Prop 13 Is for Lovers…of Property Taxes!

Last week’s “OC Watchdog” piece by Teri Sforza in the OC Register pokes the Prop 13 bear, suggesting it is time Californians withdraw their opposition to higher property taxes, by focusing on the familiar scenario of the new homeowner paying scads more in property taxes than his long-time homeowner neighbor.  For those unfamiliar with this watershed issue of California tax and public finance policy, Prop 13 is the wildly popular constitutional amendment passed in 1978 by a margin of nearly two-to-one, cutting rates on all property taxes to a maximum of 1% of 1975 property values.  Cal. Const. art. XIII A, §§ 1-2.  Prop 13 allows assessments to rise by no more than 2% per year, and revaluation may occur only when property is sold.  After its passage, Prop 13 cut statewide property tax revenues by a staggering 57%.  It is commonly blamed by politicians and the media as one of the chief causes of the decline in the funding and, more debatably, the quality, of California’s sub-par school system.

Like many Prop 13 opponents, Ms. Sforza points to Prop 13’s loopholes, such as 1031 like-kind exchanges available to commercial and investment property owners, suggesting homeowners are getting the short end of an already wrongheaded deal.  Similarly, LA Mayor Villaraigosa attacks Prop 13 as “a corporate tax give-away.”  Says Villaraigosa, “[w]e all know the history” of Prop 13:

With the state experiencing rapid growth and high inflation, we had people literally forced out of their homes by skyrocketing assessments. And we all know what’s happened since. Not only have we suffered the long?term consequences of disinvestment in public education and public infrastructure ?? Prop 13 has had the unintended effect of favoring commercial property owners at the expense of homeowners.”

However, a closer study shows Villaraigosa’s “history” is not only incomplete, it is wrong.  In fact, just six years prior to decisively enacting Prop 13, Californians even more decisively (65.9% voting against) to defeat Prop 14 (a/k/a the “Watson II” initiative), a similar proposed constitutional amendment to limit property taxes.  Four years before that, Californians rejected still more resoundingly (68% voting against) the same idea in Prop 9 (a/k/a the “Watson I” initiative).  Moreover, state law at the time placed ceilings on the tax rate that school districts could assess without the approval of a “tax override” by a majority of district residents.  As of 1971, nearly every district had approved such an override.

In the years immediately preceding the passage of Prop 13, then, Californians decisively favored property taxes.  Thus, the conventional wisdom—that Prop 13 was some reactionary and ill-considered measure carried out by tax-revolting class-warriors—fails to explain what was actually happening in California at the time.  (As I will explain in a forthcoming piece, rising housing prices resulting from increasingly restrictive land use policies also caused Californians to warm to the idea of a property tax cap.  This phenomenon, too, undermines the conventional wisdom.)  Perhaps most importantly, the conventional wisdom has put policymakers off the scent of meaningful tax and education reform.

Missing from most discussions about Prop 13 is that, once upon a time, Californians liked property taxes.  As Charles Tiebout explained, given a certain level of consumer choice and mobility, the provision of local public goods will approximate the private market.  The Tiebout model assumes there exists a variety of different jurisdictions offering a variety of bundles of public services—good schools, for example.  It further assumes voters can afford to “vote with their feet” by relocating to the jurisdiction that best meets the voters’ preferences.  (Californians move approximately every four years, suggesting Californians have sufficient mobility to vote with their feet.)  Given these assumptions, voters will not mind paying property taxes since they reflect their preferences for a particular bundle of public services.

Similarly, a corollary to the Tiebout model referred to as the “benefit view” of property tax holds that taxes paid by property owners will approximate the value of benefits received from the government.  Accordingly, voters in wealthy communities will prefer property taxes over other forms of public financing.  This is because these voters pay property taxes only for the services they consume.  Just as important, property taxes and property values in this model enjoy a symbiotic relationship:  improved local services inure to the benefit of the neighborhood, increasing values, and thus increasing property tax revenues.  Thus, a childless homeowner still has an incentive to pay property taxes toward good schools, since the fact of good area schools improve the value of his property.

Up until 1971, local taxes in California basically conformed to the Tiebout model: households could “vote with their feet” by moving to neighborhoods where tax expenditures more closely matched their preferences.  More importantly, middle class California families who bought homes could seek to do so in neighborhoods with well-funded schools.

Enter John Serrano, Jr., the man who would become the lead plaintiff in Serrano v. Priest.  Mr. Serrano is popularly described as a poor Chicano from Baldwin Park, a low-income suburb of Los Angeles.  Because Mr. Serrano’s neighborhood had only a modest property tax base, its schools were not well funded.  According to the popular description, however, Mr. Serrano was too poor to “vote with his feet,” and thus unable to send his son to a school a better-funded school.

Like the trope about Prop 13, however, this story is a myth.  As William Fischel recounts in his article, Did John Serrano Vote for Proposition 13? A Reply to Stark and Zasloff’s “Tiebout and Tax Revolts: Did Serrano Really Cause Proposition 13?”, 51 UCLA L. Rev. 887 (2004), Mr. Serrano was a college-educated social worker.  He lived in unincorporated East Los Angeles, not Baldwin Park.  Accordingly, his son attended Los Angeles Unified School District.  Although LAUSD was “property-rich” and well-funded, its schools were poor quality.  Accordingly, Mr. Serrano was advised by his son’s principal to enroll his son in another district.  Mr. Serrano and his family did just that, moving first to Whittier and then to Hacienda Heights, where Mr. Serrano’s son performed admirably in the Hacienda-La Puente Unified School District.  Interestingly, compared to LAUSD, Hacienda-La Puente USD was “property poor”:  the tax base per pupil in 1970-71 was just $5,613, compared with $13,845 in LAUSD.  Still, Mr. Serrano was satisfied with the improved quality of education his son received in his new school.

While Mr. Serrano was moving his son to a poorer but better quality school district, legal activists were devising a litigation strategy to change the next three decades of California education and public financing policy.  By the mid-1960s, legal activists, disappointed with the lack of more radical improvements in education policy since Brown v. Board of Education, began developing new arguments to achieve those improvements through the courts.  According to Kirk Stark and Jonathan Zasloff’s article Tiebout and Tax Revolts: Did Serrano Really Cause Proposition 13?, 50 UCLA L. Rev. 801 (2003), “the core of the reformers’ argument was a principle of fiscal neutrality.”  Predictably, legal activists packaged the argument in an “equal protection” analysis under the Fourteenth Amendment of the U.S. Constitution and corresponding state constitutions.  If they could convince courts that education was a fundamental interest and that wealth was a suspect classification, education funding policies based on property taxes would be subjected to strict scrutiny, requiring states to demonstrate a compelling state interest for expenditure disparities to survive.  Since states would almost certainly be unable to do so, the legal activists would all but guarantee the invalidation of the “benefit view” of property taxes, thus paving the way for more egalitarian tax policies.

Their strategy failed in the U.S. Supreme Court.  In 1973, the Court held in San Antonio Independent School District v. Rodriguez that education is not a fundamental interest and that wealth is not a suspect classification.  As long as a state could show some “rational basis” for employing the “benefit view” of property taxes—which is easily established—disparities in per-pupil expenditures were permissible under the U.S. Constitution.

Nevertheless, the activists hit pay dirt in the California Supreme Court.  Serrano v. Priest held that education is a fundamental right and that wealth is a suspect class.  Following the Court’s 1971 pre-trial decision on the Equal Protection question (which, incidentally, miscalculated the U.S. Supreme Court’s analysis to be handed down two years later in Rodriguez), the Serrano plaintiffs prevailed in the trial court in 1974, making reliance on local property taxes for public schools unconstitutional in California.  The California Supreme Court affirmed the award in 1976 in Serrano II.  California’s legislature passed AB 65, a school finance bill to comply with the decision, the following year in 1977.

It was only after Serrano decisions and the legislative response that voters finally abandoned their support for property taxes.  The very next year in 1978, the property tax cap of Prop 13—whose predecessors suffered resounding defeat immediately prior to the Serrano decisions—passed with 64.8% of the vote.

Economist William Fischel has argued persuasively that it was the redistributionist activism of Serrano, and not a generic aversion to taxes, that galvanized Californians against the property tax and in favor of Prop 13.  “By requiring nearly equal school expenditures per pupil statewide,” Professor Fischel explains, “Serrano divorced local property taxes from the amount of local school spending.”  By preventing households from voting with their feet, Californians were left without means of expressing their preferences concerning their local school districts.  In this respect, it is worth recalling that Mr. Serrano himself, prior to the fallout from the lawsuit that bears his name, enjoyed this privilege and exercised it to express his preference for the Hacienda La Puente USD, despite the fact it spent only 40% per pupil compared to his son’s former school in the LAUSD.  More fundamentally, however, this court-driven policy change meant property taxes no longer functioned to signal voters’ preferences.  Thus, according to Professor Fischel, “it made sense for the voters to nearly eliminate the local property tax for financing schools.”

Prop 13 Is for Lovers…of Property Taxes!None of this is to suggest that financing schools with education is a panacea, particularly in the 1970s.  In more than 30 years since Serrano, however, the case that education can be improved through funding is grim.  In the meantime, the immediate effect of Serrano—namely, Prop 13—remains “a fiscal incubus on California,” as Professor Fischel puts it.  “Removing it or even modifying its more extreme features would improve the workings of both state and local governments generally and would assist public schools in particular.”

However, Prop 13 will likely continue to remain the third rail of California politics as long as politicians and the media continue to mischaracterize its cause.  Until the legislature and the judiciary restore to the public a reason to embrace property taxes—that is, as a means for voters to signal their preferences for public services—Californians are unlikely to relent.  Professor Fischel is right:  “voters would be much more amenable to loosening Prop 13’s constraints if Serrano were modified to allow local property taxation to reconnect with local school spending.”

In the meantime, policymakers ought to stop blaming the voters for continuing to support Prop 13.  That support has been both fervent and continuous for 33 years now—no light or transient cause, this.  California’s policymakers must reform public finance policy to make people want to pay taxes as they did pre-Serrano, or else stop spending the tax dollars that dried up in 1978.  For over three decades, egalitarian activists have experimented with the public school system of one of the world’s largest economies and, in the process, have ruined both.  It’s time for a new experiment.  Or better, an old one.

[Cross-posted at Notes From Babel]

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24 thoughts on “Prop 13 Is for Lovers…of Property Taxes!

  1. Property taxes are troublesome to administer fairly and introduce an economic incentive to neglect that property. Why not replace them with a flat levy on income?

    While you are at it, why not have the state legislature

    1. Appropriate three sum of money: one for counties, one for municipalities, and one for school districts.

    2. Distribute them according to a formula taking into account population and personal income per capita.

    3. Otherwise leave the localities alone to perform tasks permitted by the state constitution, with few if any mandates.

    ?

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    • Art,

      The perverse incentive you refer to, to the extent it exists, owes much more to prescriptive land use regulations. It is these regulations that were the principal player in housing unaffordability and, ultimately, the housing crash. See here and here.

      Voters’ homes are their single greatest asset. Property taxes or not, their local voting decisions are based on them. Given a local land use policy that does not disastrously inflate home prices, it makes sense to tie taxes to real property.

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  2. A. You answer none of my questions. You do not appear to have understood one of them.

    B. Neither of your links is to an analysis of the economic effects of property taxes on resource use. Both abandoned slum property and deforestation are commonly cited in specialized microeconomics classes as manifestations of the ill-effects of property taxes. Are you working with an analysis that says the model is misspecified or that the quantitative effect is nil?

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      • No, it does not.

        There is not one reference to land economics or resource economics in your post, even implicitly.

        You do make reference to ‘redistributionism’, but unspecialized distributions to local government do not alter the expressed preferences of those governments. They merely ameliorate the effect of geographic variation in personal income on the capacity to fund diverse services. The utility of unspecialized revenue sharing is that it reduces pressure to centralize the performance of services due to the disjunction between propensity to consume public services and funding sources.

        The distribution of revenues for schooling would have to be specialized, however, because the provision of those services is not lodged in county or municipal governments and the boundaries of school districts are commonly not coterminous with counties or municipalities.

        I also fail to see how formulaic distribution of a kitty of funds equal to (say) 1.2% of personal income in California ‘divorces tax dollars from local preferences’ given that roughly two-thirds of the funding will come from local revenues.

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        • Art,

          Apparently we’re off on the wrong foot here. I’ll give your first comment another shot, rather than try to start in the middle:

          Property taxes are troublesome to administer fairly and introduce an economic incentive to neglect that property. Why not replace them with a flat levy on income?

          True, they are. Flat levy on income? That sounds fine. My post talks about some of the benefits of a Tiebout model, which draws on the reality that people vote on local issues primarily if not exclusively based on their most valuable assets: their homes. Because of that, there is some sense in linking local taxes to that asset. Curious to know your thoughts about that.

          1. Appropriate three sum of money: one for counties, one for municipalities, and one for school districts.

          My only objections are that it routes all taxes through the state (here in California, that means dysfunctional Sacramento), and the same issue as above.

          2. Distribute them according to a formula taking into account population and personal income per capita.

          Not sure I understand. You mean like a to each according to his need deal?

          3. Otherwise leave the localities alone to perform tasks permitted by the state constitution, with few if any mandates.

          I like the sound of that.

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  3. Tim – Here’s a question I have never been able to figure out about property tax initiatives: Having lived in both CA when prop 13 was passed and Oregon when prop 5 was passed, I remember that each was billed as a way to reduce taxes, not to shift them. Obviously, though, spending in neither state was curbed to accommodate the measures’ passage, so where (at least in CA, I assume you’d have no reason to know about OR) was the revenue taken from to replace the property tax “shortage?” Your depth of knowledge here (impressive!) makes me think you might know.

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    • RTod,

      If you mean, where was it “supposed” to come from, I think the answer is the same as with most initiatives: no one really knew. If the question is, where did the legislature actully look to try to make up the difference, it’s a good one because I’m not sure. I’ll try to see if I can find the answer this evening, perhaps in one of the sources cited in the post, on which I relied heavily.

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  4. This is well-written, Tim, but I’m not sure I agree with all your causal links.

    I’m not prepared to challenge ’em yet, either :)

    Well, except one:

    > However, Prop 13 will likely continue to remain
    > the third rail of California politics as long as
    > politicians and the media continue to
    > mischaracterize its cause.

    I think the cause isn’t as relevant, in today’s terms, as the effect. However, you’ve got a chunk of reasonable argument here to support that, so legwork needs to be done to refute it.

    > Professor Fischel is right: “voters would be much
    > more amenable to loosening Prop 13?s constraints
    > if Serrano were modified to allow local property
    > taxation to reconnect with local school spending.”

    This sort of presupposes that local property taxation is totally decoupled from all local school spending (as opposed to state-funding in particular).

    I highly doubt that the average voter believes that it is, even though the base funding model is per-pupil. Anybody who has seen the campus for, say, Puente Hills High School vs. any school in the Palos Verdes USD just isn’t going to believe that.

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  5. “Economist William Fischel has argued persuasively that it was the redistributionist activism of Serrano, and not a generic aversion to taxes, that galvanized Californians against the property tax and in favor of Prop 13. “

    I can accept that that may have been a major factor that got the ball rolling, but as a long-time resident of the state, I very clearly recall masses of people complaining about their increasing rates. This was a period in which home values in CA rose very rapidly, and it’s my very strong impression that by this time, people had seen that this rapid rise was not going to cool off any time soon (and indeed, it did not until briefly in the 90s, then finally, of course, a few years ago). Surely this could be a major reason why people who had voted against such a change a few years earlier now began to come around? If property values had been rising much more slowly (as they did in many if not most other states at that time), Prop 13 would not have affected rates significantly, and I find it hard to believe that most people would have cared much one way or another. As the deficit fiasco illustrates, there is enormous generic dislike for “increased taxes”—regardless of what they pay for—that politicians can and do use to achieve their ends.

    And it seems that we are returning to a situation of slow groth—or will when home values finally bottom out. As a property owner, I have had assessed value of one of my properties reduced by more than half. Even after we hit bottom, I anticipate that values will rise very slowly for a very long time. So a major benefit of Prop 13 will no longer exist.

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    • Andy,

      I completely agree. Upthread I posted a couple links that explain how the dramatic increase in land use regulations led to the sharp rise in housing costs in California, and ultimately were a major contributor to the housing bubble. I’m planning to talk more about this in a forthcoming piece.

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  6. Another outstanding piece, Tim.

    A significant issue that ought to be thrown in to the mix is the constitutional mandate of state spending on education. The Serrano case goes even further than Prop. 98 and mandates that the spending come in a particular way, Prop. 13 eliminates a significant source of that spending, and the state is losing the ability to enter into long-term debt financing to bridge those gaps.

    Another issue is that California has two kinds of cities and diffuse taxation authority. Most of California’s small cities are effectively political subdivisions of the state the same way the counties are. While charter cities have greater flexibility in spending and moderately greater ability to impose taxes independent of the state, the bulk of revenue generated at all levels and from all sources is run through Sacramento at some point. But more and more local governments are asked to assume more and more responsibility for providing services, with less money coming from Sacramento as the state government both services larger amounts of old debt, takes on new projects mandated by voter initiatives (some of which, while theoretically good ideas, are Constitutional amendments themselves and therefore beyond the ability of the Legislature to meaningfully modify in the face of changing fiscal and economic realities), there are legacy debts like pensions and health insurance programs to fund, and the disability entitlement system for state employees is expensively in need of reform.

    Already, cities have gone bankrupt and school districts have been placed in state receivership because the problems are too great for weaker local governments to solve on their own.

    The resolution of necessity will have to include a blend of decreased overall spending, including on education, and increased sales, excise, and income taxes. We will pay more, and get less. I have grave doubts that increased local control will produce good results, looking at the susceptability of local governments to corruption. But I also have grave doubts about the statewide government’s ability to handle the matter, considering the smoke and mirrors that the pros in Sacramento “>used to address the last round of financial problems.

    In a general sense, I think it’s too easy to amend the Constitution and spending decisions should be left to the elected officials and not the voters, who exercise too much sovereignty for their own good. (An opinion I maintain despite my deep distrust of the current and likely future crops of elected officials.) But I despair of the prospects of successfully changing the state’s Constitution in a manner that will address these problems in a meaningful way.

    Maybe we’re just going to have to ride the slope all the way to rock bottom and then burn the whole governmental apparatus to the ground before we can build a state government from the ground up, one that makes fiscal and public policy sense.

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    • Now who’s the declinist? ;-)

      I tend to agree with you here, Burt. These problems span several decades, so it’s hard to confirm this, but my sense is that the ultimate fault is on lawmakers (and to some extent, such as in Serrano, judges) who legislate over the heads of the people. The people then respond by amending the state constitution, the only recourse left to them when their leaders go rogue. It all leads to horrible unintended consequences since the people are not statesmen. But I’d also wager the people are happier with horrible legislation of their own making than perhaps less-horrible legislation passed against their wishes by we-know-what’s-best-for-you elitist lawmakers.

      Great comment, by the way, and thanks for the links. Will be helpful in the next piece I’m writing.

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  7. Thank you for a thoughtful piece. Most interesting to me is the difference of civic perspective between Northern and Southern California.

    Here in the Bay Area, we have many locally-funded (‘basic aid’) districts. In fact, the majority of students in San Mateo county go to schools that receive no state property-tax back-fill. Thus, once again, property taxes and schools are directly coupled. And we are, therefore, increasingly interested in property tax mechanics up here — who’s paying and who isn’t, how property taxes are divided up, the effect of redevelopment agencies, etc. (I am, perhaps, making your case for you!)

    Meanwhile, largely because of the post-Prop 13 allocation of taxes in LA County, for example, only BHUSD (which also receives $2000+/student in oil money) has popped to ‘basic aid.’ Somehow, LA schools seem to have been allocated 15% of the pie, while ours got 30%+. (One can understand no- and low-tax counties, but ours was hardly one of them.) Thus a large swath of the Southland is structurally unlikely to see the connection for some time.

    Having said that, my primary concern with your “It’s Serrano, stupid!” argument is that I generally hear it from people who most want to keep Prop 13 and, specifically, the disproportionate benefits it brings to a privileged group of commercial property owners. It follows on the “It’s Illegal Immigrants!” and “It’s Public Unions!” cries of earlier years. Serrano may have played a large part, but, having been pushed to buy a house by a rapidly escalating market in 1977, I can also attest to the threat of rising assessment values — especially atop the double-digit consumer inflation of the period and the twin psychic shocks of Vietnam and OPEC a few years earlier. Add to that frustrations around equal opportunity (especially in government hiring) and you have the perfect emotional storm. (I note that, even you call it a wildly popular measure … though please note that it passed by a smaller margin than, in fact, it requires for passage of future taxes.) Seeing Prop 13 as only the child of Serrano is mistaken.

    From the NoCal view in a district spending $12,000/child (averaged over elementary and high schools), your points are well made and fascinating … and/but … adding meaningful school reform to the list of ‘To Do’s’ before going to work on Prop 13 feels like a delaying tactic. To address some points made by posters:
    (1) school funding, in upper-middle-class districts with a strong professional parent-dominated school board matters a LOT … in a struggling working class district with a less qualified school board (or one dominated by ex-administrators and politicos) — especially since such a district is likely to be tied up in fed- and state-mandated red tape — the benefits of funding are less obvious
    (2) do not confuse school building/campus spending with school spending — high-income districts pass school bonds to improve the former as a way of substituting capital goods (buildings/smartboards) for labor (teaching); these ride outside the Prop 13 1% tax levy (though requiring a 2/3 supermajority to pass)
    (3) real property taxes are among the easiest to assess and administer. Unlike income, which can hide in many places, real property is out in the open for all to see. Parity between the vast majority of properties is also relatively easy to assess — if you doubt me, go to your local assessor’s website and look at the housing up and down your street. You will quickly realize who’s getting a deal and who’s paying the piper. Because you’re a qualified appraiser? No. Because you have eyes and an economic sense of what things sell for, based on taking those flyers out of the For Sale boxes in your neighborhood for the past X years. Commercial is somewhat tougher, but, again, download some data and start looking.

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    • Jennifer,

      I agree that Serrano was not the sole impetus for Prop 13.  However, I take Prof. Fischel’s point as being that Serrano was the primary impetus, or perhaps more to the point, was a larger impetus than rising home prices was.  As to the latter point, recall that rising home prices were the result of ill-considered land use policies rolled out in California over at least the past five decades.  Links are upthread here, and I have a lengthy post in the works on the subject.

      If we’re keeping score, then, California’s government is responsible for an ill-considered disruption of the desirable and efficient link between homeownership and property taxes, as well as the ill-considered artificially spiking of home prices.  The people are responsible for the response to those policies by passing Prop 13, a law that, like many voter initiatives, has devolved to us some egregious consequences, windfalls to commercial property owners perhaps most severe among them.  But why would our leaders expect Californians to back down on Prop 13 before the leaders give way on their policies that instigated it in the first place?  (I would agree, however, that Californians’ aversion to fixing the commercial windfall aspects of Prop 13 is quite irrational.)

      The commercial aspects of Prop 13 aside, this is not a “delaying tactic.”  Californians, I believe, feel that Prop 13 is their thumb in the dam; more bad will come if they take it out, not less.  I’ll be the first to agree that initiative amendments tend to make bad law.  But they are not the fault of the voters.  The people are roused to make these bad laws because their elected lawmakers are nonresponsive to their constituencies.  For better or worse, we’re left with the consequences of when lawmakers go over the people’s heads.

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