Make California Great Again — Part 2
Part 2 — Repeal Prop 13 (and increase Property Taxes)
Chance of happening: Same as my finding that unclaimed $63 million Powerball ticket under my couch cushion
Part 1 | Part 3 | Part 4 | Part 5
A 2004 NBER paper by two UCSD Economists begins with the following quote:
In 2003, financier Warren Buffett announced that he pays property taxes of $14,410, or 2.9%, on his $500,000 home in Omaha, Nebraska, but pays only $2,264, or 0.056%, on his $4 million home in California.
When Mr. Buffet bought that home, he likely paid between $100,000-$200,000. However, thanks to Proposition 13, the 2000–4000% increase in the value of his California home did nothing to affect the total he owes in property taxes.
If Mr. Buffet were a California resident and wanted to stay in the state, then there is very little reason for him to “downsize” to a $1 million dollar home that may be a better fit for his lifestyle, or even to renovate his house, lest he trigger an assessment of the “improvements” added which could easily double or triple his annual property tax.
So what is Prop 13?
I’m glad you asked. Proposition 13 was a ballot measure approved by 62.6% of voters in 1978, with majorities in all counties except 3 (San Francisco, Yolo and Kern counties). It is also known as the third rail of California politics.
Prop 13 made three consequential changes to California law regarding taxation when it was passed in 1978:
- Enacted a statewide ceiling on property taxes at 1% (bond measures and other voter approved measures can still be tacked on)
- 2/3rds supermajority required in each house of California’s legislature to pass any increases to statewide tax rates
- Froze all property values at their 1975 assessed value, and capped annual appreciation of the that assessed value at a rate no greater than 2%
Reappraisals are triggered when a transaction occurs, however, the cap in appreciation (at a rate lower than historical inflation rates) has caused California to experience rapid increases in housing prices through artificial supply cuts. Holding the stock low, and decreasing turn over rates has also had downstream effects on anything dependent on revenue from local coffers such as education and public services. The think tank responsible for Prop 13 has proclaimed that it has saved taxpayers $528 billion…think of how many potholes that could filled (or children that could have educated) (source).
Terrible news for fans of good governance: Thanks to Prop 8, if for some reason your property value plummets (see Great Recession of 2008) you can always have its value reassessed to the new market rate. That may not (but hopefully it does) help you avoid foreclosure if you’re having trouble making the mortgage payments, but if you can ride out the recession, it can be extremely lucrative as it locks in those property tax savings for as long as you own your house.
Effects on Housing Prices — longer version
A paper published by the University of San Diego suggests that Prop 13 has caused a decrease in “revenues to the brokerage industry…[of] at least a third”. The effect, as the paper puts it, ripples across all “associated industries that benefit from the sale of housing” such as moving companies, appraisers, mortgage lenders, title companies, carpet sellers, painters, and so forth. So it essentially has the opposite effect on the economy as Rocket Mortgage’s Super Bowl says its mortgage app will.
By decreasing the available supply, the effect on housing prices can be seen on the following chart. Compared with the US average, California has seen an astronomical rise in the median value of a Single Family Home when compared to the rest of the country. And yes, I realize this is not PhD dissertation level economics here, and there are definitely other confounding variables such as the lack of non-compete clauses which led to rapid innovation in the biotechnology and tech industries, but we’ll get to the PhDs in a minute.
Prop 13 has really affected only a single generation since its passage 40 years ago. As the voters who originally approved Prop 13 begin to pass their property onto later generations — inherited property incurs no re-appraisal penalty — the stock of homes protected by the legislation will only continue to grow, and supply continue to dwindle.
The University of San Diego paper cited earlier shows these trends developing even in the current housing stock. Similar to Mr. Buffet’s statement earlier, many homeowners in San Diego County are benefitting from lower effective tax rates due to favorable appreciation in their home values.
These lower effective tax rates are also correlated with lower rates of turn over as people with lower tax rates are less likely to sell their homes:
Additionally, in a non-Prop 13 market, we should expect to see limited variance due to differences in bond measures, etc. at the county level, and a mean value around 1% regardless of the age of the house as property appreciates at the market rate, not at a government-mandated ceiling. Instead, we see that as the house ages, its effective tax rate declines without exception:
And finally, the NBER paper also corroborates these findings of long rates of homeownership, except their findings introduce time and a control group. In California, they found a 25% increase in homeowner length of tenure for residents versus a 9% increase for residents in Florida and Texas from 1970 to 2000:
Entire PhD theses will/should/could be undertaken to determine the magnitude of the causal effects of Prop 13 on California property values. However, in the few examples presented, it is clear that whatever that magnitude is, it is definitely positive and it has led to 1) Longer lengths of homeownership and 2) Higher property values.
Also, these examples weren’t even cherry picked, because there is no one arguing the contrary. Even the Koch-funded taxfoundation.org website thinks it’s a bad idea…just let that sink in for a second. Yeah, they think Prop 13 a bad idea too.
Conclusion
There are a bunch of other downstream effects we can get into here, but maybe I’ll save it for another post, or just ignore it all together. One interesting point from the University of San Diego paper (using a house in the expensive neighborhood of Coronado) was that this particular homeowner(s) received a 30-year NPV subsidy of ~$250,000 (at a 3.3% discount rate) thanks to Prop 13. If this were a PhD thesis, it would be really interesting to try and explain how much of that $250,000 subsidy goes back into the market price of that home, and at a larger scale what percentage of those subsidies in the entire California housing market drive the increases in property values.
Overall, the evidence suggest that Prop 13 really sucks for Californians. While there are benefits to having a low tax burden in retirement, it is a bit disingenuous to claim this as a reason why we should keep Prop 13 around as there are not that many down-and-out retirees hanging onto their multi-million dollar homes simply because the property taxes are low. If that is the case, it probably makes more sense to sell the house and move to another state with the amount of equity that would become liquid — you’re literally a millionaire. Would be great to have some empirical evidence, however :).
Next time on Making California Great Again
The mysterious case of The Train to Nowhere
