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Prop 5 = Property Tax Crisis 2.0

A Prop 5 "No" vote is the 2nd most important vote this November

The first property tax crisis

During the 1970s, Seniors were challenged to keep their homes due to rapid home price increases and skyrocketing property tax bills.

Property tax crisis solution = Prop 13

To resolve this first property tax crisis, voters passed Proposition 13 in 1978. It has four main covenants:

1. It limits the baseline property tax to 1% of a house-assessed value;
2. The assessed value can not increase by more than 2% per year above the initial purchase price of the house;
3. It requires a 2/3 majority in both legislative houses for future increases in any State taxes (not just property tax);
4. It requires a 2/3 majority in voter approval for cities, counties, and special districts to impose new local taxes (property tax, sales tax).

Items 1 & 2 are still solid.

Item 3 is no constraint at all since Democrats have a supermajority in both houses and they are favorably inclined to any tax increases.

Item 4 is being progressively dismantled

How to dismantle Prop 13... 2/3 majority for local taxes

In March of 2000, Prop 26 proposed reducing the 2/3 majority requirement down to a simple majority (50%) to pass local school bonds financed by parcel taxes. That Prop failed (< 50% in favor of California voters).

In November 2000, Prop 39 replaced the 2/3 majority to a 55% one for local school bond measures. And, it passed (> 50% in favor).

Now Proposition 5, on this coming November ballot, proposes to reduce the 2/3 majority down to 55% beyond school bonds and just about everything else. And, it would also affect local sales tax. For more details on the subject, please refer to Nick Waranoff's excellent article.

Homeowners and renters have different economic incentives

The homeowners are directly affected by any new parcel tax since they pay for it. Additionally, they can't deduct such taxes from their taxable income since the Trump Tax Cut of 2017.

The renters do not pay property tax or parcel tax. Their landlords do. But, the landlords can deduct such taxes as a business cost. And, their properties are often under-assessed due to an ownership transfer loophole associated with commercial property. Additionally, renters benefit from increasingly stringent rent control. As a result, renters get no price signal from any new parcel taxes.

When a proposed local government initiative is financed by a bond repaid by a parcel tax, renters view the perceived benefit as "free." Homeowners do not. In $dollar term, California homeowners already pay among the highest property taxes in the US.

Given the very different price signals, we can expect renters to vote "in favor" at a far higher rate than homeowners regarding any proposed local bond repaid by parcel tax.

Exploring scenarios with different voters: homeowners vs renters

Assuming the mentioned homeowner/renter split of 55/45 let's contemplate various voting scenarios.

As shown in the table below, when using the 2/3 threshold, it is very challenging to get a parcel tax passed unless the homeowners who pay the parcel tax support it. Indeed, the three scenarios that clear the 2/3 hurdle (highlighted in red) are associated with homeowners "in favor" in the 50% to 55% range.

Next looking at the same scenarios but lowering the threshold to 55%, notice how the majority of the scenarios now pass (approved by voters).

The 2/3 threshold protects the interest of homeowners. The 55% threshold does not. A lot of bond-parcel taxes could pass with a large majority of homeowners being against them. And, they are the ones paying for the parcel tax.

For a bit of empirical evidence...

The only data I could find to observe the difference in passing rate [2/3 vs 55%] was regarding school measures. If a school raises a parcel tax (with no associated bond issuance), it needs a 2/3 majority. But, if it issues a school bond repaid by a parcel tax, it needs only a 55% majority. The graph below discloses how the % pass rate is far higher for the "55% Bond" vs the "2/3 Parcel Tax."

Source: https://www.ed-data.org/State/CA

Over the 2014 to 2023 period, the average pass rate for the "55% Bond" was 60%. This was 4 times greater than the 15% for the "2/3 Parcel Tax."

Lowering the local bond measures' threshold from 2/3 down to 55% will result in a huge increase in such measures passing.

The outlook for Prop 5 passing

As is, it is very likely to pass. This is again because renter-voters will perceive raising more local taxes as a free government benefit since they don't pay the associated parcel taxes. Prop 5 needs a simple majority of 50% to pass. Reviewing our model, 95% of the scenarios exceed the 50% threshold.

The backers of Prop 5 will make for a formidable coalition including Government & politicians at all levels, local districts, labor unions, and special interest groups (real estate developers).

In summary, Prop 5 just needs 50% to pass to reduce the threshold for local taxes from 2/3 down to 55%. The ensuing tax burden will be mainly borne by homeowners. And, they won't have much of a say. Even if 60% or more of homeowner voters are against it, Prop 5 could easily pass.

This has serious implications

• The $20 billion Bay Area Housing Finance Authority (BAHFA) bond measure was removed from the November ballot. But, if Prop 5 passes, it is most likely that BAHFA will give it a second shot in 2026. If Prop 5 does not pass, the $20 billion bond measure may be postponed indefinitely.
• The SMART train 0.25% sales tax needs to be renewed by 2029. Prop 5 does cover sales tax for public transit. If Prop 5 passes, the SMART sales tax renewal would need only 55% to pass. And, it would most likely pass. If Prop 5 does not pass, SMART sales tax renewal may fail and SMART may have to be shut down. Keep in mind, that the SMART train is a waste of money.

The above are just two prospects affecting the Bay Area. There are tens of others throughout California with as little economic merits. Prop 5, if it passes, will saddle California homeowners with far higher property tax with not much to show for it besides having the highest property taxes in the US.

Do localities have any constraints on how much debt they can raise? Not much!

Cities, counties, and school districts have a combined debt limit equal to 23.75% of properties assessed value. What does that mean for a homeowner in terms of additional parcel tax?

Let's say a home has an assessed value of $1,000,000. Prop 5 would allow localities to issue up to $237,500 in bonds against such assessed value level. Standard bond terms are 30 years at about 4%. The resulting incremental yearly parcel tax would be $13,600.

The property tax on this home could rise from $10,000 to $23,600 corresponding to an increase in effective property tax rate from 1.00% to 2.36%.

And, the all-in property tax would be much higher as there are no explicit limit on parcel taxes not related to bond issuance such as parcel tax for waste management (refuse & sewer), libraries, fire department, etc.

THE END

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