Before I get into the meat of this topic, I'd like to share one of the most enraging political ads I've seen in years:
Did you watch it? Good, I'm going to pretend you did and I'm sorry for putting you through that. The only true statement in that video is that politicians have wanted to repeal Prop 13 ever since it was passed—because it's among the most crippling and unjust laws California has ever seen.
What is Prop 13?
Often called the "taxpayer revolt," Proposition 13 was a mob-approved amendment to the California state constitution. It provided a tax break for homeowners by rolling back property taxes to 1975 values and limiting the year-over-year increase in taxable value, regardless of the market increase in land value.
With all of the foresight an irrational mob could muster, Prop 13 also contained terms that made it practically impossible to raise most taxes—forever. Evidently nobody could fathom a scenario where the state could need more revenue than it did in 1975.
But don't worry! Prop 13 didn't stop all taxes from being increased. Only the most equitable ones like property and income tax. We're still free to raise the regressive sales tax to make up for the lost revenue—and we have.
Why limit property taxes?
It's always popular with voters to guarantee taxes won't go up. The specter that inspired the property tax limitation of Prop 13 was this hypothetical tale:
George is an upstanding and hard working baby boomer just like you. He bought a house in Cupertino in his 30s and worked his whole life to pay off his mortgage before retirement. But now he's in a bind: land values in Cupertino have skyrocketed because of this newfangled fruit company moving in! George bought his house for $30,000 but now the tax assessor thinks it's worth $2,000,000.
Having pinned his retirement on social security, George's fixed income can't even pay the property taxes on the home he's lived in his whole life. Don't be George. Stop the state of California from forcing retirees out of their homes! You worked hard for your house, you deserve to retire in it safely!
Of course, the 63% of voters that approved Prop 13 weren't all baby boomers, but the argument was a convincing one. Nobody wanted to be forced to sell their home just because the land appreciated faster than their ability to pay for it.
What do property taxes pay for?
Forty years later, California is a strange beast. You can find town after town of absurdly rich people living in absurdly valuable houses, but everything leading up to their million dollar homes looks like it was built in the 50s and never touched since. Pockmarked roads, dilapidated libraries, tiny schools, dirty parks, and dysfunctional public transit litter the landscape of our otherwise wealthy communities.
(Photo credit to San Jose Mercury News)
This is in part because property taxes pay for local government. Your town, your schools, your infrastructure is paid for by your property taxes. Of all the taxes you pay, property tax is the one that will have the most immediate and direct impact on your day-to-day life. Property tax is also likely to be allocated the way you intend it to be, because your local elections are far more influenced by your singular vote. You do vote in your local elections, right?
Property tax is a flat tax on everyone in a community to pay for the things the community collectively desires—like schools. Limiting our ability to collect this tax means limiting our ability to govern our own communities. Prop 13 forces us to choose between maintaining our parks and funding our schools when there's enough money to do both ten times over.
For those that hate big government: limiting our property taxes means our local governments are more dependent on state and federal funds to pay for the basic services we expect. State and federal funds come with state and federal rules and stipulations. For those that value fairness: state and federal funds should be spent on the communities that can't afford to support themselves, not on the ones that simply choose to beg for money instead of paying their dues.
Contribution to Housing Crunch
Prop 13 allows the state to fairly reassess the land value once the property changes ownership. This means that the new neighbor next door is paying higher taxes than you are for the same parcel of land. It also means you have an economic advantage if you never sell your house. Warren Buffett points out that he pays more property taxes on his $500,000 house in Nebraska than he does on his $4,000,000 one in California.
This distortion of the housing market, or "lock-in effect" is measurable, with Californians both owning and renting for longer periods of time than ever after Prop 13. Not surprisingly, the effects are strongest in poor minority populations where mobility is already limited by other factors.
When fewer people sell their homes, each home that comes on market has more competition, which drives real estate prices higher, which makes the Prop 13 advantage of not selling your home even greater, which ... hopefully you can see the spiral we're in.
But think of the retirees!
Ah yes, George. Without the protections of Prop 13, how could he survive his predicament?
Nobody seems to pay much attention to the detail that George's house has magically appreciated to be worth $2,000,000. If he's a victim of property taxes, he's also a victim of having money literally dumped in his lap through no work of his own. Is housing a lottery that we're all hoping to win without having to pay any taxes on our winnings?
George never wanted his house to appreciate that quickly; he didn't want to win the lottery. He budgeted on a conservative 3% annual appreciation and expected his $30,000 house to be worth only $100,000 when he retired. He planned on paying $1,250 annually in property taxes during his retirement, but now his $2,000,000 home costs him $25,000 in property taxes every year.
But even if his house never appreciated another penny in his life, and even if his retirement lasted 30 years, George could pay his property taxes directly out of his home's value and still have $1,150,000 left as inheritance to his estate.
George doesn't even have to sell his house to enjoy his free money. A home equity loan would pay his taxes and have a monthly payment lower than the original property taxes he expected to pay. A loan on a house that is worth an order of magnitude more than he ever dreamed it would be. A loan that will be paid off automatically the instant he dies and his estate decides to sell the house.
George is no victim. George could be living out his retirement on an exotic island without spending a penny of his actual money. Luckily, Prop 13 allows his entire generation to do that and pay nothing in taxes to the community that made it possible. What luck!
Fixing the loophole
Any homeowner in California will sheepishly admit that they enjoy the tax loophole that Prop 13 provides them. None of us can honestly say we think it's fair that a house worth $2,000,000 is taxed as though it were worth only $100,000. And we can fix it.
My first proposal assumes we didn't just read about how fixed-income retirees don't need any protection from taxation after winning the housing lottery. We could keep Prop 13's provision that the tax assessor can only raise your property value a fixed amount year-over-year. The catch? The state has the right of first refusal on purchasing your home at the tax-assessed value when you want to sell it.
This way, there is no housing lottery. George pays the property taxes he always planned on, he has a guaranteed sale to the state for the value he planned on, and the state benefits from his ignorance of basic finance by pocketing the difference as revenue.
But let's be honest: Prop 13 isn't protecting retirees. Nobody's as dumb as George. California is full of old and rich people sitting like decrepit dragons on hoards of gold in the form of rickety 1950s shacks. That is, if they're not busy burning villages or whatever it is retired dragons do for fun.
The real solution is to simply repeal the proposition. To ease the shock, reduce the overall property tax for everyone to match current revenue. That's right, most of us actually get a tax break. George and Buffett get to finally pay their dues by skimming a bit off the top of their historically high home values.
Eventually, perhaps over the course of a decade, the state can return property taxes to reasonable values. We can use the extra revenue to lower regressive taxes, improve public transit, build libraries in communities that need them, and fund a school or two.
Assuming we can agree that public education is a good thing, too.