Reality could stifle Prop. 13 reform attempts

Housing bubblesDec. 18, 2012

By Wayne Lusvardi and Charles B. Warren

California legislators from San Francisco are “eager to reform Proposition 13 tax policies.”  But public perception is far apart from reality when it comes to the proposed reforming of Prop. 13.  The reality is that San Francisco is the only large urban county to experience no decline in property taxes since the peak of the real estate bubble in 2007.

Which means property price declines in the other areas would bring little added revenue from any proposed reforms of Prop. 13. Gains might only come should another speculative bubble wildly push up prices. But that also would hazard repeating the boom-bust cycle of disaster of the past decade.

The showcase reform that liberal tax reformers and Democratic legislators have sought for decades — the so-called “tax loophole” for commercial property transfers — is now within the grasp of reform by the Democratic supermajority in the Legislature.

But it now has come to light that this controversial tax loophole could have been reformed administratively without having to elect a supermajority to the legislature or putting such a reform on the ballot for voter approval. Even Prop. 13 reform advocate Lenny Goldberg admits in the San Francisco Examiner that changing the rule on when commercial properties are reassessed for ownership transfers is not “technically Prop. 13 at all.”   Jon Coupal of the Howard Jarvis Taxpayer’s Association agrees that a new law is not needed as much as enforcement of the existing law.

The controversial tax loophole involves strategic transfers of less than 50 percent of the ownership interest in commercial real estate.  Ownership transfers of more than 50 percent trigger a property tax reassessment.

An example would be where a large corporation sells more than 50 percent of its stock to another company but fails to alert county recorders of the change by recording a deed. But large corporations are probably more prone to legal record transfers of controlling ownership than small businesses.

Non-disclosure might lead to more recording of deeds

Probably of more concern is the non-recording of ownership transfers in small commercial properties.  According to a former assessor and an appraiser I spoke with, this practice is typical of how businesses are sold in foreign countries from which many immigrant business owners come. Sale documents between buyers and sellers are done privately and never filed with county recorders.  The problem is as much cultural as it is legal.

However, perhaps nondisclosure of real estate sales prices would lead to more recording of deeds. Many states such as Texas, North Dakota, Alaska, Idaho, Kansas, Louisiana, Mississippi, Montana, New Mexico, Utah, Wyoming and Missouri are non-disclosure states where transaction sale prices are not available to the public.

It would be costly to enforce recorded transactions for all 857,167 small businesses in California (as of 2008) and would smack of a police state.  Appraisers told me that business owners who were non-compliant with recording ownership transfer deeds probably made it less likely that they would apply for a tax appeal in a down market lest they draw the assessor’s attention to their ownership status.

Reforming commercial property transfers no budget panacea

Another misperception is that closing the loophole on commercial property transfers would generate enough revenue to rescue social welfare programs, schools and state universities and the public pension system.  Commercial and industrial properties generated $8.91 billion in property taxes in 2011 (see Table A).

Table A — Property Tax Revenues by Property Type (2011)

Property Type Assessed Value in Billions Percent of Total  Taxes @1% of Assessed Value in billions
Single family homes $2,209 53% $22.09
Multi-family & other residential $770 19% $7.70 
Commercial & industrial $891 22% $8.91
Agricultural and other non-residential $272 7% $2.72
Total $4,141
Source: California Legislative Analyst’s Office

Large businesses are only 3 percent of all businesses in California. And changes in ownership reflect only a little more than half of all property assessment changes, as shown in Table B.

Table B — Type of Property Tax Reassessment Increases

Percent of change in ownership transfers Percent of value changes due to Prop. 8 tax appeals and value adjustments in 2011 Percent of value changes due to new construction and Prop. 13 inflation adjustments
55% +/- 25% +/- 20% +/-
Source: California Legislative Analyst’s Office

Thus, we’re talking at most about large commercial properties generating 1.65 percent of the $8.91 billion in property taxes from all commercial and industrial properties in 2011 (assuming all large properties transferred title in the same year).  Again, the reality doesn’t match the public perception.

Progressive political culture may deter tax compliance

The reality is that reforming controlling ownership property transfers would be unpopular, politically incorrect and practically impossible without a police state.  Shifting California to a nondisclosure state might help.   But the public perception is that nondisclosure is not politically Progressive.

The opportunity that Democrats have awaited for decades of reforming commercial property ownership transfers under Prop. 13 may be nothing but a symbolic victory used to justify a supermajority power grab in the Legislature.

If California is going to resolve its longstanding budgetary and tax problems and keep a market-based democracy intact, the supermajority Democrats are going to have to run the state on more than demonization of big business and draconian tax changes.

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