Thornberg (and me) on Prop 13

I promised more on Prop 13.

Chris Thornberg is a California small business owner, home owner, and investor. As a “job creator” he’s just the kind of person you’d expect those on the right to celebrate. He’s also an economist who specializes in the California economy.  I encourage the curious Californian to read his well-written piece on California’s Prop 13.

Prop 13 arbitrarily limits annual property tax increases to 2% regardless of the rate of inflation. Reassessments are allowed under very few conditions. By far the most common condition is the sale of a residential property.  As Thornberg describes, commercial property investors have found novel ways to (can afford lawyers for) essentially selling properties without reassessment.

Prop 13 began in the late 1970s. During the late 1970’s and well into the 1980’s U.S. inflation was quite high, so the real (inflation-adjusted) property tax bills of long-held property have collapsed. People who bought later, during tamer inflation levels, have seen less benefit.

For example, someone who owned a property in 1977 has seen their real tax bill drop (*) by nearly 50%. Someone who bought in 1997 has a property tax bill that is a whopping 5% lower.

Furthermore, all of this is a windfall to those who owned property prior to Prop 13. A person who purchased property prior to Prop 13 would not have expected that their investment would be subject to declining real property taxes. People reasonably assume that expenses keep up with inflation.

(Right-wing cranks claim that the government intentionally and dramatically understates the rate of inflation. Thus, they would have to logically conclude that the real decline in taxes paid is even more pronounced. “Logically” is the key word here.)

In my opinion a sensible reform to Prop 13 would replace the 2% cap with the inflation rate for primary residences. Even grandma’s social security check is indexed to inflation (COLA). (Residential owners would also be able to “take Prop 13 with them” when they change their primary residence to another property they own. For example, if someone moves into a vacation home they’ve held for 20 years, then going forward their property tax bill for that property would be the same as if they’d lived in it as a primary residence for the entire 20 years.)

For other properties the cap would be indexed to nominal economic growth. Nominal economic growth includes inflation plus changes in real economic activity. Among other things, nominal economic growth is indicative of changes in rents and wages. (For certain owners who can demonstrate limitations on their property’s income growth the limit could be lower. In particular I’m thinking of owners of rent control units.)

These changes would be retroactive but with an additional annual phase-in cap to limit “payment shock”. (Elderly residential owners could avoid the cash flow impact entirely by opting to take it as a property lien that would only come due upon sale of the property or their death.) The increased property tax revenue would be refunded to California income tax filers. So it would be “revenue neutral”. This is fair and it’s good economics. (**)

Aside: California’s Prop 8 is the asymmetric cousin of Prop 13. If a property’s assessed value falls, even temporarily, the owner can demand a reassessment. This lower value then becomes the basis for Prop 13 calculations going forward. Prop 8 allows savvy owners to set their basis at cyclical lows while avoiding higher taxes during higher cyclical prices.

* Inflation data source: FRED,Consumer Price Index for All Urban Consumers: All Items (CPIAUCNS)

** This is the point where there’s the huffing, puffing, and foot stomping about not trusting the numbers and how the government will figure out a way to fake the numbers or increase taxes some other way. But if the government can and does fake the numbers and increases taxes in other ways, they’ll do it regardless of any Prop 13 reform. So save your breath.

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