Proposition 13- Unintended Consequences

A recent Field poll of California citizens indicated substantial majorities had a positive view of Proposition 13, the law which severely limits property tax increases except when real estate changes hands.

This poll was like asking people if they would like to see their taxes increase, without pointing out what the additional government revenue might be used for, or what the unintended consequences of Proposition 13 have been. For example, no mention was made of the fact that California now spends less than half of the amount per pupil on its public schools than New Jersey, the California public schools generally have serious problems, and that the shortfall in funding can be traced largely to Proposition 13.

The great resulting tax disparity can be found in a middle upper class neighborhood here in Northern California. On a Monte Sereno dead-end cul-de-sac sits eleven homes. Six families are pre-Proposition 13 taxpayers that pay a total of $14,200 worth of annual property taxes. The other five pay $125,000.

Most people are unaware that, in addition to protecting single family residential property from sharp property tax increases, Proposition 13 also shelters industrial and commercial property. Generally speaking, property owned by a corporation or partnership will not be reassessed until more than 50% of the ownership of the corporation or partnership changes hands. Careful planning can avoid such ownership changes for many decades, even after some of the shareholders or partners die. Even more startling, if real property was owned by a corporation or partnership prior to the passage of Proposition 13, it will never be reassessed, barring a sale, unless there is a shift of control of the corporation or partnership to a single individual or a single entity. That means, for example, that property owned by PG&E prior to the Proposition 13 passage will essentially never be reassessed, since no one person or entity is likely to ever gain control of PG&E by owning more than 50% of its stock.

All of this means that there has been a steady shift of the property tax burden from commercial and industrial property to residential property, while at the same time our schools have been starved of revenue.

Other tax laws significantly increased the unfortunate effects of Proposition 13. For example, except among tax lawyers and accountants, there is little or no awareness of the effect of the capital gains tax. The capital gains tax of course tends to discourage sales of property, which means that real estate changes owners less often, and is reassessed less often. If Proposition 13 were not in effect, there would be no impact of the capital gains tax on property tax revenues.

The effect is significantly increased by the fact that any property owned at the date of a person’s death is thereafter treated, for income tax purposes, as if it had a cost equal to its fair market value on the date of death. This wipes out the capital gains tax on any sale after death. It creates a significant incentive to hold on to property.

However, in California, and other states that have the concept of “community property” between husband and wife, any property that is community property receives a full new tax basis, wiping out capital gains tax, when either the husband or the wife die. A single individual might find it necessary to sell, if there were a need to move to assisted living or have access to the equity in the home. A married couple, however, has all the advantages of a sale without capital gains as soon as one of them dies. Beyond the obvious unfairness that this creates with respect to community property v. separate property, married individuals v. single individuals, etc., it makes the real estate market even less liquid by encouraging married couples to delay any sale, and thereby increases the negative impacts of Proposition 13.

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One Response to Proposition 13- Unintended Consequences

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