Prop 13 Is for Lovers…of Property Taxes!

Last week’s “OC Watchdog” piece by Teri Sforza in the OC Register pokes the Prop 13 bear, suggesting it is time Californians withdraw their opposition to higher property taxes, by focusing on the familiar scenario of the new homeowner paying scads more in property taxes than his long-time homeowner neighbor.  For those unfamiliar with this watershed issue of California tax and public finance policy, Prop 13 is the wildly popular constitutional amendment passed in 1978 by a margin of nearly two-to-one, cutting rates on all property taxes to a maximum of 1% of 1975 property values.  Cal. Const. art. XIII A, §§ 1-2.  Prop 13 allows assessments to rise by no more than 2% per year, and revaluation may occur only when property is sold.  After its passage, Prop 13 cut statewide property tax revenues by a staggering 57%.  It is commonly blamed by politicians and the media as one of the chief causes of the decline in the funding and, more debatably, the quality, of California’s sub-par school system.

Like many Prop 13 opponents, Ms. Sforza points to Prop 13’s loopholes, such as 1031 like-kind exchanges available to commercial and investment property owners, suggesting homeowners are getting the short end of an already wrongheaded deal.  Similarly, LA Mayor Villaraigosa attacks Prop 13 as “a corporate tax give-away.”  Says Villaraigosa, “[w]e all know the history” of Prop 13:

With the state experiencing rapid growth and high inflation, we had people literally forced out of their homes by skyrocketing assessments. And we all know what’s happened since. Not only have we suffered the long?term consequences of disinvestment in public education and public infrastructure ?? Prop 13 has had the unintended effect of favoring commercial property owners at the expense of homeowners.”

However, a closer study shows Villaraigosa’s “history” is not only incomplete, it is wrong.  In fact, just six years prior to decisively enacting Prop 13, Californians even more decisively (65.9% voting against) to defeat Prop 14 (a/k/a the “Watson II” initiative), a similar proposed constitutional amendment to limit property taxes.  Four years before that, Californians rejected still more resoundingly (68% voting against) the same idea in Prop 9 (a/k/a the “Watson I” initiative).  Moreover, state law at the time placed ceilings on the tax rate that school districts could assess without the approval of a “tax override” by a majority of district residents.  As of 1971, nearly every district had approved such an override.

In the years immediately preceding the passage of Prop 13, then, Californians decisively favored property taxes.  Thus, the conventional wisdom—that Prop 13 was some reactionary and ill-considered measure carried out by tax-revolting class-warriors—fails to explain what was actually happening in California at the time.  (As I will explain in a forthcoming piece, rising housing prices resulting from increasingly restrictive land use policies also caused Californians to warm to the idea of a property tax cap.  This phenomenon, too, undermines the conventional wisdom.)  Perhaps most importantly, the conventional wisdom has put policymakers off the scent of meaningful tax and education reform.

Missing from most discussions about Prop 13 is that, once upon a time, Californians liked property taxes.  As Charles Tiebout explained, given a certain level of consumer choice and mobility, the provision of local public goods will approximate the private market.  The Tiebout model assumes there exists a variety of different jurisdictions offering a variety of bundles of public services—good schools, for example.  It further assumes voters can afford to “vote with their feet” by relocating to the jurisdiction that best meets the voters’ preferences.  (Californians move approximately every four years, suggesting Californians have sufficient mobility to vote with their feet.)  Given these assumptions, voters will not mind paying property taxes since they reflect their preferences for a particular bundle of public services.

Similarly, a corollary to the Tiebout model referred to as the “benefit view” of property tax holds that taxes paid by property owners will approximate the value of benefits received from the government.  Accordingly, voters in wealthy communities will prefer property taxes over other forms of public financing.  This is because these voters pay property taxes only for the services they consume.  Just as important, property taxes and property values in this model enjoy a symbiotic relationship:  improved local services inure to the benefit of the neighborhood, increasing values, and thus increasing property tax revenues.  Thus, a childless homeowner still has an incentive to pay property taxes toward good schools, since the fact of good area schools improve the value of his property.

Up until 1971, local taxes in California basically conformed to the Tiebout model: households could “vote with their feet” by moving to neighborhoods where tax expenditures more closely matched their preferences.  More importantly, middle class California families who bought homes could seek to do so in neighborhoods with well-funded schools.

Enter John Serrano, Jr., the man who would become the lead plaintiff in Serrano v. Priest.  Mr. Serrano is popularly described as a poor Chicano from Baldwin Park, a low-income suburb of Los Angeles.  Because Mr. Serrano’s neighborhood had only a modest property tax base, its schools were not well funded.  According to the popular description, however, Mr. Serrano was too poor to “vote with his feet,” and thus unable to send his son to a school a better-funded school.

Like the trope about Prop 13, however, this story is a myth.  As William Fischel recounts in his article, Did John Serrano Vote for Proposition 13? A Reply to Stark and Zasloff’s “Tiebout and Tax Revolts: Did Serrano Really Cause Proposition 13?”, 51 UCLA L. Rev. 887 (2004), Mr. Serrano was a college-educated social worker.  He lived in unincorporated East Los Angeles, not Baldwin Park.  Accordingly, his son attended Los Angeles Unified School District.  Although LAUSD was “property-rich” and well-funded, its schools were poor quality.  Accordingly, Mr. Serrano was advised by his son’s principal to enroll his son in another district.  Mr. Serrano and his family did just that, moving first to Whittier and then to Hacienda Heights, where Mr. Serrano’s son performed admirably in the Hacienda-La Puente Unified School District.  Interestingly, compared to LAUSD, Hacienda-La Puente USD was “property poor”:  the tax base per pupil in 1970-71 was just $5,613, compared with $13,845 in LAUSD.  Still, Mr. Serrano was satisfied with the improved quality of education his son received in his new school.

While Mr. Serrano was moving his son to a poorer but better quality school district, legal activists were devising a litigation strategy to change the next three decades of California education and public financing policy.  By the mid-1960s, legal activists, disappointed with the lack of more radical improvements in education policy since Brown v. Board of Education, began developing new arguments to achieve those improvements through the courts.  According to Kirk Stark and Jonathan Zasloff’s article Tiebout and Tax Revolts: Did Serrano Really Cause Proposition 13?, 50 UCLA L. Rev. 801 (2003), “the core of the reformers’ argument was a principle of fiscal neutrality.”  Predictably, legal activists packaged the argument in an “equal protection” analysis under the Fourteenth Amendment of the U.S. Constitution and corresponding state constitutions.  If they could convince courts that education was a fundamental interest and that wealth was a suspect classification, education funding policies based on property taxes would be subjected to strict scrutiny, requiring states to demonstrate a compelling state interest for expenditure disparities to survive.  Since states would almost certainly be unable to do so, the legal activists would all but guarantee the invalidation of the “benefit view” of property taxes, thus paving the way for more egalitarian tax policies.

Their strategy failed in the U.S. Supreme Court.  In 1973, the Court held in San Antonio Independent School District v. Rodriguez that education is not a fundamental interest and that wealth is not a suspect classification.  As long as a state could show some “rational basis” for employing the “benefit view” of property taxes—which is easily established—disparities in per-pupil expenditures were permissible under the U.S. Constitution.

Nevertheless, the activists hit pay dirt in the California Supreme Court.  Serrano v. Priest held that education is a fundamental right and that wealth is a suspect class.  Following the Court’s 1971 pre-trial decision on the Equal Protection question (which, incidentally, miscalculated the U.S. Supreme Court’s analysis to be handed down two years later in Rodriguez), the Serrano plaintiffs prevailed in the trial court in 1974, making reliance on local property taxes for public schools unconstitutional in California.  The California Supreme Court affirmed the award in 1976 in Serrano II.  California’s legislature passed AB 65, a school finance bill to comply with the decision, the following year in 1977.

It was only after Serrano decisions and the legislative response that voters finally abandoned their support for property taxes.  The very next year in 1978, the property tax cap of Prop 13—whose predecessors suffered resounding defeat immediately prior to the Serrano decisions—passed with 64.8% of the vote.

Economist William Fischel has argued persuasively that it was the redistributionist activism of Serrano, and not a generic aversion to taxes, that galvanized Californians against the property tax and in favor of Prop 13.  “By requiring nearly equal school expenditures per pupil statewide,” Professor Fischel explains, “Serrano divorced local property taxes from the amount of local school spending.”  By preventing households from voting with their feet, Californians were left without means of expressing their preferences concerning their local school districts.  In this respect, it is worth recalling that Mr. Serrano himself, prior to the fallout from the lawsuit that bears his name, enjoyed this privilege and exercised it to express his preference for the Hacienda La Puente USD, despite the fact it spent only 40% per pupil compared to his son’s former school in the LAUSD.  More fundamentally, however, this court-driven policy change meant property taxes no longer functioned to signal voters’ preferences.  Thus, according to Professor Fischel, “it made sense for the voters to nearly eliminate the local property tax for financing schools.”

None of this is to suggest that financing schools with education is a panacea, particularly in the 1970s.  In more than 30 years since Serrano, however, the case that education can be improved through funding is grim.  In the meantime, the immediate effect of Serrano—namely, Prop 13—remains “a fiscal incubus on California,” as Professor Fischel puts it.  “Removing it or even modifying its more extreme features would improve the workings of both state and local governments generally and would assist public schools in particular.”

However, Prop 13 will likely continue to remain the third rail of California politics as long as politicians and the media continue to mischaracterize its cause.  Until the legislature and the judiciary restore to the public a reason to embrace property taxes—that is, as a means for voters to signal their preferences for public services—Californians are unlikely to relent.  Professor Fischel is right:  “voters would be much more amenable to loosening Prop 13’s constraints if Serrano were modified to allow local property taxation to reconnect with local school spending.”

In the meantime, policymakers ought to stop blaming the voters for continuing to support Prop 13.  That support has been both fervent and continuous for 33 years now—no light or transient cause, this.  California’s policymakers must reform public finance policy to make people want to pay taxes as they did pre-Serrano, or else stop spending the tax dollars that dried up in 1978.  For over three decades, egalitarian activists have experimented with the public school system of one of the world’s largest economies and, in the process, have ruined both.  It’s time for a new experiment.  Or better, an old one.

[Cross-posted at Notes From Babel]