The Free-Market Case Against Prop. 13
Prop. 13 is Crony Capitalism for California's Long-Time Homeowners
One of the fundamental convictions regarding economic policy I have developed over the years is that economic growth is essential to a healthy society. This puts me at odds with many of my progressive friends, who tend to be more skeptical of growth. There is a widespread assumption on the left that economic growth has been, on the whole, bad for the poor and the environment. I agree 100% that growth can have negative consequences; I believe in the need for policies that provide a social safety net for the poor and consider the environment by addressing pollution. But that said, underestimating the importance of growth is a substantial philosophical and historical mistake: one of the striking things about the last 200 years of economic history is that the growing societies successfully uplift the poor and better their environment. Markets and growth are tools: they alone do not create inclusive prosperity, but without them, there is no example of a society becoming prosperous. Andrew Koppelman writes in his article Socialists for Capitalism:
Socialism’s purpose is assuring everyone the resources to live a decent life. Because we should all want that, we should all be socialists. The most dependable means for delivering those resources, however, is a capitalist economy, supplemented (as, in America, it has not been lately) by an array of state interventions that assure everyone an adequate share of the wealth. So today’s socialists should also be capitalists.
Here in California, I have written extensively about how our state’s progressive establishment has, for too long, let their anti-growth bias lead them to oppose housing of all kinds, especially in our largest, most dynamic cities. It has had disastrous consequences for economic opportunity and the environment because it turns out that when you stop building housing in cities, you make those cities unaffordable to the poor, who move out to parts of the country like Vegas and Arizona which are far less suited to environmentally sustainable living than California. Earlier this year, I wrote a piece in the OC Register making this exact point:
But extensively criticizing bad left-wing policy can get you accused of “only punching one direction” (as the kids these days would say). I don’t think that is a fair criticism. Progressives hold power in California, and I believe it is always wise to be more critical of those in power (I also dispute the idea that intellectual discussion is akin to “punching.”) However, I think it’s intellectually honest to point out that clinging to bad policy is not exclusive to the left in California. After all, one of California’s most significant obstacles to housing growth is the most prized policy achievement of conservatives in California over the last 50 years: Prop. 13. Prop. 13 was a decisive part of the 1970s “tax revolt.” California homeowners voted to permanently cap property taxes in California. So in the spirit of trying to “throw punches in all directions,” I wrote a piece in the OC Register arguing that Prop. 13 is bad for economic dynamism. You can read the article here (clicks are always appreciated!):
Now, I purposefully wrote the piece for the most prominent regional right-of-center media outlet in Southern California because I wanted to make a different type of case against Prop. 13, one that focuses on economic opportunity and growth:
For the last 50 years, right-of-center politics in California has been laser-focused on one subject: keeping taxes low. For these voters, the passage of Proposition 13 (or “Prop. 13”) in 1978 was a monumental achievement that put hard caps on how much property taxes could rise for existing homeowners. Even as California politics has become dominated by Democrats, Prop. 13 is still considered an untouchable part of California politics. This is a real problem because Prop. 13 has eroded economic opportunity in California, and it's high time we take action to reform the outdated law.
Almost all arguments against Prop. 13 come from progressives who want to use property taxes to increase funding for education and affordable housing priorities. I don’t necessarily disagree with progressives that there are worthy programs in those domains which more government funds could serve, but I think it is a misguided pitch to voters. California still has a huge overall state budget. Many voters, even those who are center-left, are very frustrated with how poorly California has managed its pension funds for teachers and how inefficiently it spends affordable housing dollars (with per unit costs over 1 million dollars in some places). Voters like this have a compelling argument that it is wiser for California to reform the broken process rather than continue throwing more money at the problem. Other authors cite significant racial disparities in who benefits from Prop. 13. This is factually accurate but unlikely to be persuasive to the median voter in California, who is not necessarily sold on the idea that disparities are a surefire indicator of injustice. Recent pieces about Prop. 13 published at the OC Register (including pieces by their editorial board) are laser-focused on debunking these lines of argument.
But while the progressive critique of Prop. 13 may not be persuasive, the conservative defense might have more problems. For one, Prop. 13 has not substantially changed the overall tax burden for Californians. Instead, Prop. 13 has shifted the state’s tax burden to younger property owners and to other forms of taxation:
The merits of Prop. 13 are often argued along the lines of political beliefs in the size of government. Progressives in California bemoan the forgone revenue, and conservatives embrace Prop. 13 as a means of “starving the beast” and constraining the size of government. But this debate is tired and inaccurate to facts on the ground: Studies show that tax and expenditure limits like Prop. 13 are generally ineffective at limiting spending. California is no exception: in 1978, California had the 4th highest tax burden of any state in the nation. In 2022, California has the 5th highest burden in the country. Why is this? California has adapted to Prop. 13 by increasing other taxes, collecting the 4th highest personal income tax, the 7th highest corporate income tax, the highest state sales tax, and the 7th highest combined sales tax. Prop. 13 hasn’t kept taxes from rising; it’s shifted the tax burden to alternative taxes.
Since most people do not spend much time looking at property tax rolls, most people are unaware of how much property tax rates differ based on when the house was bought:
Worse yet, Prop. 13 has perverse impacts on good taxation policy. The Tax Foundation’s foundational tax policy principles include simplicity and neutrality. Unfortunately, Prop. 13 violates both principles through one of its central features: it bars the re-assessment of a home’s value unless it is sold or re-developed. This provision has led to huge disparities in tax burdens, as many homes in California have doubled or tripled in value over the last ten years. As someone who is house hunting, I get angry when I look at tax records and realize I will have to pay five to 10 times the tax rate of my neighbors simply because I happened to buy into the market decades later.
Let’s imagine that tomorrow, California proposes that half their residents would pay a 20% tax on their income, while the other half would pay a 2% tax on their income. The tax rate would be decided by a coin flip. That would be unfair. But this is precisely the system that Prop. 13 sets up — two identical properties can be taxed at wildly divergent rates based solely on the luck of when you were able to buy into the market. In 2018, theLA Times found that actor Jeff Bridges and his siblings paid $5700 in property taxes on the Malibu mansion they inherited, which was estimated to be worth 6.8 million that year. The LA Times estimated that at a theoretically identical house next door, a new purchaser would be paying at least $76,000 annually in property taxes, a rate thirteen times greater than Bridges.
Jeff Bridges is a real-estate entrepreneur: he inherited a valuable property that happened to be in a prime location. But instead of having tax incentives build more housing units with high economic value to society, Prop 13 encourages him to simply rent the property as is for about $16,000 a month, a steady profit stream. Even though he relies on public infrastructure and services that cost the government more yearly, Bridges is insulated from rising taxes to pay for those services. What a great business model!
This inequality in taxation is not congruent with free-market notions of a flat and fair tax. Yet homeowners who otherwise believe in free markets easily abandon those principles when they can get a tax cut. Thus, I think crony capitalism is an apt description of Prop. 13:
Crony capitalism, sometimes called cronyism, is an economic system in which businesses thrive not as a result of free enterprise, but rather as a return on money amassed through collusion between a business class and the political class. This is often achieved by the manipulation of relationships with state power by business interests rather than unfettered competition in obtaining permits, government grants, tax breaks, or other forms of state intervention
It’s not hard to find examples of business leaders praising the merits of competition until they have the opportunity to lobby the government for a tax break. Intel’s current lobbying for huge tax breaks from the US government through the CHIPS act, thus keeping their business model afloat, is crony capitalism. Long-time homeowners who vote themselves (and use their political power to maintain) a huge tax cut also align with the definition of crony capitalism. After all, owning a home is a business transaction, even though most homeowners don’t want to see it this way, and giving tax breaks to homeowners is subsidizing Jeff Bridges’ (and millions more like him) business model.
Now, it's worth pointing out that tax breaks can be beneficial IF they create social value for everyone. Intel can at least argue that domestic chip manufacturing is necessary for national security. All economists agree on the fundamental tax policy principle that tax incentives matter. Whatever gets taxed, you discourage. This argument was the crux of the Reagan-era supply-side economics: high marginal tax rates on income deterred productive economic activity. America in the 1970s had been wracked with stagflation, shattering belief in the expansion of economic opportunity. The supply-siders argued that by fixing these tax incentives, you could unleash growth that would benefit everyone. Whether the Reagan-era tax cuts actually did this is still debated. But there are clearly examples in history where changing tax incentives led to economic growth that benefited everyone.
Unfortunately, Prop. 13 utterly failed to create good tax incentives for economic growth:
Voters who believe in the importance of economic growth should embrace property taxes as the best way for governments to raise the revenue they need. All taxation hinders economic growth to some extent, but property taxation does far less to deter growth when compared to income or sales taxes. Since land cannot leave the state, many across the political spectrum have argued that land-focused taxation can create economic growth by encouraging property owners to respond to market incentives to develop their land, maximizing its market value. Milton Friedman famously called land taxes the “least bad tax,” while conservative urban planning guru Chuck Marohn argues that land value taxes can incentivize economic growth in under-invested communities.
Unfortunately, Prop. 13 flips this incentive around. Becauseredevelopment and improvements can trigger a property tax reassessment, property owners are encouraged to do nothing and become land speculators, free-riding off rising prices throughout California. Worse yet, after Prop. 13,California nudged cities to charge developer fees as an alternative source of revenue. Today, some cities' fees areover $150,000 per unit, which drives up housing prices and discourages development. This combination of perverse incentives has encouraged California’s cities to become simultaneously stagnant and outrageously expensive, as valuable land with great economic potential sits underutilized.
Land is a fascinating economic resource because it’s almost impossible to create more, and its value primarily depends on other factors. Research by a team in Philadelphia argued that most of the factors that go into land value lie outside the control of the actual landowners. More specifically, they found the most significant factors that create land value were: 1) amenities of nature like the ocean, 2) the city’s decisions about infrastructure and zoning, and 3) the broader economic growth of a region. Thus, it is difficult to argue that taxing land will ever squash productive behavior, and one can more generally argue its pro-growth to tax it! Pennsylvania is one of the few states actively pursuing a modest land value tax. Its utilization was a big reason why cities like Harrisburg and Pittsburgh bounced back faster than neighboring midwestern cities in upstate New York and Ohio. Chuck Marohn explains it at a greater length below:
But again, Prop. 13 has meant that this tax burden has shifted from landowners to developers (in the form of fees), which most definitely limits growth.
So, where does this leave us? Prop. 13 is actively bad for California but still wildly popular. A couple of weeks ago, Prop. 13 came up in a conversation with some of my wife’s extended family. One member of the family pointedly lamented that “they” were coming for Prop. 13 (she didn’t realize I was one of the dreaded “they”). To make progress on the issue, you need to do something incremental. Here is what I proposed:
A full-scale repeal of Prop. 13 would be politically untenable and highly disruptive, but that does not preclude all reform. One idea would be to eliminate Prop. 13’s prohibition on the re-assessment of property values for all future property transactions (both sales and inheritances) while allowing existing homeowners to keep their current assessment while they stay in their homes. In addition, reform could give commercial and investment properties a short grace period (i.e., five years) before re-assessments begin. While this would allow tax inequities in the short-run, inequities would phase out over time without creating disruptions for those who bought their home under the assumptions of Prop. 13. Finally, assessment reform could be partnered with imposing strict limits on municipal developer fees to ensure that the tax burden on new buyers is limited.
The second idea would be to reform Prop. 13 to create a split-rate system, where the tax rate on improvements is limited or even eliminated, but the tax rate on land is allowed to rise (on eligible properties). Evidence from split-rate taxes in Pennsylvania showed that most homeowners would not see land taxes increase their taxes, especially in less affluent areas of California where land prices are low.
Housing policy is California’s largest barrier to economic growth. As the crisis worsens, the state legislature has started to address zoning reforms, albeit far tooslowly. Partnering these zoning changes with property tax incentives that promote, not penalize, building housing could unleash growth. Of course, no housing reform will fix all of California’s economic problems, but Prop. 13 reform is still a necessary step in the right direction.
How is this being received? Well, the heckling in the comment section of the piece was not encouraging:
Making the case against Prop. 13 is not about trying to get something done in the short-term but helping people see what is needed in our long-term vision for the state. And while that project requires patience, I refuse to give up hope.