Prop 13, Part 2: How to Fix California's Broken Property Tax Law

Proposition 13, the constitutional amendment enacted in 1978, transfers wealth from young to old, from poor and middle-class to rich, from black and Latino to white, and from renter to owner. As the “third rail” of California politics, reforming the law will be challenging. But there are realistic, workable solutions to the problems posed by Prop 13, and reform has the potential to provide incredible benefits for the majority of California’s residents.

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Image source: Capital and Main .

In **Part 1**of this two-part series, I discussed all of the reasons Prop 13 is such a backwards, destructive law: basically, it does a poor job of targeting those most in need of assistance; forces the government to find revenues in other, less progressive places; places a greater burden on young, new, and non-white residents of California; and discourages physical and economic mobility. It also ignores the key fact that people whose homes increase in value virtually always  come out ahead. Way ahead. The value of someone’s house goes up by 50 percent and they’re the ones we’re worrying about? In a state with nine million people living in poverty? Really??

Ahem.

So, with the law’s many faults laid bare, I’d like to turn to how we make things better—how to change Prop 13 into something that protects those in need of protection, and creates a fairer, more equitable tax structure for the rest of us.

WHAT TO KEEP

There are two things that people really love about Prop 13 as it pertains to property taxes. First is that it keeps their taxes relatively low by putting a cap on the property tax rate (one percent) and limiting how quickly the assessed value of their homes can increase (two percent per year). Second, and for the same reasons, it makes their property tax payments very predictable—as long as they stay in the same place. These are nice things to have, and people who enjoy them are predictably loathe to give them up.

For primarily political reasons, any reforms to Prop 13 will probably need to preserve these two features: low rates and predictability. If changes result in dramatically higher or wildly unpredictable tax payments for a large number of Californians, they’re very unlikely to be adopted by a vote of the people. Fortunately, it’s entirely possible to resolve many of the worst aspects of Prop 13 without placing any additional burden on homeowners—at least no burden they’ll ever feel.

WHAT TO CHANGE

The most nonsensical thing about Prop 13 is that it treats rising home prices as though they’re harmful to property owners. This is very obviously false. I know this because if I owned a home and it increased in value by $100,000, I would be very happy, not very sad. Even if it meant paying an extra thousand dollars a year in property taxes (which it would, without Prop 13), I would still be really excited about it.

What we need to do is change the law in a way that recognizes the glaring fact that increasing values are good for homeowners, while also acknowledging that there are some who can’t afford significantly higher property tax payments—pensioners and others on a fixed, limited income. And, that while there are quite a few homeowners who could afford to pay taxes on the full value of their homes, they’d rather not. Reform must balance these interests without agitating anyone too greatly.

The way to do that is fairly simple, and it would look like this:

1. Let people continue paying property taxes on their homes as though they’re increasing in value by just two percent per year.
2. Reassess the actual value of people’s homes every few years, and track the difference between what they’re paying at the two percent level and what they would pay at the full, actual assessed value of their home.
3. When they sell their home, collect the difference from the proceeds of the sale.

Under this system, no one is being forced out of their home by rapidly increasing property tax payments. More property tax revenue is collected, allowing the state government to cut income and sales tax rates. Residents are placed on a much more equal footing, regardless of age or tenure. Current homeowners are less discouraged from moving to a new home when it otherwise makes sense for them to do so.

Money is currently being transferred from newer to older residents, and from younger to older and non-white to white homeowners. This is a system very clearly in need of fixing. Source: Dowell Myers, Urban Planning Research .

And people who win big in the housing appreciation lottery still come out way ahead. Take, as an example, a home that’s purchased for $400,000 today. Assume its actual resale value increases by an average of 5 percent per year, but under Prop 13 its taxable value only increases by 2 percent annually. Over a 20-year period the taxable value of the home would increase to $583,000 and the homeowner would pay $107,000 in property taxes.

That home’s actual value—what it would sell for on the open market—is $1.01 million. If the owner sold their home and had to pay the difference between the “true value” property taxes and the “two percent per year” Prop 13 taxes, they would owe an extra $38,500 in property taxes at the point of sale. They’d still come out with a healthy profit of $465,000 on an initial $400,000 investment. If their home’s value instead increased by 6 percent per year, they’d owe $55,000 at the point of sale, but they’d have earned a total profit of $648,000—the faster their property value increases, the larger the difference between their resale value and their total property tax bill. I don’t feel too bad for them; do you?

MORE BENEFITS

Although this system doesn’t raise quite as much revenue as if Prop 13 was abolished completely (since the incremental taxes are collected after the actual assessment, when inflation had eroded some of their value), that’s actually okay. The purpose of this reform isn’t to increase revenue, it’s to level the playing field. Over time the property tax would increase as a share of total government revenues and the state could pare back its contributions to local school districts by an equal amount (or a lesser amount, if we wanted to prioritize education). This would in turn allow California to cut sales taxes and/or income taxes—say, by eliminating the lowest tax brackets altogether, and effectively giving every working Californian a pay raise.

Cutting taxes elsewhere to “pay” for this bill would be a great political sell, too: not only would no one’s property tax bill go up in the short-term, everyone would also get a break on other taxes. The immediate impact would be to put more money in people’s pockets; those tax cuts would be back-filled in the least painful way possible, and by those in the best position to pay. Because this reform’s impacts would take at least a few years to accumulate to a noticeable level, reductions in sales, income, and other taxes would also need to be phased in slowly.

Over time, homeowners would see less need hold onto their homes for tax reasons, and we’d see more of them moving to new homes in locations that were actually convenient for them. This would benefit the homeowners themselves, obviously, but would also help young and first-time homebuyers who are competing in a housing market with extremely limited supply. This in turn could help mitigate some of the demand pressures that are making housing so expensive—for both owners and renters.

CONCLUSION

This is just a general framework for reform; the specifics could well look very different. I think this proposal strikes a strong balance between the interests of current homeowners (who will tend to be supportive of preserving Prop 13 and need to be brought along somehow) and those that rent or can’t afford to own a home (who will tend to be supportive of reforms in whatever form they take). Both groups will be needed to change the law, and so the needs of both must be addressed.

As with everything else I write about, this isn’t the final word on the subject, so let me know what you think of this idea, potential pitfalls, and what you might change to make it work better. And share with your friends, neighbors, advocates, and elected leaders if you think this idea has potential!

Click here to read Part 1: Why California’s Property Tax System is So Broken