-
Website
http://cafehayek.com/ -
Original page
http://cafehayek.com/2009/06/some-unlucky-numbers-for-opponents-of-proposition-13.html -
Subscribe
All Comments -
Community
-
-
Top Commenters
-
Popular Threads
All Comments
I lived there then.
Then as now, the problem was Sacramento and Washington (it wasn't a District of Chicago in those days) spending money we could not afford.
Then as now, the PTB could not see that.
According to the tax foundation, Californian's pay about 10.5% of their income to state and local governments. The national average is 9.7%.
Anyone would have a hard time arguing that legal restrictions on raising money is causing CA's fiscal woes.
CA is so far in the hole right now, my company ALREADY has to pay our 2009 taxes based on our ESTIMATED income for the year.
We just paid thousands in tax in April, and now the 2009 tax, for the full year mind you, is due by June 15th. The estimate was based on our 2008 earnings and did not appear to be adjusted for the possibility that our revenue will be considerably less in 2009 as a result of the continued downturn in the economy.
How many people had to be laid off for businesses to comply? I am sure more than a handful.
But, my real question is - how is it legal for the state to ask for an advance on the taxes from our future earnings?
Additionally - personal tax refunds have YET to be paid by CA to many individuals.
California is following the same old tired political tricks used in my state over the years. That is, whenever there is a "crisis" due to "revenue" issues, politicans always cut the meat in the budget and not the fat. This way, the voters instantly feel the pain, and will then support higher taxes. Moreover, the politically connected "fat" in the budget--i.e. the patronage jobs and patronage projects- are protected. As an example, in my state, the schools are cutting the most popular programs rather than eliminate the least popular programs. And of course, the popular teachers get the layoff notices, and not the assistants to the vice-directors of the chief administrative head of the pencils-and-pens purchasing department.
California taxpayers should hold tight.
To understand why the woes of California's economy threaten the nation's, we must understand the state's road to insolvency. The Age of Reagan did not commence with the Great Communicator's inauguration in 1981. For its real beginning, we need to go back to June 1978, when Californians went to the polls and enacted Proposition 13.
By passing Howard Jarvis's malign initiative, California voters reduced the Golden State to baser metal.
That's hilarious!
Prop 13 wasn't itself the problem, but the precedent it set of budgeting via initiative. Since then there have been a large number of initiatives that tie up the budget in ways that make deficits nearly impossible to resolve via legislation.
There's not much good to be said about government budgeting obviously, but in comparison to ad hoc budgeting via initiative it looks damned good.
Prop 13 had another effect that's rarely noted. By forcing muncipalities to shift away from reliance on property taxes it encouraged them to focus on retail development for revenue via sales taxes. The great number of streets full of giant box stores are not actually a free-market outcome, but a consequence of the incentives muncipalities face under the current tax system.
(That latter is not a liberal argument against big-box stores and consumer culture--just a statement of fact. It's hard to say what Cali would look like in the absence of Prop 13, but it seems safe to say there would still be big box stores. Perhaps fewer, though.)
I have a question for you, James Hanley. Why didn't Prop 13 encourage municipalities to shift away from reliance on property taxes by reducing expenditures?
It's articles like this that really very much scare me. This is a journalist at one of the largest papers in the USA who has filed this report.
I am watching a common nonsensical nightmare called Atlas Shrugged. I struggle to sleep well. And I am not kidding.
Spending on "takers", "thumbsuckers, and "harebrained" ideas like deregulating one half of a market equation.
They really need experienced businessman Barney Frank to help them out.
--------------
Posted by: Brian | Jun 11, 2009 5:04:04 PM
Interesting Brian, your entire comment, thanks.
I wouldn't be too critical of Jacob for reporting the numbers in nominal terms, since he followed this up with this statement
"Reed checked his numbers against the inflation rate, and found that “property tax revenue has increased by more than triple the combined rate of inflation and population growth.”
"politicans always cut the meat in the budget and not the fat. This way, the voters instantly feel the pain, and will then support higher taxes."
Precisely. If instead the poli's cut say, 1/3 or 1/2 of the least visible expenditures, 95% of the voters either wouldn't notice or wouldn't mind the loss, and the jig would be up.
Which brings us, by the way, to what governments SHOULD be doing to stimulate the economy--cutting expenses and selling assets. You could probably lay off 1/3 of the federal workforce, cut back to have time operations, and hardly anyone would notice.
----
The move away from property taxes is a good move, even if it does make tax revenues less predictable.
The worst part is, Cal will extract their pound of flesh somehow.
They will probably start hiring more cops to write traffic tickets 24/7 after they raise the fine for speeding to $3000.
the real problem with prop 13 is that it ties the assessment of properties for the purpose of determining property taxes to the year the property was purchased.
A house purchased in 1978 has its taxes tied to the value of the home in 1978, and the taxes have increased at a fixed rate that is far less than the rise in property values.
Someone buying an equivalent property in 2005 would pay property taxes based on the value of the home in 2005.
So a homeowner whom has owned the same home since 1978 will pay far lower taxes than another homeowner who has owned an equivalent house since 2005.
That is fundamentally unfair.
Oh commmon guys. Any Californians out there. What about the Mello Rouse law--you have a house in a subdivision and you pay an additional fee via a law (in spirit circumvents Prop 13) called Mello-Rouse. With MR you pay an additional "fee" for infrastructure and improvements, can be up to $300 per month for a smallish townhouse. Facts, facts,.....All distracted by the red herring of lower property taxes. Ugghhh sad state of economics disucssion in the media and even among economists--the rube goldberg complexity of revenue rasing is amazing.
Look-up Mello Roos--it snuck in as a 1982 facilities act. Its essentially a property tax in addition to the low rate. Harold Myerson like most of his ilk is selective on the facts. Call him on it Don. With Mello Roos property taxes in Ca are comprable to most other states--ie. the homeowner is getting bilked just the same as in other states.....Hate to agree with De Long but why o why can;t we have a better press corps? What can't they find some facts? Why not get them on this point?
If this is not a property tax what is?
http://74.125.95.132/search?q=cache:qcnQoifsE2oJ:www.mello-roos.com/pdf/mrpdf.pdf+mello+rouse+tax&cd=1&hl=en&ct=clnk&gl=us
It may vary by area but where I live (San Francisco) Mello-Roos is not meaningful -- I think I pay less than $100 per year because of it.
As was discussed above, Prop 13 has been largely ineffective in curbing gov't spending. That is in part because real estate prices have risen fairly steadily over the last few decades, so there was a steady supply of new homeowners paying more taxes based on increased housing prices. It will be interesting to see how the current downturn (which is much more severe than anything CA has experienced before) will affect matters.
Mello-Roos is intended to have the people who directly benefit from new infrastructure pay for it. Why should our neighbors in older sub-divisions pay so that we can get brand new sewers, roads, etc., under our brand new homes? It should definitely be calculated in Californians' overall tax burden, but I don't think it goes into general revenue, just pays off specific bonds.
John Stuart Mill, the nineteenth century philosopher/economist, wrote “Everyone who receives the protection of society owes a return for the benefit.” Today most Americans accept paying taxes as just return for government protection and services, and of course our moral code takes into consideration ability to pay (or income level). But there is one category in which John Stuart Mill’s philosophy does not apply and that is real estate ownership. In the United States, homeowners receive more government benefits and pay less tax than renters (Keep in mind that renters pay local property taxes indirectly through their rent).
Property ownership benefits are as follows: The police and military protect property from domestic and foreign threats. The Army Corps of Engineers protect from severe weather such as flooding. Local fire departments and the federal forestry service protect against fire damage. Property disaster relief reimburses property owners for disaster loss. The Federal Reserve monitors and attempts to keep stable financial and asset markets by adjusting interest rates or the money supply to assure constant positive appreciation of property values. The government guarantees bad mortgages. The government provides funds that enable refinancing homes at lower interest rates. And the government reduces property owner debt and limits liability in the event of foreclosure or bankruptcy.
On the tax responsibility side of the equation, the additional tax burden renters incur over home owners is two fold. First, rental income is taxed (via the landlord). Thus, both Federal and State governments take in more revenue from rental property than primary owned property. Second, the Federal and some State governments allow homeowners a numbers of tax deductions. These deductions include: the mortgage interest deduction, the deduction for property taxes, the $500,000 capital gains exclusion which can be taken every two years, the deduction for points on mortgage loans, the deduction of up to $100,000 on home equity loans, and trust advantages in valuation of property that is eventually passed on to heirs. Additional tax breaks added recently are: an exemption from the Alternative Minimum Tax (Renters, subject to the AMT test, rarely realize this exemption because with no mortgage deduction they usually pay more than the AMT limit even if they have a hefty state tax deduction), a new $1000 real estate tax deduction for those who do not itemize deductions, and an up to $8000 tax credit for home buyers who have not owned a home in the last two years.
So, how are property owners able to avoid paying their fair share of taxes? The answer is democracy. There are more homeowners than renters, and the majority has voted themselves these tax breaks. This phenomenon, the tendency of majority advantage over the minority, is a known flaw of democracy. Nineteenth century French political thinker Alexis de Tocqueville referred to this as Tyranny of the Majority. American founding father James Madison wrote about this subject in Federalist Paper 51, “It is of great importance in a republic not only to guard the society against the oppression of its rulers, but to guard one part of the society against the injustice of the other part.” Thus, The Bill of Rights is included in the Constitution as a check and balance to guard against both our rulers and one another, and The Supreme Court is supposed to nullify democratic tyranny type laws. But unfortunately, the Supreme Court is influenced by majority opinion and precedent and often does not correct tyrannical laws for long periods of time until majority public opinion changes, as Jim Crow Laws prove.
Democratic tyranny arises from racial, religious, ethnic, gender, class, generation, and sexual orientation differences. Real estate tax inequity is based on class tyranny (property owners versus renters), but also generational tyranny. Generational tyranny is the tendency of past and present generations to burden future generations. Other examples of generational tyranny are: The Federal deficit and growing debt; Union contracts that grandfather benefits for past employees while future employees do with less; “No Child Left Behind,” in which the past requires 100% of the future (children) to meet reading and mathematic proficiency, a scientific impossibility considering that innate learning deficiencies or disabilities exist among at least 15% of the population; and the different legal status of alcohol versus marijuana (Both are recreational drugs with similar health effects, but marijuana is not accepted by the majority and mostly older generation).
Generational tyranny is an ideal form of democratic tyranny. The future is absent and unavailable to vote or retaliate against tyranny of the past. As long as the next generation continues to pass the burden (particularly those involving money) on to the next generation, the day of reckoning is postponed. It must be pointed out that education and social security, in which one generation pays for the benefits of another, are not generational tyrannies as long as the benefits are not excessive. The youth who receive education benefits today will pay back to the education system when they become adults, and working adults paying for social security today will receive benefits at a later age. However, Medicare could be considered a generational tyranny since everyone needs healthcare and only the elderly receive universal coverage. The reason universal healthcare for all has remained so long in discussion mode is because the majority is satisfied with the healthcare they receive either from their employers or through Medicare. Universal healthcare will only be address when the now 20% minority (mostly young) without healthcare grow to a more disturbing and threatening number.
But here’s how generational tyranny relates to real estate policy: Whenever a new tax break (or benefit) for property is made available, property becomes more economically desirable and the price rises accordingly. Current property owners benefit both from lower taxes and higher property value. Future buyers of property may realize the tax break, but must pay a higher purchase price. Then to add to the inequity, the government must make up the lost revenue from the tax break by increasing the deficit or increasing other taxes that are likely to penalize non property owners and the future. These tax breaks (or benefits) for property owners are usually sold to the American people as relief for the “Middle Class”, but only property owners (not renters), at the time the tax break is issued, realize relief. In truth, the term “Middle Class” has become code for property owner.
Some real estate tax breaks may be justifiable. For example, the City of Philadelphia offers ten years of tax abatement for any property that is rebuilt. The purpose of this tax break is to improve blighted urban areas. This tax break must be earned and is limited in time (does not go on forever). The person or entity who benefits is the one who improves the property. Anyone who purchases an already renovated tax abatement property should not be fooled into thinking they are receiving a cost break. They do pay a higher purchase price which offsets the tax abatement. But, the future does benefit from an improved neighborhood.
But almost all other real estate tax breaks are not constructive for the future. They all serve to increase property values, thus raising the bar to renters and potential home owners. Mistakenly, most American politicians believe the opposite, that offering real estate tax breaks helps provide affordable housing going forward. Thus, the government continuously adds more and more and more tax breaks which only serve to increase property values often to unaffordable levels, shifts tax responsibility to non property owners and the future, and widens the wealth gap. In truth, future home owners would be better off without these tax advantages in favor of lower and more affordable pre-tax break home prices. In contrast, Canada does not offer tax deductions for property owners and reassesses property every five years to maintain equity and fairness. Home ownership in Canada and the United States is equivalent, about 67%, but is less stable in the United States.
In addition to legislative tax and benefit policy, monetary (Federal Reserve) policy plays a major role affecting real estate (as well as other wealth or asset) markets. The Federal Reserve’s tool of choice is the fluctuation of interest rates in an attempt to keep asset markets stable, from either over heating (due to speculation or inflation) or over weakening (due to recessionary forces). But interest rate fluctuation sometimes is not enough to correct extreme asset price swings. In these events, reigning in or expanding the money supply is the secondary tool available to the Federal Reserve to affect asset value. Growth in money supply always causes inflation, and contraction always causes deflation. However, the money supply is almost never reduced during times of inflation and is continuously expanded on a regular basis, thus assuring constant positive housing and other asset inflation. The money supply is expanded by printing money or allowing increased public and/or private debt. Public debt is expanded through government deficits, and private debt is expanded through increased bank leveraging.
Federal Reserve policy follows a widely held belief among economists that an expansion of the money supply spurs growth and a contraction of the money supply causes recession. And since prices correlate with money supply, deflation is feared. But this belief is not true. “Strong growth has occurred during deflationary times, for example during the post Civil War period and in the early 1950’s.” Germany’s and France’s economy has shown significant improvement in the first half of 2009 despite deflation as lower and more affordable prices encouraged consumer activity. Deflation can serve as a healing mechanism during recessionary periods. In truth, whether deflation or inflation is better depends on point of view. A property or asset owner benefits from inflation (higher asset value and return on asset). A renter or future purchaser of assets benefits from deflation (lower rent, cost of living, and housing prices).
Whether inflation or deflation is better for the economy, as a whole, depends on the wealth gap between those with assets or wealth and those without. If the wealth gap is narrow, “inflation may likely spur growth by redistributing wealth away from the wage earning class, who tend to consume it all, and towards the wealth class who will invest their gains in productive capital” (rational used to support supply-side economics). But if the wealth gap is wide, growth may be inhibited by consumption limitations (consumers lack money to purchase), and thus deflation may be preferable since it offers affordable consumption growth. The affect money supply has on the wealth gap cannot be ignored. For example: “After the First World War, Germany experienced hyperinflation (due to an expansion of the money supply) which did untold harm to Germany. The impoverishment of the middle class, the redistribution of income, and frantic instability unquestionably helped to lay the groundwork for Hitler’s emergence later.”
Milton Freidman, a Nobel Prize winning economist and advisor to Ronald Reagon during the emergence of supply-side economics, developed the theory currently being followed by the Federal Reserve. He suggested mildly increasing the money supply on a consistent basis to insure constant but low inflation or in excess to spur economic growth in recessionary times. His theory does have some holes which he overlooked in his own analysis. The quotes in the previous paragraphs are his, and provide support for an alternative theory as those paragraphs suggest. Granted, banks and financial institutions need support toprevent collapse, but expanding the money supply for the additional purpose of propping up prices is counter productive.
In the decade preceding the current 2008 housing crash, easy credit and overleveraging of the private (bank) sector artificially increased the money supply and caused both real estate and stock market inflation. Note that the inflation was concentrated in stock and real estate prices, but general inflation as measured by the Federal Reserve (which does not include stock or real estate prices) remained relatively low. For example, real estate prices soared, while rents remained flat. This uneven inflation scenario suggests a widening wealth gap. The excess money supply tended to accumulate in speculation of stock and real estate value with the asset owing class and did not trickled down to the wage earning class. The inability of the wage earning class to afford the inflated asset values made this scenario unsustainable. Stock and real estate values crashed and the additional money supply was wasted and proved artificial.
In response to this economic crisis, the Federal Government has chosen to replenish the lost artificial money supply with public money in an attempt to rebuild or make real the artificial wealth (in particular real estate wealth) thus hoping to spur economy recovery. They are using Milton Freidman’s playbook. But will it work? Well, wealth will be replenished but not as expected, not evenly, and at a loss of relative value (due to a devaluation of the dollar). The money that pours back into the economy will not likely be directed towards productive capital (new business development) or real estate value since the wealth gap prohibits those at the middle and lower end of the gap to afford new products or higher prices without easy credit (which caused the real estate bubble in the first place). For example, the wealth class is not likely to invest the extra money in new businesses and jobs to build widgets or homes that few can afford to buy. But the new money supply must go somewhere, and the finance industry will most likely channel it into speculation of stocks and products that consumers must buy such as food, energy and other commodities. For example, crude oil is likely to re-inflate maybe to $150/BBL or higher. Thus we have a stock and commodity recovery without a jobs recovery. Also, the wealth gap expands as the wealth class gains from the stock and commodity inflation while the wage earning class and future struggle to afford the inflated prices.
Although Inflation plays a role in expanding the wealth gap, also problematic is the different and higher tax rate of labor income (earnings from actual work) as opposed to the lower tax rate of wealth income (capital gains and other investment tax advantages). For example, capital gains of commodities (gold, oil, etc.) are taxed at 15%, yet income from labor is taxed up to 35% plus Social Security and Medicare tax (Self Employed pay double Social Security and Medicare plus other taxes such as unemployment tax). Keep in mind that labor contributes work, of which the idle commodity investor does not, but then supply-side economics supports this scenario which places a higher importance on investment wealth over labor. Tax inequity between labor income and real estate (a wealth) gain is even more profound. Tax on real estate gain is essentially zero (for home owner gains up to $500,000 every two years).
But ultimately, debt must be addressed to turn the economy in a healthy direction. Besides reducing wasteful government spending, the most reasonable way to do this is to not only tax wealth income appropriately, but recover past obligations through inheritance tax. Year after year, budget deficits have allowed taxpayers to accumulate personal wealth while failing to pay for the government services they’ve utilized. John Stuart Mill’s quote, “Everyone who receives the protection of society owes a return for the benefit,” would suggest that these people still owe, particularly property owners. Collecting the debt at death prevents the debt from being passed on to the future. Besides, who better to tax than dead people? They don’t need the money any more.
So far, discussion has focused primarily on federal government policy. But state and local real estate law can add to the home owner versus renter and future inequity. Many states adopt similar property owner advantages. But there’s one that deserves special mention. Have you ever wondered why real estate is so expensive in California? Hint: it is not because everyone wants to live there. The answer is: In 1978, California property owners voted themselves a huge financial benefit called Proposition 13. Whereas Federal tax inequity is static, meaning the inequity occurs only when a new tax break is enacted and a new equilibrium reached, Proposition 13 is dynamic, meaning that the inequity grows with time. It is interesting that California, which prides itself on a purer democratic system with its voter proposition system, is easy prey to democratic tyranny or in this case generational tyranny. (Prop 8, which disallows gay marriage, is also a democratic tyranny.)
Proposition 13 reduced the real estate tax rate to 1% of assessed property value. Like Federal government tax breaks, Proposition 13 not only instantly reduced taxes but increased the asset value of the property going forward which, as discussed earlier, benefits property owners but raises the bar to future property owners. To make matters worse for the future, Proposition 13 limits property tax increases to 2% per year. Since housing inflation has consistently exceeded 2% per year over the past thirty years, long time property owners pay much lower property taxes than new owners. As a result, a value gap has developed between what a long term owner values a property and what a newer or prospective owner values a property.
A long term owner, with low expenses (taxes), values their property much higher than a prospective buyer. In a potential sales transaction, an agreeable price is not likely to be arrived at, and the long term owner maintains ownership. The property then may become a rental if the long term owner has need or desire to move, even if it is a move to another state or country. As fewer properties are supplied to the marketplace for sale, a dearth in supply increases real estate prices even more than general inflation. The value gap widens further, and now 30 years later, California has the highest real estate prices and the lowest home ownership rates in the country, 57% (except for New York at 55%, but New York City has its own generational tyranny type real estate laws).
Proposition 13 is like a pyramid scheme. The sooner one buys real estate, the better. As long as newcomers strongly desire ownership, even when renting is more economical, the pyramid scheme continues. In theory, the Proposition 13 effect should always guarantee an upward pressure on property values. This realization initiated the interest only mortgages following the dot-com bust in early 2000’s. At the time, real estate was beginning to falter, particularly in California’s high tech areas. Real estate values had grown too high during the tech bubble for the average person to afford both interest and principle. Thus, to keep the real estate market moving upward, interest only loans were created. This may have worked if the interest only loans had been limited to only those who were able to afford the payments and did not spread to other States that do not have a Proposition 13 type law. But the mortgage industry became too lax, and bad loans were issued.
It should be noted that California is ground zero for sub-prime mortgages. Although California makes up about 12% of the US population, over 50% of sub-prime mortgages were initiated in California. And considering housing values are higher and have fallen further in California than in other states, a huge disproportionate amount of Federal government funds have poured into California to support the Proposition 13 induced value gap. For example, in early 2009, Sacramento housing prices dropped 50%, but two thirds of the sales were of foreclosed homes. This means that new buyers value property at a 50% discount (bottom of the value gap) and existing owners, who do not need to sell, value their property much higher (at the top of the gap) and choose to wait out the storm. When the crisis is over and the stock of foreclosed homes is depleted, housing prices should bounce to the top of the value gap level. Since the Federal government is subsidizing the value gap on foreclosed homes, Proposition 13 has become a United States tax payer problem.
A few other states have followed California’s lead and adopted Proposition 13 type tax laws. Florida limits real estate tax increases to 3% per year, but the law only applies to primary residences. If a Florida homeowner moves the tax advantage is lost, encouraging the owner to sell, and thus eliminating the tendency of property switching to a rental. Pennsylvania, at the urging of Governor Ed Rendell, recently adopted a real estate tax savings law tied to slot machine gambling that locks in tax responsibility indefinitely. At some point, Pennsylvania’s future will face the consequences.
To exacerbate the Proposition 13 pyramid scheme, California tax breaks may be passed on from generation to generation. Not only are assets hereditary in California, but tax rates are too. This nepotistic proposition is separate from Proposition 13 and took effect in 1986. It is known as the ‘parent-child reassessment exclusion’. The underlying purpose of this newer proposition is similar to that of the discriminatory Jim Crow ‘grandfather clauses’ that were enacted after the Civil War. For example, one of these Jim Crow clauses stated that if you have a relative that voted prior to the 15th amendment then you are allowed to vote. The 15th amendment provided blacks with the right to vote, but the ‘grandfather clause’ essentially eliminated that right. Likewise, Proposition 13 rules that if you or relatives own a property a long time, and by the way you’re most likely white, considering new Asian and Hispanic immigration, you get to pay lower taxes.
In the 1980’s, long-time Californians became alarmed by the increase of Asian and Hispanic immigrants to California. They also recognized that their own children would face steep property taxes in the future due to higher property values, ironically because of Proposition 13. Long term Californians needed to tweak the property tax laws to protect their own children and keep the newcomers out, or at least to keep them from buying into the community. Although Proposition 13 and the parent-child reassessment exclusion are designed to protect and maintain a demographic status quo, the opposite occurs. Ownership may remain mostly white, but residency does not. Young adults desiring home ownership to begin their own families find that the timing of inheriting their parent’s home does not coincide with their fertility clock, and the cost of purchasing their own home is insurmountable. Compared to other states, young native California adults are more likely to remain childless, move to another state, or live with their parents in multi generational households. Immigrants, who are more likely to accept renting and crowded living conditions to attain the American dream, move in to replace the dwindling numbers of the next generations. California leads the nation in the number of people per household.
Did you ever notice that a law which is enacted to correct a perceived injustice many times causes a different injustice? Then another law is enacted to correct the second injustice which then causes another injustice and so on. Well, Proposition 13 was enacted to provide justice (but created generational inequity) for Californian property owners, and that was followed by the 1986 parent-child reassessment exclusion to provide justice (but creates demographic inequity) for their children. But Californians noticed that not all newcomers are bad. These include teachers, police, firemen, healthcare workers, etc. So, subsidized rental and/or home ownership programs are created for essential workers. Of course this subsidized housing comes from tax revenue paid for in large part by new California residents who can’t afford their own homes. So, something should be available to appease the other new “non-essential” residents. Thus, a subsidized low cost housing lottery is established, and the people are easily pacified by an extremely remote illusion of home ownership. Perhaps a more logical approach would be to go back and eliminate the first law and all the problems would disappear.
The effect Proposition 13 has on new residents is similar to that of trade tariffs. Trade tariffs are put in place to provide advantage and protection for domestic business from cheaper foreign product invasions. Similarly, Proposition 13 gives advantage to and protects current property owners from invasion of new California residents, whether from another community, State, or another country. New residents pay the higher tariff (taxes). Proposition 13 makes it easier for current owners, including landlords, to maintain ownership, but harder for new residents to become owners.
This brings us again to Milton Friedman, who in addition to his monetary prowess was also a free-market (no tariffs) conservative economist. He lived in the Russian Hill section of San Francisco from 1977 until his death in 2006 and benefited from Proposition 13 since its inception in 1978. Mr. Friedman was a “strong proponent of Proposition 13”, despite its effect on a free and fair real estate market. Desire for personal gain is the root of hypocrisy. Milton Friedman is not alone. Other free-market, property-owning economists, politicians (most notably the late President Ronald Reagan and California Governor Arnold Schwarzenegger), businessmen, and members of the news media are guilty of hypocrisy too. Schwarzenegger was even brass enough to use the campaign slogan, “Protecting California Dreams” (from whom, newcomers?) during his previous campaigns for governor. Schwarzenegger forgets that he was once a new immigrant. Even liberals fall into the hypocrisy trap. For example, Congresswomen Nancy Pelosi has constantly supported Federal assistance and tax breaks for property owners. She forgets that her San Francisco constituency is almost 70% renters.
Proposition 13 and the parent-child reassessment exclusion are unlikely to be altered, at least democratically, for many years. Homeowners still outnumber renters in California, and a reversal these propositions must garner two thirds of the vote. Barring evasive action from the Supreme Court, only serious resistance from the renter class will force change sooner. A replacement of Proposition 13 and the parent-child reassessment exclusion is likely look something like this: The tax rate may remain at 1%, but taxes will be equalized through regular statewide reassessments. Many (mostly investors) will put their property up for sale. Supply will increase and real estate values will drop significantly. The newest owners will lose asset value but will most likely pay lower taxes as their asset base drops. Long term home owners will pay higher taxes, but a more fair contribution to the state tax base. More renters will be able to afford the lower property costs and fund construction of new property, helping to revive the economy. Fewer renters will lead to lower rents. Deflation has its advantages.
Finally, a complete discussion of real estate and generational tyranny must include rent control. Rent control is similar to Proposition 13 in that it limits rent increases and leads to inflated rents for future tenants. Rent control can only exist in areas that have a majority of renters, otherwise it would be voted out. Almost all college Microeconomic 101 textbooks present a case study on rent control. Thus since so many others have written about the economic effects of rent control, the supply and demand curves and the associated theory won’t be presented here. Please refer to these numerous sources. But in summary, rent control creates a shortage of rental units. As a result, rents increase for new tenants. This rent increase is dynamic, similar to the effect Proposition 13 has on real estate prices. The dynamic effect means that the cost gap between old and new tenants increases with time. New and younger tenants end up subsidizing the rents of the older tenants. Elderly tenants tend to hold on to spacious units when they no longer need the space, while younger tenants with families crowd into smaller accommodations.
Rent control results in an interesting phenomenon in terms of demographics. Rent control supposedly helps the poor, but in reality does the opposite. Poor renters at the time rent control is enacted are helped, but not so for future poor renters. Rent control elevates rents for future tenants, thus future tenants must be wealthier. The future poor are priced out of the market. Over time, the future poor are pushed out of the community, and the older poor die off. In the mean time, many older poor, protected under rent control, are disheartened as their grown children move far away to more affordable communities.
Manhattan, San Francisco, and Oakland all have rent control, and all have experienced an outward migration of the poor. Unfortunately, blacks make up a disproportionate amount of the poor for reasons which won’t be discussed here. But the changing black demographic make up of rent control areas proves the effect rent control has on the poor. Rent control was enacted in San Francisco in 1979 and in Oakland in 1980. In San Francisco, the black population subsequently dropped from 13% to 6.5% from 1980 to 2005. In Oakland, CA, the black population dropped from 47% to 31% during the same period. Manhattan, whose rent control dates back to World War II, also has seen a significant drop in its black population. Rent control has been the most legally effective method of manipulating race demographics. Only education reform (punitive use of standardized testing) has the potential to eclipse rent control as a race migration force.
So, what will happen if rent control is eliminated? Many long term renters are fearful. They believe that their rent will quadruple, or more, to current market rates, a figure they cannot afford. Well, rents will adjust, but not to current market rates. Supply will immediately expand, and market rates will drop. Most long time tenants will see rent increases, but more recent tenants will see decreases. Many elderly long term tenants will be able to afford the new rent and will stay put. Some long term tenants (especially elderly who no longer need as much space) will move to smaller, more affordable units freeing up more space and supply for the younger generation. As rents fall, so will property values. Some renters will be able to afford and purchase their own homes, freeing up even more rental units and further reducing rents. This scenario should not be scary for tenants.
In fact, San Francisco is already moving towards phasing out rent control. All condominiums and single family homes rented on or after January 1, 1996 are exempt from rent control restrictions. Also, all apartment structures built after 1994 are exempt. Many existing apartment complexes are gradually being converted to condominiums which will eventually be exempt. Also factor in the increased number of rental units converted from primary owner occupancy due to the Proposition 13 effect. As time goes on and the elderly, locked into rent control, die out, fewer and fewer rental units will be covered under rent control. The effect of the January 1, 1996 condominium and single family home exemption has already had an impact on rent. Rents in San Francisco have since moderated. Over the next 10 to 20 years, this trend should continue until almost all rent control units are equalized to market rates. As fewer residents are rent control protected, rent control will most likely be voted out entirely.
There’s no question that real estate policy in the United States needs a more forward thinking and equitable direction. Maintaining high property values (or rent control) for the past and providing affordability for the future are conflicting goals. Double mindedness (having things both ways) never works. A common sense approach suggests that the past (even if they are the majority) needs to show consideration for the future and should sacrifice some of their advantage to bring the system to healthy balance.