Oct. 17 (Bloomberg) -- California voters approved Proposition 13 to rein in property taxes that had doubled in 10 years. More than three decades later, that rebellion has mortgaged the state’s future, saddling it with the nation’s highest debt and lowest credit rating.
The measure led to reductions that dropped per-student school spending from seventh to 29th nationally, prompted cities to pursue sprawling retail development to compensate for lost revenue, and pushed the state into budget gridlock, including a $705 million revenue shortfall announced Oct. 10, by requiring two-thirds approval for any tax increase.
“Proposition 13 set up an unfair and dysfunctional two- tiered system of property taxes,” said Kevin Starr, a history professor at the University of Southern California and the author of a series of books on the state. “It choked off a source of revenue, and the lack of that revenue has brought California to the edge.”
The measure, approved in 1978, was the inspiration for an antitax movement that has taken hold of the public discourse in Washington and in state legislatures throughout the country. It caps real estate levies at 1 percent of a property’s most-recent sale price. Before it passed, local governments could raise revenue as they saw fit.
Spread to Washington
In July, antitax fervor fed by the Tea Party movement led Republicans in the U.S. House of Representatives to dig in against any increase in the nation’s debt ceiling that included raising taxes. The compromise that resulted threatens automatic spending cuts across the government if a congressional supercommittee can’t agree on ways to cut the federal deficit by more than $1 trillion.
In his 1990 autobiography, “An American Life,” former President Ronald Reagan called Proposition 13 “a prairie fire” sweeping the nation. In just the past two years, New York and New Jersey enacted laws inspired by it. At least 20 states now have some sort of property-tax cap, according to the Lincoln Institute of Land Policy, a Cambridge, Massachusetts, foundation that researches property issues.
In California, where Proposition 13’s tax ceiling has long shaped public policy, the effect of that movement is clear.
In addition to the effect on elementary schools, the most- populous state cut support for its public universities by 18 percent to $4.5 billion this year, according to the California finance department. The world’s ninth-largest economy’s general- fund backed debt has risen to $82.6 billion from $2.25 billion in 1978, state figures show. California carries more debt than any other state and ranks eighth on a per-capita basis, with $2,542 for each resident, Moody’s Investors Service has said.
Proposition 13 created disparities in tax payments that amaze Larry Stone, the assessor in Santa Clara County, home to Silicon Valley and companies such as Apple Inc. and Intel Corp. Stone’s new neighbor in Sunnyvale will pay almost $18,000 in annual taxes and special assessments compared with the $3,000 Stone pays for the house he bought in 1975.
“You couldn’t invent a crazier system,” Stone said in a telephone interview.
The measure also created loopholes that businesses exploit to avoid paying their fair share, says San Francisco Assemblyman Tom Ammiano, a 69-year-old Democrat who has sponsored legislation to tighten rules on business-property transfers.
For instance, billionaire Michael Dell structured the 2006 purchase of an ocean-view hotel in Santa Monica, a Los Angeles suburb, to avoid the automatic tax increase that comes with acquisition of more than a 50 percent interest in any property, Los Angeles County officials said in a statement filed in court.
The founder of Texas computer maker Dell Inc. and his wife, Susan, bought shares in Ocean Avenue LLC, the corporation that owns the 302-room Fairmont Miramar hotel. They did it through a partnership, a limited liability corporation and a trust, none of which bought more than half of the hotel’s stock.
“This is emblematic of the cavalier way people try to skirt the law,” Ammiano said. “If you’re looking at a school that has to lay off teachers, if you care about elder care, money like this could make a real difference.”
The Los Angeles County Assessment Appeals Board ruled last year that the hotel had changed hands and the property’s value could rise to its $200 million purchase price from the previous assessed value of $85 million -- that corresponds to an annual tax increase of about $1.3 million. Ocean Avenue is suing in state court to reverse the decision, while paying higher taxes as it pursues the matter. Todd Fogarty, a spokesman for Dell’s private investment firm, MSD Capital LP, declined to comment on the entrepreneur’s behalf.
Proposition 13’s success had another effect as well: It inspired an explosion of ballot measures, from carving out part of the budget for schools to legalizing marijuana for medicinal purposes. Since 1978, the state has amended its constitution through initiatives 69 times, compared with 47 times in the previous 65 years, according to the Secretary of State.
That trend spread to other states such as Colorado, where voters in November will decide whether they want to raise income and sales taxes to fund schools where per-pupil funding ranked 39th in the U.S. in 2009, according to Census Bureau figures.
“It’s had a profound impact on multiple levels,” said Jean Ross, executive director of the California Budget Project, a nonpartisan research group in Sacramento. “The one that’s underestimated is the shift in decision-making from the local level to the state. All of our public systems have been affected by our seemingly perpetual budget crises.”
Demands for Change
In the years since antitax crusader Howard Jarvis led the Proposition 13 campaign, demands for changes to the law have become more vocal, if not more likely to succeed.
Los Angeles Mayor Antonio Villaraigosa, 58, like Assemblyman Ammiano, advocates creation of a “split roll” that lets levies on commercial properties rise more quickly than those for residences, so that business owners pay more.
“Prop. 13 has had the unintended effect of favoring commercial property owners at the expense of homeowners,” Villaraigosa said Aug. 16 at the Sacramento Press Club. “Let’s apply Prop. 13’s protections to homeowners and homeowners alone.”
Yet the measure remains popular for both businesses and homeowners. In a Sept. 23 Field Poll, 63 percent of California voters said they would support the measure if it were up for a vote again now. As for the split roll idea, Democrats endorsed it 53 percent to 37 percent, while Republicans opposed it 70 percent to 23 percent.
It’s one of the initiative’s ironies that business people, who opposed the measure in 1978, have become its biggest beneficiaries. In Los Angeles County, where a quarter of the state’s $4.38 trillion in assessed property value is located, commercial and apartment buildings represented 60 percent of the tax rolls in 1975, while single-family homes accounted for 40 percent. Today that ratio is almost reversed.
In the late 1970s, tax-strapped homeowners were the driving force behind Proposition 13. Jarvis led five attempts to gather enough signatures to put the measure on the statewide ballot and finally succeeded, over the objections of Democrat Jerry Brown, 73, the governor then and now.
In the year after the measure passed, property-levy collections dropped 52 percent to $4.9 billion from $10.3 billion, according to the Board of Equalization, the state’s tax administrator.
Shifting Tax Base
Proposition 13 “effectively shifted the financing of portions of local government services and education from the property-tax base to the more volatile income- and sales-tax bases,” Standard & Poor’s said in a Sept. 8 report.
California has the 12th-highest sales tax rate in the country, with a combined state and local levy of 8.13 percent, according to the Tax Foundation, a non-partisan Washington-based research group. Its income tax collections placed it fifth in the nation in 2008, at $1,531 per capita.
Without the ability to boost local levies, Vallejo, a city of 116,000 in the San Francisco Bay area, in 2008 had to declare bankruptcy, the city’s former finance director, Robert Stout, told attendees at the Bond Buyer’s California Public Finance conference on Sept. 15. The process cost $12 million in legal bills and forced a one-third reduction in police staffing.
“I’ve worked for cities in Florida, New York and Connecticut,” Stout told the group. “We were always able to raise taxes.”
At the San Bernardino City Unified School District, the eighth-largest in the state with more than 50,600 students, revenue has fallen by $54 million, or more than 10 percent, in the past four years, as the state reduced funding. The district east of Los Angeles fired 68 educators, eliminated summer school and increased class sizes by a third, to average 30 students for each teacher.
“This is a nightmare,” said Mohammad Islam, San Bernardino’s assistant superintendent who has worked in school finance for 22 years. “It’s impossible what the state is doing to us.”
Lacking the ability to raise taxes locally, cities, counties and school districts have been forced to cut jobs, adding to California’s second-worst-in-the-nation 12.1 percent unemployment rate, according to John Husing, an economist specializing in the so-called Inland Empire east of Los Angeles.
Local governments in that area fired 12,600 employees, including teachers and firefighters, in August as nongovernment employers added 6,300 jobs, he said.
“What we now have is a government-created recession,” Husing said in a telephone interview. “It’s mostly school and local-government workers. It’s been a goddamn disaster for local governments to be put under the thumb of the Legislature.”
With property taxes capped, city officials have tried to find ways to keep as much as they can of what’s left locally, typically through redevelopment agencies, a 1945 creation designed to help cities improve blighted areas. The agencies advance city funds to developers, often from bond sales, which are paid back from the increased property assessments their projects generate.
Redevelopment agencies receive 12 percent of property taxes statewide, up from 4 percent in 1983, according to California’s Legislative Analyst’s Office. A March audit of 18 of the agencies by State Controller John Chiang found no consensus in how they defined a blighted area or in how they tracked job creation.
A formula worked out after Proposition 13 was passed also fixed cities’ share of revenue collections at their 1970s levels. That means the San Francisco Bay area city of Hercules, which had a low rate, collects only five cents of every dollar in property taxes paid while neighboring cities get as much as 25 percent, according to Liz Warmerdam, the former interim city manager. That encouraged the previous city manager to pursue development projects, particularly retail ones, to increase the city’s base, Warmerdam said in a telephone interview.
The city of 25,000 now has $130 million in debt, much of it spent on failed projects such as Sycamore North, a half-built shopping and residential center, and Big League Dreams, a softball stadium, Warmerdam said. Hercules sued its former city manager, Nelson Oliva, in August claiming he sent more than $3 million of city funds to a consulting firm his family owned. His attorney, Richard Ewaniszyk, said the city was aware of the relationship and that the family divested its stake.
Faced with a $6 million budget deficit this year, partly from $1.8 million in payments to the redevelopment agency, Hercules cut 40 people, or 30 percent of its workforce, and closed City Hall on Fridays.
Because Proposition 13 also requires a two-thirds majority in the state Assembly and Senate to pass any tax increase, legislators find themselves at constant loggerheads during budget negotiations.
Last October, then-Governor Arnold Schwarzenegger signed a budget 100 days late. This year, Republicans blocked Brown’s efforts to extend previously enacted tax increases to help close a $25.4 billion projected deficit. Democrats, who control just under the two-thirds threshold in both legislative chambers, passed a budget on the last day of the fiscal year in June only by adjusting their revenue estimate upwards by $4 billion.
“The dysfunctional element here is that the minority party is in complete charge of all matters revenue-related,” state Senator Mark Leno, a San Francisco Democrat who leads the budget committee, said by telephone. “That is not democracy.”
The battle over taxes continued until the last day of the legislative session in September. The Howard Jarvis Taxpayers Association, a conservative group that carries on its founder’s tax-cutting mission, helped convince legislators to vote against a Brown proposal to raise $1 billion in taxes from businesses, mostly out-of-state companies, and redirect the money to local job-creation efforts.
The group released two statements objecting to the legislation and used its full-time lobbyist in Sacramento to buttonhole legislators. The association’s executive director, Jon Coupal, met one-on-one with Brown to voice his displeasure.
“He was trying to move a complicated tax-reform proposal forward and we were not in position to support it,” Coupal said in a telephone interview. The measure died in the Legislature.
Meanwhile, disparities in property taxes linger. Take the case of Roy Sakioka, a former sharecropper who spent time in a World War II internment camp before becoming one of the largest landowners in Southern California. He left a fortune estimated at $325 million when he died in 1995. Among his purchases: a three-story office building in Beverly Hills assessed for taxes at $1.5 million and worth as much as 17-fold more today.
The building’s owner, Sakioka Farms, pays $17,000 a year in taxes, according to Los Angeles County assessors’ records. A building behind it with a third of the square footage and half the land is assessed at $7 million and pays $72,000 in taxes annually. That’s because the Sakioka building was purchased decades ago, while the one behind it changed hands in 2009, so the smaller structure has a more recent valuation.
Harvey Englander, a Los Angeles political consultant who worked with Jarvis for two years after Proposition 13 passed, said the man who led one of the nation’s most famous tax revolts would support changing the terms today.
“H.J.’s goal was property-tax relief for homeowners or renters,” Englander, a Democrat, said in an interview. “He didn’t love big corporations. He said, ‘Someday Prop. 13 will need to be updated.’”
Raising Business Rate
Englander suggests raising the rate business pay, to 1.5 percent, from one percent. “What people want is certainty,” he said. “They want to know exactly how much they are going to pay.”
The Board of Equalization estimates that another approach, raising assessments on commercial property to current market value, would generate $2.5 billion more a year in taxes statewide, according to Anita Gore, a spokeswoman for the board.
All those changes are a nonstarter for Coupal, the Jarvis association director. Raising property taxes will only drive more businesses from the state, he said by telephone.
“The anti-Prop. 13 jihad hasn’t thought this out well,” he said.
Proposition 13’s supporters may not have much to worry about, as no statewide leaders are pressing for a major change.
“It doesn’t poll well,” said Controller Chiang, a Democrat who had to hand out IOUs to creditors three years earlier, when legislators couldn’t agree on a budget.
What about just changing it for businesses, he was asked? Chiang shook his head no.
Brown also seems unlikely to take up Villaraigosa’s call to action on Proposition 13. When asked at a Sept. 1 event if he had any ideas for changing the measure, the governor said he didn’t.
“Nor have I found anyone else that has a plausible pathway,” he said.
--With assistance from James Nash and Michael B. Marois in Sacramento, California. Editors: Jeffrey Taylor, Ted Bunker.
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