Landlords and Heirs: Why Prop 13 isn’t just unfair, it’s un-American

Last year I wrote about ballot props. This year, I’m taking a closer look at Prop 13 (here are two primers), the original sin underlying so many of California’s problems and inequities. The dynastic subsidy of landlords and especially land inheritors distorts markets, has subtly (if unintentionally) racist effects, and is fundamentally antithetical to the idea of American meritocracy.

A family of landlords, passing their property down from one generation to the next.

With a statewide housing crisis in full swing, Proposition 13 of 1978 is one of the most emotionally charged political issues in California. Unfortunately, the “debate” too often comes down to “it’s not fair they pay so little!” vs. “but we can’t let seniors lose their homes!” There is some truth on both sides: new homebuyers often do pay 5 to 10 times(!) what their older neighbors pay in property taxes, and many of those older neighbors would not be able to afford the current rates. But it’s clear the fairness argument isn’t changing anyone’s mind, especially given how sympathetic widows and pensioners are as a group. In fact, I believe framing the debate this way actually inhibits discussion of some aspects of Prop 13 that are potentially more tractable, including two of the most egregious: the perpetual taxpayer subsidy of landlords and heirs, the new landed gentry of California.

Landlords

Most people think about Prop 13 from the point of view of the homebuyer, but it applies to basically all real estate, including commercial buildings, rental properties and vacation homes. In other words, we’re not just protecting people from being forced out of their own homes, we’re directly subsidizing real estate investors. Landlords’ rents rise with the market, but unlike virtually everywhere else in the country, their taxes do not. Prop 13 is effectively rent control for landlords (in fact, Prop 13 was a major catalyst for new rent control programs, including San Francisco’s).

A personal example: 15 years ago I lived in a 2BR duplex in downtown Palo Alto owned by a major Palo Alto landlord, splitting the $2,000/month rent with a roommate. My old unit was listed for rent last year for nearly $8,000, a 4x increase in 15 years. And the landlord’s tax bill? It turns out this unit is part of a tax parcel that includes three buildings with a total of 8 units. The landlord pays $7,480 a year for the entire parcel. Yes you read that right. His annual tax for 8 units is less than the monthly rent he collects for a single unit. In other words, he pays less than $1,000 per unit per year; at a current market value of $1.5 million (it’s probably higher), a new buyer would pay more than 15 times that amount.

It’s important to note that the tenants aren’t seeing any of those tax savings. They pay $8,000/month, full market rate. Landlords charge whatever rent the market bears — older investors receiving large Prop 13 subsidies simply enjoy a higher profit margin than younger ones who do don’t. Whom are we protecting by giving landlords an essentially permanent tax exemption?

Heirs

Now for the most insidious feature of Prop 13: inheritance. In 1986 and 1996 respectively, California voters passed Propositions 58 and 193, which extended Prop 13 to exclude from reassessment property transfers between parents and children (58) and grandparents and grandchildren (193). As a result, when you inherit a home in California, you inherit its tax assessment as well. In other words, we’re not just making sure granny can stay in her home — we are subsidizing her children and grandchildren forever. Our country was founded on the idea that it shouldn’t matter who your parents were. The founding fathers were violently opposed to anything even smacking of aristocracy. Prop 13 is fundamentally anathema to this principle: if your parents were able to buy a home 30 or 40 years ago, the state dramatically subsidizes your property tax bill for the rest of your life. There are so many benefits to having parents with means — in America, a lifetime tax discount should not be one of them.

A potentially controversial aside: the earlier your parents bought their home, the bigger your tax discount. But not everyone could buy homes in the 70s or 80s — until shockingly recently, redlining and other discriminatory policies made it extremely hard to buy a home in nice neighborhoods if you weren’t white. The structural barriers that prevented racial minorities from buying homes for decades now render their children and grandchildren ineligible for the biggest individual tax break our state offers. I have long wondered if there could be a constitutional basis to overturn Props 58 and 193 on equal protection grounds.

And it’s not just the family home that receives the dynasty discount: the inheritance transfer exclusion applies to investment properties as well. There is a $1 million limit per property [EDIT: apparently it may be a lifetime limit, I haven’t clarified the law here yet, apologies] but it’s $1 million of assessed value, not market value. So in the case above, my old landlord’s children could inherit all eight units, worth well over $10 million but currently assessed at just $665,060, with no reassessment and no tax increase.

All of this is to say…landlords and heirs are often the same people, and Prop 13 provides a tremendous incentive to be a landlord. Many of the largest residential and retail landlords on the peninsula are multi-generational companies run by the children and grandchildren of the original property owners. They are the new landed gentry of California, collecting 2017 Silicon Valley rents while paying 1970s tax rates. Only new buyers pay.

The idea: revoke the subsidy for landlords and heirs, and use it to lower property taxes for everyone

The original purpose of Prop 13 was to slow down runaway property tax rates for homeowners who couldn’t afford them. There are two changes that feel like no-brainers to me, yet keep to that original spirit:

1. The 2% annual tax increase cap should apply only to one’s primary residence. No commercial buildings, no rental buildings, no vacation homes. If you don’t live there, you shouldn’t get a subsidy #StopSubsidizingLandlords
2. Inheritance should trigger reassessment. Repeal props 58 and 193 — you’re already getting a free house, surely you can pay the same tax as buyers who had to pay for theirs #StopSubsidizingHeirs

These two changes (rolled out gradually) would generate a huge amount of tax revenue for the state. This would allow us to lower the baseline property tax rates for everyone. In other words, what if we held tax revenue constant, and just smoothed out who pays? Wouldn’t that be more fair?

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Epilogue: want to work on this?

Obviously the key unanswered question here is: how much are the discounts for landlords and heirs actually worth? To paint a more accurate picture of how these dynamics work in reality, we need data. To my knowledge, there is no statewide dataset that includes 1) whether each residential unit is owner-occupied, 2) the complete tax and transfer history for each residential and commercial unit, and 3) a reasonable current market value estimate (a la Zillow’s Zestimate). If you are a data scientist and either know of such a dataset or are interested in working with me to create one, get in touch by commenting on this piece or finding me on Facebook!