Enough, Time to Fix Prop 13

Brian Strope 

Summary

Prop 13 is one of the causes of California's housing crisis. It contributes to long commutes, environmental damage, and homelessness. Fixing it is a non-starter politically. 

A novel solution is proposed here. Instead of repealing it, or tweaking the numbers, we move the cap from the individual property owner to the state. Instead of saying your property taxes can't go up by more than 2% per year, we say the state revenue from all properties can't go up by more than 4%. 

As fair market prices go up, and as more properties come online, the effective tax rate goes down for each individual property owner. Collectively, we only have to contribute our share to meet the state-capped revenue total.

Instead of protecting your property against run-away property taxes, we protect everyone's property, including the next generation of future buyers.

The change would be phased in over 20 years. For many of us who have been here for 20 years already, it would mean little change in our taxes. The extremes would gradually shift to the group average, which would be around 0.3% of fair market value today. In 20 years, it's likely to be closer to 0.2%. The current effective rate of 0.3% of fair market value is more than some people are paying now, but it's still a third or a quarter of the rate people pay in most states. And again, people wouldn't reach those rates for 20 years.

This paper outlines the problem, and includes examples of how we are paying now. It motivates a proposed solution, and gives projections for the taxes paid by example owners, if we make the change.

Prop 13

Proposition 13 passed in 1978 as part of a modest tax revolt. The math was simple: inflation was high, home prices were going up faster, and older people on retirement income (who vote!) shouldn't have to pay more in taxes, or worse, be kicked out of their homes, just because some new rich family could afford to move in next door.

Grandma gets to stay, regardless of how crazy the real estate market gets. 

It's great politics, and it means seniors (again, who vote) can plan for what they need to spend, to stay in their houses. It passed, and it's become accepted wisdom that it can never be changed. It's now Gospel, according to California.

It's time to change it. The housing crisis affects everyone, and Prop 13 is part of the problem. The changes can be simple, slow, and fair, and can be made with minimal impact on the markets, or the quality of people's lives. It only takes the political will to go after a third rail issue, and a slight shift in perspective. 

Regressive Wealth Transfer

The motivation was to keep Grandma in her house. It had unintended consequences. It went too far. Many are now essentially trapped in their houses, taking supply off the market, which raises prices for everyone. The net effect is wealth transfer from the new poor (who pay increasing rents pulled up by the runaway housing prices) to the old rich (who are often trapped by the increasing values of their homes). Many can't afford to live here at all.

Prop 13 Basics

First, some details to remind people what proposition 13 is. I strike it rich, and then buy a house for $1M. The state decides I need to pay $10K a year as a wealth tax, for the rights to own my fancy new house (it's actually closer to $12.5K, or about 1K / month for each 1M in property I bought). If I'm rich enough to buy the house, then I'm rich enough to pay a little extra for the services the state provides. Okay, I'm in, to pay my share.

Then next year, when home prices in my area go up by 5%, my property will be worth $1.05M and, on paper at least, I will feel a little richer. In most of the rest of the country, the state would notice, and decide that instead of $10K in taxes, I should now pay $10.5K. 

Prop 13 caps the increase in my property taxes to 2%. Hey, special deal, just for me! So instead of $10.5K, next year, I pay $10.2K. I know, who cares? $300 seems like a small difference, on a house that's worth a million. Where's the wealth transfer?

Time, Exponents, and Supply

Despite relatively low inflation for the last 35 years, the housing market in California has been more closely linked to the the stock market. Instead of 3-5% a year, 8-10% has been common. There have been variations and corrections, but the overall trend, especially in the Bay Area is more connected to stock market prices. They could be correlated because only the rich can afford to buy houses here, and the wealth of the rich is often in the stock market.

Still, that difference can't matter that much. Can it? Here's where the exponents kick in.

Three Little Piggies

Let's make up three characters. To be part of the "rich enough" to be able to buy a place, you have to be a little bit of a piggie. Our first little piggie will be Dr. Abe. Dr. Abe had the good fortune of buying a very nice (let's say mid-high end) home, in the Bay Area, for around 100K in the mid 1970s. Our second little piggie will be Engineer Bob. Bob was lucky enough to buy a modest house, for around 500K, in the late 1990s. And third, we will have our new Teacher Christine. Teacher Christine ended up with a bunch of cash and was able to buy a condo downtown, for almost 2M, just a few years ago. Condos are pricey. Lucky Christine! 

Actually, it's complicated.

Let's compare them:

Maybe the chart isn't obvious. If not, Dr Abe owns the most (big dark green bar), and Teacher Christine pays the most (big dark red bar). The relative heights of the different values and taxes (all in absolute dollars, or thousands of dollars) are almost random.

Are we comfortable with Teacher Christine paying almost 6 times what Dr. Abe pays (in absolute dollars), when she lives in a much more modest place? Is that fair? Sure, she had the good fortune of having the cash to buy the place, but now that she owns it, she's still on the hook to the government to pay 2K / month, for a place she already owns. And that's before condo fees. Who can afford to live here again?

Another way to look at it is to figure out what the tax rate is for each, based on the market values of their homes.

Comparing tax rates, Teacher Christine's rate is 3 times Engineer Bob's rate, and 17 times Dr. Abe's rate.

Politics, and Unsubtle Messages

One generation passed the law, and the next generation is paying for it. Hmm, is that really what they wanted? Kids don't vote. Old people do. Is it that simple?

The message from one generation to the next is clear: kids, you're not worth it. Either you pay for everything, or go away. Or maybe more desperately, the message is stay with me, forever: you're trapped, too, just like I am.

It's also a tax law implementation of the prescient Wood Guthrie message: If you ain't got the do ray mi, you better go back... And by all means, if you're willing to pay for everything -- we won't take your word for it, we'll set up a tax law requiring it -- then please do join us. Or, if you're willing to sneak in, without owning anything, and discreetly clean our toilets, while living in constant fear of deportation, that will be fine, too. It's an unconscionable, and shockingly entitled message.

One generation financially alienates their kids, runs huge federal deficits, and destroys the planet for their grandkids. The me-generation is consistent.

Imagine if Teacher Christine were Dr. Abe's daughter. Do you think he would still support the current tax arrangement? Probably not, but he might. Here's one way he could rationalize it: he knows that his windfall inheritance gift of his house to his daughter will be higher because Prop 13 has propped up the value. Remember it's politics, for the me-generation, so it's all about him, and his windfall gift to her. Besides he's convinced it can never be changed, and he votes. 

Or in many instances he might already just pay her taxes. In those cases, the me-generation is becoming the me-and-my-own-generation.

Is this a fair system that we'd want for our grandchildren?

Back to the Shares

If we add up all 3 homes, owned by our 3 little piggies, we have around $11 million in property value. And more than half of that belongs to Dr. Abe.

And since there's about $37 thousand in property taxes collected between them, that means from the state's perspective, the aggregated effective tax rate is around 0.3%. But Teacher Christine is paying more than her fair share. Teachers and women always do more than their fair share. We're all conditioned to be comfortable with that. This is America, after all. But this much more?

Teacher Christine is paying more than 60% of the property taxes for all 3 piggies. Her fair share, based on the value of what she owns, would be 18% of the total, which means she's overpaying by a factor of 3.2. And Dr Abe, who was around when it got started, now gets almost an 80% reduction of his actual tax rate, as he's underpaying, not compared to his original rate, but compared to the group average by a factor of 4.5.

How did it get this far off?

We started talking about a cap, and the difference of 300 dollars. That doesn't seem like this kind of a difference. What happened?

We're back to the exponent, and the compounding interest thing. 2% over 50 years is 1.02^50, or about 3. So Dr. Abe's taxes went up by about a factor of 3. His house went up more like 8-9% a year, or 1.085^50, or about a factor of 60. Those are huge differences because of time and exponents. That's why it's time to fix this.

In the graph above we project out 50 years. It's the difference between the actual rate and the cap that drives the large difference between the market value and the assessed value. Actual market value also has much more volatility, than these simple exponential projections. But it's the same story as comparing investments in a CD vs the stock market. With Prop 13, we tax people based on a fictitious CD rate imposed their property, that has increasingly little to do with its actual value.

Until Dr. Abe dies, and his estate sells his house, it only gets worse from here. And when that finally happens, assuming one of his heirs doesn't move in, the state finally gets more revenue, and we have more extreme variation in tax rates.

Let's do a little more, so that we can make some more comparisons.  If we divide the assessed value (times 0.0125) by the projected market value of the house (the red line above, divided by the blue line above), then we get the actual tax rate based on the market value of the property (instead of Prop 13s fictitious assessed value). 

In the Bay Area at least, the net effect of Prop 13 is to discount the actual property tax rate by about a factor of 2, every 10 years. In 20 years, you're paying 1/4 the original tax rate. In 30 years it's something like 1/8th the original rate. Live forever, and stay in your house forever, and then compared to the value of your house, your taxes essentially go to zero.

With that perspective, it makes some sense that Dr Abe's paying less, because he's been paying for a long time. Here we show the effective tax rates for each of our 3 little piggies, again assuming constant historic long-term changes in housing prices.

Teacher Christine's rate will fall eventually, assuming the trends of the last 50 years continue. Right now (2020), with Dr Abe and Eng Bob getting huge discounts, Teacher Christine is holding up the fort, and paying most of the taxes. Asking someone how long they've been in their house, is similar to asking them how much their current taxes are discounted.

We might argue that Dr. Abe has been paying longer, so it makes sense that he should now pay less of the overall share. But if we look at the accumulated amount of money paid in taxes, Teacher Christine is still paying way more than her fair share. And since it's starting at a higher value, it's going up by a bigger dollar amount each year. Both are capped at 2%.

But Dr Abe paid his early taxes with more valuable 1970s dollars. Doesn't that mean that he's really paid more than we might guess? Inflation peaked before Prop 13, and has been mostly below 5% since. Here we assume a constant 3% inflation rate, and convert all taxes paid into 2018 dollars, which are about 3.3 times less valuable than 1978 dollars. 

Despite missing the first 20 years, it took only 13 years for Eng Bob to pay more in cumulative taxes than Dr Abe, in constant dollars. In 50 years, compared to Dr Abe, Eng Bob will have paid twice the property taxes for a house worth about half as much, and he will have missed out on 20 years of living in it. How is that fair?

Despite paying no taxes at all for the first 40 years, when Dr. Abe was in his house, (in constant dollars) Teacher Christine's total lifetime amount of taxes paid goes above Dr. Abe's total in 2027, only 9 years after she bought the condo. 15 years after that, in 2042, she will have paid $507K in taxes, and Dr. Abe will have paid $230K, again, all in constant 2018 dollars.

At that point, she's been in the condo 24 years, he's been in the house 64 years, so he's almost been there 3 times longer. His house is worth 3 times her condo. If things were somewhat fair, then in 2018 dollars, we'd expect that Dr Abe would contribute something like 9 times more in tax payments than Teacher Christine would (3x the time for 3x the place). Instead, at that point, she's paid more than twice what he has, again in constant 2018 dollars, which means something like 18 times more than she should. 

This can't be fair (to Teacher Christine), and it can't be healthy for society.

One off?

We might guess that Dr. Abe was lucky, and is a one off: a genius of timing and clever choices. He probably did buy a great house, in a great neighborhood, at a great time. But the key was mainly staying in the house for decades. It's a lock, if you stay, because of Prop 13, and only the rich can afford to stay for decades.

Here we sample 15 random houses on Zillow: 5 from West Menlo, 5 from South Palo Alto, and 5 from Downtown Palo Alto. 15 is a tiny sample, but the distributions are already striking. The plot shows the histogram of effective tax rates defined as 1.25% times the assessed price, divided by the Zillow estimate of the market price. Zillow lists both. The first "count value" for the "0-bin" of 5 means that 5 houses are paying taxes at an effective rate between 0-0.1%. The next count value of 1 means that 1 house was paying between 0.1-0.2%, and so on.

12 of the 15 randomly selected houses are paying a lower effective tax rate than Eng Bob (who's been in his house for 20 years) and 1 (not Eng Bob) is about the same, implying that most houses were last sold more than 20 years ago. Only 2 of the 15 randomly sampled houses were recent sales. The total value of the 15 homes was $54M. The effective tax rate for the group is 0.3%, which is the same rate as it was for our 3 little piggies. The two recent buyers alone are paying half the taxes for the whole group, and about 4 times what they should. The five lowest payers, who have been in their houses the longest, should be paying about a third of the overall taxes. Instead, together they're collectively paying about 5% of the overall taxes. There are outliers, but most rates are clustered just below the overall average rate of around 0.3%. They all live within about 8 miles of each other, and the most expensive house in this sample is worth about twice the least expensive house. The highest tax rate in the group, 1.1% is 27 times the lowest rate, 0.04%. How can that possibly be fair?

The average home ownership for the US is 13 years. 20 years after Engineer Bob moved in, he's considering retirement, and if the random selection of 15 houses is representative, then most of his neighbors probably still see him as the new kid. Neighborhoods around tech giants are filled with retirees.

Why don't they move?

No Moving means Less Supply

If Engineer Bob would want to move, on paper, he'd be able to sell his 2.5M house and have the money to buy a new place. Why not double down on real estate and move up to a nicer place? Or maybe save a little money, and move to a smaller place nearby? Bob's effective tax rate would triple, if he were to move. What about Dr Abe? His rate would go up by a factor of 12. In general, people don't move until they have to, or until they die. Moving gets harder as we get older, but the only move that makes sense financially is to leave the state, and go somewhere where houses are so cheap, that we'd be willing to pay the property taxes. 

That's a hurdle to moving that impacts everyone. So unless we make, or inherit, huge windfalls, most of us stay in our homes, until we really have to move. It's the center of the tech world, people change jobs every 2-3 years, and many of us stay in our houses for decades. 

That means there's less supply. Limited supply, for a valued asset, that everyone needs means that prices go up. There are bidding wars for what used to be tiny "starter homes" in the 1950s and 1960s, now selling for millions of dollars, because there's limited supply, in part because the tax code encourages people not to move.

Wealth Transfer

Limiting supply is the beginning of a wealth transfer, from poor to rich, that impacts everyone in California. Dr. Abe doesn't move, and stays in his house into his 90s, and longer. His neighbors are doing their best to keep up. And that takes away supply, which drives up prices, which makes it less likely that Dr. Abe will ever move.

Teacher Christine ends up being the victim. She pays a California sum for her modest condo, and then pays a shocking fraction of the overall property taxes. Thank you, Teacher Christine! She's doing exactly what her parents' generation required of her. She doesn't revolt because we have her out-numbered (and "out-wealthed"). Remember of the 15 randomly selected, 5 were paying at or below Dr. Abe's rate, and 13 of the 15 were at or below Eng Bob's rate.

That means 13 of 15 are getting a sweet deal, as they exploit 2 of the 15. Let's vote to see if we change anything! No need to vote, and we'll keep the exploitation just the way it is. Thank you very much. And we somehow ignore the shame of requiring Teacher Christine to pay for everything. To add to the insult, we'll tell her that it's impossible to change it. 

We say the same things about all forms of social injustice, until we fix it. This one feels similarly entrenched, because it's about money after all. But it's also only been 4 decades of dysfunction. Other forms of social injustice lasted centuries, if not millenia. We can get past this short-lived entrenchment, too, just like the others.

Some proponents of Prop 13 argue that tax revenue has increased since passing Prop 13. How could that be? Again, thank you, Teacher Christine! Because Prop 13 helped to inflate prices, new owners are now paying way more than anyone else ever has, and the variation in tax rates by house (in the same neighborhood) is shockingly high, just like it is in our tiny sample of 15. It's become part of what drives the extreme variation of wealth in California. Prop 13 increases the aggregate revenue from property taxes, by exaggerating the variation in effective property tax rates. Let's get a little more money by stretching things further apart. Hmm... Really, we want that?

Many will argue that a free market will be efficient. But here, the combination of property taxes and Prop 13 means that we have a law that distorts the free market, tilting the opportunities for huge amounts of wealth to the families who got here first, the same families who often have the most money. It's backward.

What's the harm? Dr. Abe's a good guy, and some other nice rich guy is going to move in to his place when he dies, and that'll correct some of it.

The harm is that all housing prices go up. And that drives rents up. And that means people have to live far away from their jobs, work multiple jobs, and suffer through long commutes, that puts a bigger toll on everything: people, roads, and of course, the environment. Or worse, some can't afford to live in a home at all. 

All Connected

Every house price is connected to every other house price, which is connected to every rent price, which is connected to every evicted tenant, which is connected to every homeless person. Trickle down doesn't work with tax breaks (because rich people save the extra money, surprise!), but it does with housing prices. With housing, rich people are always setting the prices, either by bidding them up, or by raising the rents. One house sells at a premium, and all the house prices go up.

Dr. Abe's family was guaranteed wealth, because a law was passed to make sure Grandma isn't kicked out of her house. The cost of that wealth is essentially trapping many people in their homes, which in turn helps increase housing prices and rents, to the point that working people can't afford to live here.

Enough, time to fix Prop 13.

Fixing It

Changing prop 13 is a non-starter politically. It's a third-rail issue that ends political careers. It's Gospel, according to California. The people with houses, and money, and all the rest vote, and they'll never vote against their own economic interests.

Instead of fixing it directly, we'll consider housing subsidies, and homelessness programs, special housing for teachers, and vouchers, and so many other interventions. Each tries to correct for the inefficiencies of a free market, that has, in fact, been distorted for the richest, by a regressive tax law. Those efforts miss the irony, that it was a similar effort of saving Grandma's house, with an intervention, that helped create the mess in the first place.

Requirements

Any change to Prop 13 would have to be gradual so that everyone can see what's happening, and could plan accordingly. Repealing it directly would shock the real estate market, and would likely trigger another tax revolt. It would be a disaster for individuals and the state. It's a political non-starter for a good reason.

And obviously we wouldn't have to repeal it directly in order to fix things. There are lots of creative options.

Any change to prop 13 could also be roughly revenue neutral. In other words, it's possible to change it without increasing the amount of money that the state gets. Taxes were too high in the 70s, and if that unfairness is intolerable, then lowering aggregate property tax rates could reasonably be Prop 13's permanent legacy.

Another interpretation of Prop 13 is that California real estate is different than most places. Specifically, there's a long-term risk that California real estate is more correlated to the stock market. If so, it's unreasonable to ask homeowners to take on a future payment obligation that grows in proportion to the stock market. 

The good part of Prop 13 is that it decoupled the property taxes from the stock market for existing owners. The bad part is that it let the future tab run up for future buyers.

So any change to Prop 13 needs to leave property taxes largely decoupled from the stock market for existing owners, while also doing something similar for new buyers. We need to take care of the next generation, and not just by paying our own kids' taxes.

Big Numbers

Let's count all the money the state gets in property taxes today. If we just look at residential, that might be $40 billion in property taxes, on something like $4 trillion of assessed value. If our collection above were representative of the state, then we'd expect the $4 trillion, in assessed value, to correspond to something like $12 trillion, in fair market value.

Said the other way, if California gets $40 billion from $12 trillion, then the effective state tax rate is 0.3% instead of 1.25%. That effective tax rate has been falling since 1978. With no policy change, it would still go a little lower, but it's close to stabilized by now.

Cap the State

Maybe the problem with Prop 13 was that it capped individuals. That freezes people in houses and breaks the market. More directly, we could cap the growth of the total revenue that California collects. Instead of capping individuals, let's cap the state. Clearly the state needs some revenue growth, but we can cap that. One estimate for that growth might be inflation (3%) + population increase (1%), or around 4%.

There are currently around 14M households in California, and that number also increases as new homes and condos are built, adding to the property tax base. As more units are available, more owners are part of the pool contributing to the total tax base, lowering the fraction that each has to pay.

Divide it Up

With this proposal, to figure out this year's total state property taxes, the state starts with three numbers: last year's collected revenue, or $40B, for this example, last year's market value of all homes, $12T, and this year's value of all homes, $13T.

The difference between 12 and 13 is 1, and 1/12 is around an 8% increase. That's higher than our state cap of 4%. That means instead of increasing the state property tax revenue by 8%, we increase the state revenue from $40B to $41.6B, or 4%. Then the state tax rate, for everyone, for this year becomes: $41.6B / $13T, or 0.32%, which is slightly lower than last year's rate of $40B / $12T, or 0.33%.

Tax rates on everyone go down, because the state is getting what it needs, and more properties of increasing value are sharing the tax burden. If in addition to an 8% increase in market value, we also had a 1% increase in homes, then we'd have more than $13T in total value, and the tax rate for everyone would be even lower. Because we're capping the state (at inflation + population growth), more homes mean more people to share the tax burden.

Dividing it up is fair, and because the state is capped, there's little long-term risk of kicking Grandma out of her house. She can plan, and she's also now free to move. Prop 13 put the cap in the wrong place.

But we can't change it immediately. If we did, Dr Abe, and 5 other people in our random sample would see their taxes jump immediately from almost nothing to 1/3 the national average, and there'd be a revolt. The me-generation is consistent. Yes, we know, we can't change Prop 13.

But 1/3 the national average, with an obvious cap to keep property taxes low in the future means there's little upside risk to runaway property tax bills, even if housing prices stay correlated to the stock market.

Still, an abrupt increase in property taxes will never fly, even if the rate is remarkably low, and contained against future increases.

To smooth the transition, we'll phase it in. Then we pick the rate of the transition.

The faster we make the transition, the sooner we stop exploiting Teacher Christine, and the sooner Grandma would be free to consider a move. But that would also mean Dr. Abe, along with 5 of 15 in our sample, would lose their Prop 13 advantages over their newest neighbors. Who knows, maybe some people feel shame while others are happy about it. Again, the final rates are still low, and capped, so they'll continue to drop, if housing prices keep going up.

Phase in

There are good reason to go slow. Shocking the real estate markets is likely to have unintended consequences.

There are lots of mechanisms to implement the phase in. A simple approach is to compute both: Prop 13 taxes, and FMV taxes. Then your final property taxes become a weighted average of these two. Over time, the weighted average moves to the stable long-term (capped) FMV taxes.

Let's say we wanted to fix it in 20 years. The first year would be 95% Prop 13 and 5% FMV, and the next would be 90% Prop 13 and 10% FMV, etc.

It's a linear change, and the graph of the weights is just two lines.

In 2030, we'd pay the simple average of the two taxes, and by 2040, and after that, we'd pay only FMV taxes.

The 3 Piggies

Taxes re-centered around fair market value, clearly have the most impact on Dr. Abe's tax bill. His current Prop 13 taxes are around $4K, and on a $6M estate, his target long-term fair market value tax would be around $18K. But it's a 20 year transition. In the first year of the transition, he pays: 0.95 * 4K + 0.05 * 18K, or 4.7K, which would be a $700 increase on his $6M property. 10 years from now he'd be halfway through the transition, and would be paying something like $11K on $6M.

Engineer Bob, and many others in the 15-house random sample, would have similar taxes with either calculation, so the Phase in wouldn't do much.

Teacher Christine would get the most correction. Her target long-term taxes on fair market value is $6K on her $2M property, and she's currently paying $23K by Prop 13. In the first year of the transition, her taxes would be 0.95 * $23K + 0.05 * $6K, or $22.15, which would save her a little more than $800.

It's not immediately fair, but it helps, and it's moving in the right direction.

New Owners

We keep computing Prop 13 taxes for everyone during the 20 year transition. A new owner in 2025 would pay 0.75 times the Prop 13 Tax computation based on a 1.25% tax rate, and 0.25 times the FMV calculation based on approximately a 0.3% tax rate, that would likely keep falling with increasing property values. That means something like 1% as a starting tax rate. Over the next 15 years, the taxes on the new owner would keep decreasing to the FMV calculation.

The transition period avoids any short term discontinuities that might motivate people to wait or rush their home purchases for tax purposes. Because it's small changes over 20 years, it doesn't really matter when you buy or sell.

Selling the Idea

This is a political non-starter. People won't vote against their own economic interests. And yet poor people elect a billionaire, who enacts trade policies that undermine the poor people's businesses, and rich people vote for socialists. 

Voting isn't simple. It's about culture, and California's housing crisis impacts everyone, and the entitled message of Prop 13 has cultural impact.

There's something fundamentally unfair about Prop 13, and it's deeper than taxes are too high, and it's deeper than poor Grandma. It's something about us and them, where "us" is all of us older white people with all the money, and "them" are all the young, and new, and increasingly brown people we apparently must be trying to keep out. Prop 13 stinks for a reason.

Prop 13 is an economic border wall, brought to you by the same people who complain about the current president's attempts to build a physical border wall. That can't feel right to most California voters. Many of us feel the shame of the current arrangement. Really, we want our kids to pay our taxes?

And increasingly, many people can't afford to buy houses (partially because of prop 13), and they don't get the advantages of prop 13, and eventually, they'll figure out how to vote too.

Saying we can't fix it, is a way to give up without starting. It's rationalizing social injustice. There are always major interests in keeping things unfair. If most of us know that it's unfair, then there have to be strong forces in place to keep it that way. 

The people who say it can't be fixed are mistaken. If they hold on to that view, they become part of the rationalization of the injustice. If they consider the possibility, that it can be changed, then it changes. This is California. It's just a policy. And it's just money: let's make it fair.

It's like interest rates and monetary policy. If we fix it, then it's crucial that we change it slowly, without changing much for anyone. Everyone moves closer to fair. We have time, and we can do this. 

But there would be two taxes, with a complicated transition. How do you explain this in an elevator? How about this: 

Instead of capping individuals, we're going to cap the sum of revenue that the state collects from everyone. If housing prices continue going up faster than inflation, then everyone's effective tax rates keep going down. Currently that tax rate would be 0.3%, or about 1/4 of what it is now for new owners. The change will be phased in over a 20 years. Things will move slowly, it will be fair for everyone, and the state will be just fine.

What about Grandma?

The fictitious Grandma of Prop 13 is of course real. Especially back in the 70s when inflation was a huge problem, and when we assumed it always would be. That means housing prices would go through roof, and her taxes on them would become unaffordable. And if her income wasn't increasing fast enough, she'd be in a hard place. She'd have to go somewhere else.

But inflation hasn't happened. In fact inflation peaked 2 years before Prop 13 passed. Why hasn't it happened? Is it all monetary policy? Maybe, but there's more to it.

Think of hi-fi systems over the last 60 years. Your parents' or grandparents' system from the 1960s had tubes, and it sounded pretty bad, and it cost an arm and a leg. By the 1980s it had transistors, and integrated circuits, it worked better, and it was half the price. Today it's almost a throw-away commodity. If it were to break, we'd just throw it away, and buy another that would be nicer and cheaper.

Or think of a nice flat screen TV, that you might have bought 10 years ago for $5-10K. It looked great, and it still does. If you want a new one, with better resolution, it's now only a few hundred dollars.

What's going on? Do we have deflation now? 

Yes, but it's focused. Anything that can become an information process, tied to computers, is getting exponentially better, and exponentially cheaper. At one extreme, Google does lots of helpful things for everyone, essentially for free. Farming is getting better too, and many things are getting more efficient. Free markets work. But not everything is going down in prices with increased efficiencies. Things that are fundamentally limited in supply, like land, are not getting cheaper.

So does that mean we have to kick grandma out of her house?

After technical innovation that makes everything cheaper, the main two knobs we have, as a fair society, to keep Grandma in her house are the property tax rate, and monetary policy to keep inflation under control. Our state is working to some extent today, with an effective property tax rate around 0.3%. By capping the state revenue, the property tax rate will continue to fall, if housing prices continue to go up, and more houses are being built. That continues to protect Grandma.

Having a wealth tax on a house, in a capitalistic society does mean that Grandma can't stay in her 10M estate right next to Google, if she doesn't want to pay around 30k/year in property taxes. What's a fair number for her? Is 10k/year about right? What about 1k/year? When we gave her that break with Prop 13, we didn't give it to just her. We gave it to every owner, and we propped up the real estate market, trapping people in their houses and limiting supply. We gave money to the rich, and to their heirs, with costs born by the poor, who can no longer afford rent. Our intervention broke a free market.

With this kind of change, yes, some Grandmas will end up moving from Silicon Valley to Napa or San Luis Obispo. They'll move because they want to, because at last, they're free to. They'll like it there. The weather is warmer, and there won't be so much traffic. With Prop 13 corrected, Grandmas will be able to afford to move, because their taxes will actually go down, like they should, when they move to a cheaper place. And with that, they'll have a little left over for a nice trip, or a gift to a grandchild. Or maybe they'll be able to afford to move closer to their grandchildren.

Those of us on fixed incomes today would never move to a cheaper place, if it means our taxes will go up (old-person 101). By not wanting to kick Grandma out of her house, we trapped many people. We distorted the market for the rich, and drove up rents and homelessness.

I also wonder if the fictitious Grandma has always been mostly fictitious. Sure it happened, but the real point of prop 13, for most owners was closer to: when I buy my house, I don't want to buy into paying my share of property taxes in the future. Sure, I'll pay them now, but they're already way too high, and so they'd better be discounted over time. And yes, of course, I want to keep the upside of the increase of the house price over time. That's mine, and for my heirs, and this is America. I just don't want to pay property taxes on it. And I'll come up with a story about Grandma to make everyone feel okay about, well, sort of paying property taxes, for a while at least.

And now in aggregate, property taxes are discounted to about 1/3 of the level they were before. That's progress. Let's keep that going. And let's make it fair. We can do that by pushing the cap back to the state. That gets us back to a free market, where Grandma can afford to move to Napa, if she wants to.

Real Estate

Okay, but if Prop 13 is propping up the real estate market, and if we're changing it, doesn't that mean that my house is going to go down in value? I've been paying it off assuming Prop 13 would be there forever, and now I'm paying for something that is worth less than it was, because you changed the rules. Foul!

Relax, it's okay. Here's why. 

The Prop 13 influence on prices has mostly stabilized. When we change the rules to make it more fair, we're doing 2 things: we're smoothing the huge variation in property taxes that are currently being paid, we're capping the increase in total revenue to the state which lower, and crucially, we're lowering initial property taxes toward the effective tax rate (again, 0.3% instead of 1.25%).

If you're buying a 1M house and are expecting to pay 1% in property taxes, that means you have to also come up with 10K / year, after paying for your house. If you want to pay for those property taxes with investment income, then you need something like 20 times that much money invested, and set aside to pay future property taxes. So instead of 1M, if you include the future property taxes, your new house really costs something like 1.2M (rich person 101).

As initial property taxes fall, to the effective tax rate of 0.3%, that means the extra money, that you need to keep around for future property taxes, dropped to 1/3 of its previous value. Instead of 1.2M, now I only need 1.07M to pay for a 1M house. Again, lucky me. In a tight real estate market, that reduction gets passed on as increased prices. Instead of 1M, I bid 1.1M for the house now, since I estimate that my 1.2M will now cover the property taxes on a 1.1M house, because the rate has dropped to 0.3%. Or more accurately, I do that because I know other rich bidders will figure it out, too.

With these changes, there are downward pressures on prices, by increasing supply, by slightly increasing the taxes on people who are at the extremes, and there are upward pressures on prices by decreasing taxes for new and recent buyers. We're slowly moving to a fair market, and overall prices will be fine.

More importantly for real estate agents, when people will no longer feel as locked into their houses for decades, there will be more moving around, which will generate more home sales and more realtor commissions. Yay, everyone loves realtor commissions!

Other Alternatives

Why not just increase the cap? Instead of 2% per year, Grandma, and her rich cronies are now on the hook for a 4% per year increase. That feels fair. It might feel like the right direction, but it does more harm than good. First, that's not a revenue neutral change. That's just more taxes. Second, applying that kind of change now doesn't fix things in a way that's proportional to how far off things are. It hits Teach Christine the hardest, because she's starting with the highest base. The instincts are well-aligned with traditional American values, but we can't really ask young women to do everything. Not even in California. Third, long-term it doesn't move toward a stable equilibrium where everything is fair. 

The cap on individual properties was a terrible idea, socially and economically, and it was hugely popular with voters (old people).

Why not just get rid of property taxes? That makes sense, and would keep Grandma in her house, while also having stable long term free markets for house prices. The upside of fair property taxes is that they're progressive, and rich people in nice houses pay more. Unfair property taxes, through Prop 13, end up being regressive, and the richest pay the least. If we got rid of them altogether, presumably, the state would have to make up for the loss of property taxes with increased sales taxes and income taxes. Sales taxes are not progressive, and income taxes can be. The only problem with income taxes is that rich people hide their income. And until Prop 13, you couldn't hide the value of your house. Which is another interpretation of why Prop 13 remains popular. For some reason avoiding taxes is treated like a competitive sport in this country, even in progressive states.

Why not correlate property taxes and income taxes? This one also seems interesting. You only owe the wealth tax of a property tax, when you're also generating high income. Think of it as an income-triggered wealth tax. We can still get the taxes from the rich tech workers, and we don't have to kick Grandma out of her house. The problem is that tech workers retire. That kind of arrangement would put more pressure on people to retire earlier. Retire now, and save the property tax! It would also put more pressure to get other people, who aren't working, on the titles of the houses. No really, it is Grandma's house, and yes, she is too still alive.

At some point, you either have a wealth tax, or you don't. The fancier it gets, the more creative people will be, and the more unintended consequences will distort the market, almost always for the rich.

What about a one-time sales tax on housing sales? If we could assume that California would run an endowment like Stanford does, then the sales taxes of 7% or so could be invested to generate 1/20th of that, or 0.3% annually, forever. As long as there are enough home sales, California could reasonably do the investing that rich people do to pay for long-term expenses. And people in existing homes could buy out their future obligations, or keep paying annually. The problem there is that politicians don't run surpluses that become endowments. They spend it all, and then some more, to get votes. Without fiscal leadership in government, private citizens have the discipline to do the investing, to pay for the taxes, that pay for the services. Or they just keep working, making money for the state.

What about making the property tax itself progressive? That also works, assuming the richest and most powerful would support paying more money. Property taxes could start at the median fair market value for a home, and people are only required to pay taxes on whatever their home is worth above that. If Grandma's house is a median house, she pays no taxes. And if her taxes get too high, because Google happens to start a successful business, she gets to sell her house at a profit, and move somewhere else, where she can buy a median house, and still pay no property taxes.

That feels reasonable, but it would have an unequal impact on the housing market. Again, it could never be done abruptly, and would need to phase in the new effective tax rates that are now a function of the relative value of the house. The Bay Area and LA would end up paying for everything, and maybe that's fair too.

There are many creative alternatives that could meet the constraints and achieve the desired results. Increasing the current cap to 4% is the worst, and penalizes recent buyers the most. Moving the cap to the state, with a 20 year phase in might be the most direct, and might have the least risk of unintended consequences.