly committee hearing in April, Goldberg testified that in 1977-78 homeowners and commercial property owners each paid 50 percent of Santa Clara County’s property taxes. In the decades that followed, Apple, Cisco Systems, Yahoo, Google, Intel, and countless other high-tech businesses located their headquarters in the county. Yet despite soaring real property valuations, the relative tax obligations of commercial property owners shrank: Today, businesses pay only 30 percent of the county’s property taxes.

“The same thing happened in San Francisco,” Goldberg says. “Same thing in L.A. Same thing in San Mateo.” Unable to reassess commercial property that doesn’t change ownership entirely, and unable to reassess the land beneath such properties, counties lost out on huge amounts of tax revenue.

Indirectly, Prop. 13 also prevented local governments from replacing that lost revenue. The initiative required a two-thirds vote of the Legislature to pass a budget or increase taxes at the state level. A series of court rulings then led to a state Supreme Court ruling that, likewise, a two-thirds popular vote is required before a locality can levy a special-use tax. (Santa Clara County Local Transp. Auth. v. Guardino, 11 Cal. 4th 220 (1995).)

After Guardino, tax revenues that previously had been dedicated to transportation and schools fell under the two-thirds requirement. The ruling frustrated attempts by local governments to adequately budget for basic infrastructure – and forced the state to assume major public education responsibilities that formerly had been undertaken by local school districts.

As Larry Spikes, administrative officer for Kings County, points out, this represented a fundamental shift of power to the state.

“The single biggest problem with Prop. 13 is the unintended consequences,” Spikes says. “The small print in the measure says taxes shall be set for the state. That meant that we [the counties] lost revenue – we had to absorb that loss of property taxes taken by the state. The man on the street doesn’t understand the complexity of this system. It’s a really dumb way to govern.”

When voters passed Prop. 13 Goldberg was in his mid-30s – a doctoral candidate in economics at UC Berkeley who had made an unsuccessful run for the city council as part of the local Berkeley Citizens Action coalition. Working as a legislative staffer for then-Assemblymember Tom Bates, he was deeply immersed in state tax policy. The more he researched Prop. 13, Goldberg says, the more he was stunned by “the crapshoot we’d just taken in California.” He realized that together Prop. 13 and Prop. 4 – a ballot initiative sponsored by Paul Gann and passed in 1979 – would act as a wheel clamp on the entire public sector.

Prop. 4, called the Gann Limit Initiative, required state and local governments to return to taxpayers any appropriations that exceed a growth limit: the percentage increase in the cost of living, plus the percentage increase in the state or local government’s population. (See Cal. Const., Art. XIII B.) It passed with nearly 75 percent of the vote, beating even Prop. 13’s margin of victory.

Prop. 4 had a drastic effect on school funding. In 1987 the state was forced to rebate $1.1 billion in excess revenue to taxpayers, prompting the California Teachers Association to sponsor its own effort to remedy basic state finances. Prop. 98, passed by voters in 1988, effectively put a legal floor under public school funding by requiring that a minimum percentage of the state budget be spent on K-12 education. And it mandated that any excess revenue as determined by Prop. 4 be used for public education rather than returned to taxpayers.

In the span of a decade, the revenue-raising ability of state and local governments had been crippled, and California’s spending obligations had increased dramatically. To meet the Prop. 98 funding mandates, in 1992 the Legislature shifted certain amounts of property tax revenues from cities, counties, and special districts to dedicated educational revenue augmentation funds (ERAFs). But ERAFs alone couldn’t make up for the shortfalls in local tax revenues.

The state of California soon discovered that it could no longer produce a balanced budget: Unable to levy special taxes because of the two-thirds majority requirement, the Legislature faced routine shortfalls in revenue – and the voting public became increasingly disdainful of its competence.

As Goldberg sees it, Prop. 13 ended up hurting all levels of government. In System Failure: California’s Loophole-Ridden Commercial Property Tax, his 2010 analysis of the initiative, he wrote, “In 1977-78, California ranked 5th in the country in property taxes as a percentage of personal income: $63.47 per $1,000, compared to a national average of $43.74.” Thirty years later, California had dropped to 36th in the country, paying on average $27.61 per $1,000 of personal income, compared to a nationwide average of $34.92 – a figure brought down in part, he argues, by Prop. 13’s impact in California.

For all its flaws, Prop. 13 has been – until recently – politically untouchable. The power of prevailing antitax rhetoric is probably why Governor Brown – who opposed Prop. 13 during his re-election campaign in November 1978 – made an uneasy peace with it during his second term. Elected governor again in 2010, Brown’s critique of Prop. 13 is oblique; he has chosen to keep his distance.

The day after Brown’s inauguration in January 2011, for instance, he told editors and reporters at the Los Angeles Times that Prop. 13 had “started the centralization of power” in California; that it “took away the power of counties to tax, for the most part; it sent the decisions up to Sacramento. So we want to redistribute all that.” But he ended the meeting by making it clear he did not support higher property taxes.

Last November, Brown had to muster all of his political skills to win passage of Prop. 30, which temporarily increases sales taxes, as well as income tax rates on high earners. Voters also approved Prop. 39, which will bring in revenue of several hundred million dollars by recalculating corporate income taxes on multistate businesses based on their in-state sales.

After those successes, Brown appears to be in no hurry to push for further tax reform. In fact, given his reluctance to increase public spending this year, it’s possible Brown would oppose major changes to Prop. 13. His office declined to comment for this article.

The political danger of antagonizing the antitax lobby helps explain why Senate President pro tem Darrell Steinberg (D-Sacramento) has indicated he won’t attempt to bring a Prop. 13 bill to a vote before 2014. An earlier generation of state politicians – including former Assembly Speaker Willie Brown – also learned to tiptoe around Prop. 13, despite its obvious harm to the state’s finances.

In fact, in the three decades between Governor Brown’s administrations, few tax initiatives have even come close to passing. Prop. 111, an exception that squeaked through with 52 percent of the vote in 1990, enacted a staggered 9 cent-per-gallon increase in gasoline taxes to fund specific projects, and it eased state appropriation limits set by Prop. 4. But Prop. 111’s increases were limited to sales taxes, one of the most regressive ways to raise revenue. And even then, passing the measure took an all-out effort by unions, tax reformers, and parts of the business community concerned about the state’s crumbling infrastructure.

In November 2000 voters approved a constitutional amendment permitting local governments to pass certain school bond measures with a 55 percent majority. The initiative was approved with just 53 percent of the vote, despite support from the California Chamber of Commerce. A decade later voters passed Prop. 25, which finally overturned the two-thirds margin requirement for passing a state budget, changing it to a simple majority. But the initiative’s authors left in place Prop. 13’s supermajority requirement for raising taxes. Though these reform measures were small in scale, they took a disproportionate amount of political effort to pass.

By 2012, however, public attitudes appeared to be changing. Opinion polls conducted last year and again this spring by the Public Policy Institute of California (PPIC) showed that although residents feel Prop. 13 as a whole has been good for the state, a majority now favors modifying some of its parts – in particular, to tax commercial properties at their market value. This is a marked change from 20 years ago, when Prop. 167 – a proposal to permit reappraisal of most business-owned real property after a specified change in ownership – went down by a 3-2 margin.

Even among Republican voters, support for some sort of Prop. 13 reform now hovers around 50 percent. The latest PPIC survey shows a majority of voters also supports allowing localities to raise specific-use taxes with a 55 percent vote. That shift comes in the wake of failed local measures in Los Angeles County and elsewhere last November; designed to fund basic infrastructure, they fell just shy of the two-thirds requirement.

Prop. 13’s longtime opponents see signals of opportunity in the new polling numbers. At least seven bills to amend Article XIII A of the state Constitution have been introduced since January.

“A number of my colleagues have introduced 55 percent [majority vote] bills for funding a number of things – schools, libraries, public safety, you name it,” says state Sen. Hancock. “I think my bill is the one we’ll all get behind. There’s something about 55 percent that makes people comfortable, and it gives them the psychological cushion to vote for it.”

Hancock’s proposal, Senate Constitutional Amendment 11, doesn’t target individual revenue streams, but instead would simply reduce the threshold required for local governments to pass any special taxes. This, she says, would free localities “to invest again in themselves, restoring small-d democracy to California. We have too many two-thirds requirements. They don’t work in a democracy.”

Because SCA 11, like most of the other Prop. 13 reform bills, involves amending the state Constitution, it would require a successful voter initiative in addition to passage by the Legislature. Hancock predicts that her bill will win legislative approval later this year or early next, in time to be placed on the 2014 general election ballot.

Assemblymember Ammiano’s AB 188, the subject of the tax-reform hearing last April, wouldn’t need to go before voters if it is approved by a two-thirds vote in each house of the Legislature and signed by the governor. The bill seeks to eliminate the structured-transaction loophole, specifying that if 100 percent of the ownership interests in a legal entity are sold or transferred within a three-year period, the real property has changed ownership and thus must be reassessed at market value. Ammiano calls it a populist measure that “makes sure commercial property owners pay their share, which right now they are not.” The bill, identified by the California Chamber as a “job-killer,” is opposed by a broad coalition of business interests.

At the hearing, Ammiano listened patiently as his antitax colleagues – many of them a generation younger than he – explained how important Prop. 13 is for the well-being of seniors in their constituencies. “As a senior myself,” Ammiano finally responded, sliding his glasses down his nose for effect, “sure, I’d like low property taxes. But I want other things too, including health care. I don’t see Prop. 13 as being the white horse that saved seniors.”
Goldberg believes that, at last, he can detect the scent of victory. He predicts some tax reform will be enacted in 2014; bigger changes to Prop. 13, requiring a ballot initiative, he says, would likely follow in 2016.

Progressive groups statewide are testing the waters, aware that antitax sentiment remains strong. In January, Los Angeles-based California Calls and its allies launched a research project to determine how much revenue key counties in the state forego because of structured real estate transactions permitting commercial property owners to avoid reassessment. Based on the data it collects, the group will then push for budget-revenue reform in 2016.
If the reform winds are indeed favorable, proponents will still have to choose the right target. “All dragon slayers have to pick their dragon carefully,” says Fred Silva, senior fiscal policy advisor at California Forward, a public policy think tank. “The question is, what is the issue people are willing to talk about regarding the Prop. 13 requirements?”

Silva notes that Democratic control of the Legislature is limited, reliant as it is on the votes of fiscal conservatives in the party who are almost as reluctant as Republicans to raise taxes. Faced with implacable business opposition to a split-roll property tax system – which would separate commercial and industrial property from Prop. 13’s acquisition-based valuation scheme – Silva says, the Democrats will be cautious. They might manage to make it easier for local governments to raise revenue for schools, but he doubts they will approve property tax hikes to accomplish it.

That’s where Goldberg and his California Calls allies come in. If they can convince lawmakers that their numbers hold up – that changing Prop. 13’s commercial transfer-of-ownership provisions would raise $10 billion to $12 billion a year without crippling business in the state – then they believe they can rally the public to amend Prop. 13.

“You beat your head against a wall,” Goldberg says of his 35 years in the wilderness working to undo Prop. 13. “The legislators would say, ‘You’re right. [But] go away.’ That’s how it’s been. So I’ve learned to be patient.
“My goal is to get Prop. 13 on the table,” he says. “Because once it’s on the table, you can’t avert your eyes from how messed up the state’s finances are” because of it.

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