A TALE OF TWO TAX JURISDICTIONS : THE SURPRISING EFFECTS OF CALIFORNIA'S PROPOSITION 13 AND MASSACHUSETTS' PROPOSITION 21/2

I Introduction IN RESPONSE TO CITIZEN COMPLAINTS about increased property taxes, and to charges that state and local taxes had risen too rapidly for the services provided, California voters passed Proposition 13 by an almost two-thirds majority in 1978. Proposition 13 rolled back property tax assessments to their 1975 level, restricted increases in assessments to 2% per year (as long as the property does not change ownership or undergo substantial improvement), prohibited property assessments that exceeded a property's full value, required that two-thirds of a jurisdiction's voters approve local tax increases, and required a two-thirds majority of both houses of the California legislature to increase state taxes. For properties that turned over in the market, assessed values reflected the sales prices; for those that did not turn over, assessed value reflected the 1975 assessment, adjusted by Proposition 13's 2% maximum annual assessment growth cap. Unfortunately, as a result, similar properties have been assessed at different amounts and therefore have different effective tax rates. This alleged inequity prompted the unsuccessful challenge to Proposition 13 in the U.S. Supreme Court (Nordlinger v. Hahn) in 1992. It is also likely that Proposition 13 has led to some inefficiencies in the housing market, since the tax policy tends to make owners less mobile. Specifically, the lower tax on houses that have been off the market for many years creates a strong incentive for long-time owners not to sell their houses (O'Sullivan, Sexton, and Sheffrin 1995). Of course, all property tax systems distort optimum-location and structure-size patterns. This paper focuses on California tax trends and expenditures at the state and local level. In particular, it examines the fiscal effects--both immediate and long term--of Proposition 13. In addition, it also compares the results of Proposition 13 with a similar property tax limitation measure, Massachusetts' Proposition 2 1/2 in 1980. Both Propositions substantially reduced state and local revenues and expenditures due to the property tax limitations--at least initially. This was expected, since not only were property tax reductions the explicit goal of both Propositions 13 and 2 1/2 (Citrin and Levy 1981; Courant, et al. 1980), but the mechanisms of the restrictions--both tax rate and assessment growth limitations--ensured that result. By 1990, the Propositions had reduced real per capita property taxes to levels far below their earlier peaks. This again resulted from the assessment growth limitations and a low property tax-base elasticity, which lowered the post-proposition growth rates of property tax revenue. This was also consistent with earlier overall findings for states with property tax limitations (Preston and Ichnioski 1991). It takes time for various levels of government to institute and implement changes, but following a brief lag, California and Massachusetts began to make up those lost revenues, largely through rapidly growing non-tax fees and charges. During a period of "tax revolt," these revenue sources were both less constrained and less visible to voters than taxes. In California and Massachusetts, because of state and local government enhancements of these alternative, non-property tax revenues, by 1990 combined real per capita property taxes and non-tax revenues in both states exceeded their pre-Proposition peaks. This result supports the hypothesis that, given time, voter-initiated revenue limits intended to reduce the size of state and local governments will be undermined by growth in other sources of revenue. Within a decade or less, in these two states, changes in non-tax fees and charges more than offset the reductions in property taxes. Because of these increases in non-tax revenues, combined with tax revenue growth, total real per capita revenues and expenditures in both states exceeded their pre-tax revolt peaks within a decade. …