Next week, Californians will vote on a ballot initiative, Proposition 15, that would lift longstanding limitations on commercial property taxes. It’s hard to imagine a worse time to raise property taxes. Office and retail vacancy rates are skyrocketing, and it’s an understatement to say that Californians are already highly taxed. California’s top state income tax rate of 13.3 percent is the nation’s highest, according to the Tax Foundation. It ranks fifth in per capita state and local tax collections, and sixth in overall state and local tax burden. The state that Woody Guthrie, in his famous Dust Bowl Ballads, called “a Garden of Eden, a paradise to live in or to see,” is no longer a magnet for newcomers but instead a goad driving residents to Texas, Idaho, and other states.
Yet while the initiative is ill-advised, problems remain with the measure that it is designed to undo—Proposition 13, the statewide property-tax limit passed in 1978. Though Prop. 13 has served as a last line of defense against an even greater tax burden, it has also distorted California’s housing market by encouraging long-time owners to stay in houses larger than they need and making it more difficult for potential newcomers to buy or rent in a state that has enjoyed one of the nation’s strongest economies.
Still, repealing Prop. 13, either for commercial or residential property, would be a mistake. What’s needed instead is a thoroughgoing reform of the state’s tax regime—one that might raise property taxes on some, but only if income or other taxes were lowered.
California’s current system freezes residential assessments at a home’s most recent sale price, even if the underlying value of the home has risen. Not surprisingly, the state’s Legislative Analyst’s Office has found that “the share of properties sold each year in California has been on the decline since the passage of Proposition 13.” It found that 16 percent of properties were sold in 1978, compared with just 5 percent in 2015. The National Bureau of Economic Research came to the same conclusion, calling the sales decline the “lock-in effect.” The law thus protects those whom Harvard economist Edward Glaeser refers to as “incumbents” at the expense of, say, those who would like to move to the Bay Area from a region of high unemployment, thus playing a part in the national trend of wage stagnation.
Prop. 13 also diminishes local control of public finance and spending choices. Thanks to a 1976 state supreme court decision that found reliance on local property taxes for public education funding unconstitutional, Sacramento pools and then disburses property tax revenue throughout the state. Dartmouth economist William Fischel showed how that court decision factored into support for Prop. 13 two years later; after the court decision, voters had no assurance that their municipality would see any benefit if their property taxes went up. The result has been a downward spiral in public services, including education.
Property taxes are the most sensitive barometer of a city’s quality of life and public services. Severing them from local control limits a municipality’s capacity and incentive to maintain and improve itself. In a healthy state, municipalities compete to provide not just better services but different types of services. The combination of control from Sacramento and the Procrustean bed of Prop. 13 distorts this process.
Proposition 15 would address this distortion, but only for commercial properties, while leaving in place a punishingly high state tax rate and state control of local spending levels. It would also send a disastrous signal to investors and undermine the struggling commercial real estate business. What California desperately needs is something very different: a lower overall tax burden, more sensibly determined and distributed.
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