Property Taxes, Schools, and Fairness

One often overlooked casualty of the great real estate slowdown has been revenues from property taxes. Counties, cities, and school districts are the primary beneficiaries of property taxes. In fact, over 80% of the revenue raised by property taxes are used to fund these 3 entities, with schools getting over 50% of the total property tax revenue. So it is not just Realtors, mortgage brokers, and over-mortgaged homeowners who are the biggest casualties of our real estate slump. Schools are a big loser as well. In fact, our school districts are in financial crisis, and proposed budget cuts are deep and painful. The Pleasanton Unified School District expects a $4.5 million shortfall this year alone.

In order to understand the impact of the real estate slowdown on property tax revenue, you must understand the now famous Prop 13. The two major provisions of Prop 13, enacted in 1978, are that (a) property taxes are based on the market value of the property when it is purchased or transferred and (b) the assessed value is limited to a 2% annual increase, regardless of market value. Prior to Prop 13 in the wild days of the 70’s, homeowners were seeing huge increases in the assessed value of their properties, and therefore huge tax bills, as the real estate market appreciated rapidly. At that time, properties were assessed according to their market value, so if your home appreciated 30% for example, so did your property tax bill. This led to the famous taxpayer revolt that produced Prop 13.

What has kept the system relatively healthy is the steady appreciation rates of residential property in California. When properties sell, there is normally a net increase in property tax revenue, as appreciation translates into a higher assessed value for the new owner. This increase in revenue is especially strong in a booming real estate market, as not only are assessed values higher, but there are more sales to boot. But the reverse is true in a real estate slump. Property values have declined, as well as the number of sales. When sales of real property drop 50% for example, property tax revenue takes a hit as well. There is still usually a net increase in assessed value on many properties, depending on how long the previous owner owned it, but the number of reassessments drops with the level of sales. So there is a net decrease in revenue.

There is normally a steady amount of discussion about the relative fairness and effectiveness of the current property tax system. When we have periods of fiscal crisis, these issues tend to move to the forefront. So is the Prop 13 property tax system fair? It depends on who you ask.

For example, consider 2 houses that are the same size next to each other. One house has been owned by the same owner for the last 20 years. Let’s say the property tax generated by this house is $3000 per year (not unusual in our area). And let’s say the house next door sold last year for $900,000, so the annual property taxes on this house are $10,000 per year, or three times the amount. It is quite possible that the owner paying $3000 per year has a couple of kids in school. And the owner paying $10,000 per year may not have kids yet. So from a use standpoint, one could argue that the owner paying $3000 per year is getting his kids public school education subsidized by his neighbor. It is hard to argue that this is fair.

Or how about a long time home owner with a very low tax base who decides to retire to the desert or the foothills, and rents their home out to a young family with school age kids. Again, this would be a net loss to the school district, as the revenue generated from the low tax assessment will most certainly not cover the cost of educating the tenant’s kids.

Or how about new homes. Local governments and school districts have collected (some say extorted) millions of thousands of dollars from new home builders in permit fees, school mitigation fees, and other fees levied on builders for the privilege of building homes in the community. This raises the cost new homes, sometimes by as much as $50,000 to $100,000. So one could make the argument that buyers of new homes bear an disproportionate share of the tax burden to fund schools and local governments. And to make it even less fair, when new homes cost more, resale homes generally benefit from an increase in value, while enjoying a cap on what they pay into the system.

On the other side of the equation, property taxes are not cheap. And homeowners need the certainty and protection of limits on the increase of assessed values. Even long term property owners need protection against huge increases in property taxes, especially those on fixed incomes. Is it fair to force an elderly home owner to sell their home because they can’t afford the taxes on their property under the old system?

There is a strong argument that while there are inequities in the current system, there is stability. When you buy a property, you know what the taxes are going to be, and you are protected against huge increases in property taxes. As is often the case, how much someone is paying in property taxes has a lot to do with their feelings on the fairness of the system.