Understanding California’s Property Taxes

Understanding California’s Property Taxes MAC TAylor • l e g i s l A T i v e A nA l y s T • nove MBer 29, 2012 An LAO RepOR t 2 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t ConTenTs executive summary ..................................................................................................5 Introduction ..............................................................................................................7 What Is on the Property Tax Bill? .............................................................................7 How Are Property Taxes and Charges Determined? ..............................................8 What Properties Are Taxed? ...................................................................................14 How Is the Revenue Distributed? ..........................................................................17 Why Do Local Government Property Tax Receipts Vary? ....................................22 Are There Concerns About How Property Taxes Are Distributed? ......................24 What Are the strengths and Limitations of California’s Property Tax system? .........................................................................................26 Appendix 1: The History of California’s Property Tax Allocation system ................................33 Tax Allocation Prior to Proposition 13 ..................................................................34 Proposition 13 and the state’s Response .............................................................34 Changes to the AB 8 system ..................................................................................37 Limits on the state’s Authority over Property Tax Allocation ...............................................................41 Looking Forward ....................................................................................................43 Appendix 2: Property Tax and Local Government Publications ..............................................44 www.lao.ca.gov Legislative Analyst’s Office 3 An LAO RepOR t 4 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t exeCUTIVe sUmmARy The various taxes and charges on a California property tax bill are complex and often not well understood. This report provides an overview of this major source of local government revenue and highlights key policy issues related to property taxes and charges. A Property Tax Bill Includes a Variety of Different Taxes and Charges. A typical California property tax bill consists of many taxes and charges including the 1 percent rate, voter-approved debt rates, parcel taxes, Mello-Roos taxes, and assessments. This report focuses primarily on the 1 percent rate, which is the largest tax on the property tax bill and the only rate that applies uniformly across every locality. The taxes due from the 1 percent rate and voter-approved debt rates are based on a property’s assessed value. The California Constitution sets the process for determining a property’s taxable value. Although there are some exceptions, a property’s assessed value typically is equal to its purchase price adjusted upward each year by 2 percent. Under the Constitution, other taxes and charges may not be based on the property’s value. The Property Tax Is One of the Largest Taxes Californians Pay. In some years, Californians pay more in property taxes and charges than they do in state personal income taxes, the largest state General Fund revenue source. Local governments collected about $43 billion in 2010-11 from the 1 percent rate. The other taxes and charges on the property tax bill generated an additional $12 billion. The Property Tax Base Is Diverse. Property taxes and charges are imposed on many types of property. For the 1 percent rate, owner-occupied residential properties represent about 39 percent of the state’s assessed value, followed by investment and vacation residential properties (34 percent) and commercial properties (28 percent). Certain properties—including property owned by governments, hospitals, religious institutions, and charitable organizations—are exempt from the 1 percent property tax rate. All Revenue From Property Taxes Is Allocated to Local Governments. Property tax revenue remains within the county in which it is collected and is used exclusively by local governments. State laws control the allocation of property tax revenue from the 1 percent rate to more than 4,000 local governments, with K-14 districts and counties receiving the largest amounts. The distribution of property tax revenue, however, varies significantly by locality. The Property Tax Has a Significant Effect on the State Budget. Although the property tax is a local revenue source, it affects the state budget due to the state’s education finance system—additional property tax revenue from the 1 percent rate for K-14 districts generally decreases the state’s spending obligation for education. Over the years, the state has changed the laws regarding property tax allocation many times in order to reduce its costs for education programs or address other policy interests. The State’s Current Property Tax Revenue Allocation System Has Many Limitations. The state’s laws regarding the allocation of property tax revenue from the 1 percent rate have evolved over time through legislation and voter initiatives. This complex allocation system is not well understood, transparent, or responsive to modern local needs and preferences. Any changes to the existing system, however, would be very difficult. www.lao.ca.gov Legislative Analyst’s Office 5 An LAO RepOR t California’s Property Tax System Has Strengths and Limitations. Economists evaluate taxes using five common tax policy criteria—growth, stability, simplicity, neutrality, and equity. The state’s property tax system exhibits strengths and limitations when measured against these five criteria. Since 1979, revenue from the 1 percent rate has exceeded growth in the state’s economy. Property tax revenue also tends to be less volatile than other tax revenues in California due to the acquisition value assessment system. (Falling real estate values during the recent recession, however, caused some areas of the state to experience declines in assessed value and more volatility than in the past.) Although California’s property tax system provides governments with a stable and growing revenue source, its laws regarding property assessment can result in different treatment of similar taxpayers. For example, newer property owners often pay a higher effective tax rate than people who have owned their homes or businesses for a long time. In addition, the property tax system may distort business and homeowner decisions regarding relocation or expansion. 6 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t InTRoDUCTIon For many California taxpayers, the property tax bill and how these levies are calculated. It tax bill is one of the largest tax payments they then describes how the funds collected from make each year. For thousands of California local property tax bills—$55 billion in 2010-11—are governments—K-12 schools, community colleges, distributed among local governments. Last, because cities, counties, and special districts—revenue from California’s property taxation system has evoked property tax bills represents the foundation of their controversy over the years, the report provides budgets. a framework for evaluating it. Specifically, we Although property taxes and charges play a examine California property taxes relative to major role in California finance, many elements the criteria commonly used by economists for of this financing system are complex and not well reviewing tax systems, including revenue growth, understood. The purpose of this report is to serve stability, simplicity, neutrality, and equity. The as an introductory reference to this key funding report is followed with an appendix providing Graphic Sign Off source. The report begins by explaining the most further detail about the allocation of property tax common taxes and charges on the property revenue. Secretary Analyst WHAT Is on THe PRoPeRTy TAx BILL? Director Deputy A California property tax bill includes a variety the 1 percent rate and voter-approved debt. In our of different taxes and charges. As shown on the sample property tax bill, “Box A” identifies the sample property tax bill in Figure 1, these levies taxable value of the property and “Box B” shows commonly include: the property’s tax levies that are calculated based Figure 1 • The 1 percent rate Sample Annual Property Tax Bill established by Proposition 13 (1978). Secured Property Tax for Fiscal Year July 1, 2012 to June 30, 2013 • Additional tax rates Property Owner Information Detail of Taxes Due to pay for local voter- approved debt. Property ID: 1234567 Agency Rate Amount Mailing Address: Doe, Jane General Tax Levy 1.0000 $3,500.00 B 1234 ABC Street • Property assessments. Sacramento, CA 00000 Voter-Approved Debt Rates City 0.0201 $70.35 Water District 0.0018 6.30 School District 0.1010 353.50 • Mello-Roos taxes. Community College District 0.0102 35.70 A Property Valuation on Jan 1, 2012 Direct Levies C • Parcel taxes. Sidewalk District Assessment $9.36 Flood Control District Assessment 64.39 2012-13 Roll Assessed Value Street Lighting District Assessment 12.71 Mello-Roos District 86.51 The Constitution Land $115,000.00 School District Parcel Tax 125.00 Improvements $242,000.00 establishes a process for Total Taxes Due $4,263.82 D Total $357,000.00 Less Exemptions $7,000.00 determining a property’s 1st Installment $2,131.91 Net Assessed Value $350,000.00 2nd Installment 2,131.91 taxable value for purposes of calculating tax levies from www.lao.ca.gov Legislative Analyst’s Office 7 ARTWORK #120521 An LAO RepOR t on this value. Levies based on value—such as the factors, such as the benefit the property owner 1 percent rate and voter-approved debt rates—are receives from improvements. known as “ad valorem” taxes. As shown in “Box D,” the total amount due on Under the Constitution, other taxes and most property tax bills is divided into two equal charges on the property tax bill (shown in amounts. The first payment is due by December 10 “Box C”) may not be based on the property’s and the second payment is due by April 10. taxable value. Instead, they are based on other HoW ARe PRoPeRTy TAxes AnD CHARGes DeTeRmIneD? Ad valorem property taxes—the 1 percent rate in the nearby box, some voter-approved rates are and voter-approved debt rates—account for nearly used to pay obligations approved by local voters 90 percent of the revenue collected from property before 1978.) Bond proceeds may not be used for tax bills in California. Given their importance, general local government operating expenses, this section begins with an overview of ad such as teacher salaries and administrative costs. valorem taxes and describes how county assessors Most local governments must obtain the approval determine property values. Later in the chapter, we of two-thirds of their local voters in order to discuss the taxes and charges that are determined issue general obligation bonds repaid with debt based on factors other than property value. rates. General obligation bonds for school and community college facilities, however, may be Taxes Based on Property Value approved by 55 percent of the school or community The 1 Percent Rate. The largest component college district’s voters. Local voters do not of most property owners’ annual property approve a fixed tax rate for general obligation bond tax bill is the 1 percent rate—often called the indebtedness. Instead, the rate adjusts annually so 1 percent general tax levy or countywide rate. The that it raises the amount of money needed to pay Constitution limits this rate to 1 percent of assessed the bond costs. value. As shown on our sample property tax bill, Property tax bills often include more than one the owner of a property assessed at $350,000 owes voter-approved debt rate. In our sample property $3,500 under the 1 percent rate. The 1 percent rate tax bill, for example, the property owner is subject is a general tax, meaning that local governments to four additional rates because local voters have may use its revenue for any public purpose. approved bond funds for the city and water, Voter-Approved Debt Rates. Most tax bills school, and community college districts where the also include additional ad valorem property tax property is located. These rates tend to be a small rates to pay for voter-approved debt. Revenue percentage of assessed value. Statewide, the average from these taxes is used primarily to repay general property tax bill includes voter-approved debt rates obligation bonds issued for local infrastructure that total about one-tenth of 1 percent of assessed projects, including the construction and value. rehabilitation of school facilities. (As described 8 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t Calculating Property Value for landscaping, or other developments. The assessed Ad Valorem Taxes value of land and improvements is important because the 1 percent rate and voter-approved One of the first items listed on a property debt rates are levied as a percentage of this value, tax bill is the assessed value of the land and meaning that properties with higher assessed improvements. Assessed value is the taxable value values owe higher property taxes. of the property, which includes the land and any improvements made to the land, such as buildings, Debt Approved by Voters Prior to 1978 The California Constitution allows local governments to levy voter-approved debt rates—ad valorem rates above the 1 percent rate—for two purposes. The first purpose is to pay for indebtedness approved by voters prior to 1978, as allowed under Proposition 13 (1978). Proposition 42 (1986) authorized a second purpose by allowing local governments to levy additional ad valorem rates to pay the annual cost of general obligation bonds approved by voters for local infrastructure projects. Because most debt approved before 1978 has been paid off, most voter- approved debt rates today are used to repay general obligation bonds issued after 1986 as authorized under Proposition 42. Some local governments, however, continue to levy voter-approved debt rates for indebtedness approved by voters before 1978. While most bonds issued before the passage of Proposition 13 have been paid off, state courts have determined that other obligations approved by voters before 1978 also can be paid with an additional ad valorem rate. Two common pre-1978 obligations paid with voter-approved debt rates are local government employee retirement costs and payments to the State Water Project. Voter-Approved Retirement Benefits. Voters in some counties and cities approved ballot measures or city charters prior to 1978 that established retirement benefits for local government employees. The California Supreme Court ruled that such pension obligations represent voter- approved indebtedness that could be paid with an additional ad valorem rate. Local governments may levy the rate to cover pension benefits for any employee, including those hired after 1978, but not to cover any enhancements to pension benefits enacted after 1978. Local governments may adjust the rate annually to cover employee retirement costs, but state law limits the rate to the level charged for such purposes in 1982-83 or 1983-84, whichever is higher. A recent review shows that at least 20 cities and 1 county levy voter-approved debt rates to pay some portion of their annual pension costs. The rates differ by locality. For example, the City of Fresno’s voter-approved debt rate for employee retirement costs is 0.03 percent of assessed value in 2012-13, while the City of San Fernando’s rate is 0.28 percent. State Water Project Payments. Local water agencies can levy ad valorem rates above the 1 percent rate to pay their annual obligations for water deliveries from the State Water Project. State courts concluded that such costs were voter-approved debt because voters approved the construction, operation, and maintenance of the State Water Project in 1960. As a result, most water agencies that have contracts with the State Water Project levy a voter-approved debt rate. www.lao.ca.gov Legislative Analyst’s Office 9 An LAO RepOR t Under California’s tax system, the assessed or the rate of inflation, whichever is lower. This value of most property is based on its purchase process continues until the property is sold, at price. Below, we describe the process county which point the county assessor again assigns it assessors use to determine the value of local “real an assessed value equal to its most recent purchase property” (land, buildings, and other permanent price. In other words, a property’s assessed value structures). This is followed by an explanation of resets to market value (what a willing buyer would how assessors determine the value of “personal pay for it) when it is sold. (As shown in Figure 2, property” (property not affixed to land or voters have approved various constitutional structures, such as computers, boats, airplanes, and amendments that exclude certain property business equipment) and “state assessed property” transfers from triggering this reassessment.) (certain business properties that cross county In most years, under this assessment practice, a boundaries). property’s market value is greater than its assessed Local Real Property Is Assessed at Acquisition value. This occurs because assessed values increase Value and Adjusted Upward Each Year. The by a maximum of 2 percent per year, whereas process that county assessors use to determine market values tend to increase more rapidly. the value of real property was established by Therefore, as long as a property does not change Proposition 13. Under this system, when real ownership, its assessed value increases predictably property is purchased, the county assessor assigns from one year to the next and is unaffected by it an assessed value that is equal to its purchase higher annual increases in market value. For price, or “acquisition value.” Each year thereafter, example, Figure 3 shows how a hypothetical the property’s assessed value increases by 2 percent property purchased in 1995 for $185,000 would Figure 2 Property Transfers That Do Not Trigger Reassessment Proposition Year Description 3 1982 Allows property owners whose property has been taken by eminent domain proceedings to transfer their existing assessed value to a new property of similar size and function. 50 1986 Allows property owners whose property has been damaged or destroyed in a natural disaster to transfer their existing assessed value to a comparable replacement property within the same county. 58 1986 Excludes property transfers between spouses or between parents and children from triggering reassessment. 60 1986 Allows homeowners over the age of 55 to transfer their existing assessed value to a new home, of equal or lesser market value, within the same county. 90 1988 Extends Proposition 60 by allowing homeowners to transfer their existing assessed value to a new home, of equal or lesser market value, in a different participating county. 110 1990 Allows disabled homeowners to transfer their existing assessed value from an existing home to a newly purchased home of equal or lesser market value. 171 1993 Extends Proposition 50 by allowing property owners affected by a natural disaster to transfer their existing assessed value to a comparable replacement property in a different participating county. 193 1996 Excludes property transfers between grandparents and grandchildren (when the parents are deceased) from triggering reassessment. 1 1998 Allows property owners whose property is made unusable by an environmental problem to transfer their existing assessed value to a comparable replacement property. 10 Legislative Analyst’s Office www.lao.ca.gov Graphic Sign Off Secretary Analyst Director Deputy An LAO RepOR t Figure 3 Market Value Can Exceed Assessed Value $600,000 Market Value Increases or decreases based on local real estate conditions. 500,000 400,000 Property Purchased in 1995 Assessed at acquisition value. 300,000 Property Sold in 2002 Reassessed to acquisition value, then increases by up to 2 percent annually. 200,000 Assessed Value Increases by up to 100,000 2 percent each year. 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 be assessed in 2012. Although the market value acquisition value. For example, if a homeowner of the property increased to $300,000 by 2002, purchased a home in 2002 and then added a garage the assessed value was $200,000 because assessed in 2010, the home and garage would be assessed value grew by only up to 2 percent each year. Upon separately. The original property would be assessed being sold in 2002, the property’s assessed value at its 2002 acquisition value adjusted upward each reset to a market value of $300,0A00. RBecTausWe of Othe RKyea r #wh1ile 2the0 ga5rag2e w1ould be assessed at its 2010 large annual increase in home values after 2002, market value adjusted upward. The property’s however, the market value was soon much greater assessed value would be the combined value of the than the assessed value for the new owner as well. two portions. (As shown in Figure 4, voters have Property Improvements Are Assessed excluded certain property improvements from Separately. When property owners undertake increasing the assessed value of a property.) property improvements, Figure 4 such as additions, Property Improvements That Do Not Increase a remodeling, or building Property’s Assessed Value expansions, the additions Constitutional Amendments Approved After June 1978 or upgrades are assessed Proposition Year Type of Improvement at market value in that year and increase by up 8 1978 Reconstruction following natural disaster 7 1980 Solar energy construction to 2 percent each year 31 1984 Fire-safety improvements thereafter. The unimproved 110 1990 Accessibility construction for disabled homeowners portion of the property 177 1994 Accessibility construction for any property 1 1998 Reconstruction following environmental contamination continues to be assessed 13 2010 Seismic safety improvements based on its original www.lao.ca.gov Legislative Analyst’s Office 11 An LAO RepOR t Assessed Value May Be Reduced When Market drops the property’s market value below its Values Fall Significantly. When real estate values Proposition 13 assessed value. At this time, the decline or property damage occurs, a property’s property receives a decline-in-value assessment market value may fall below its assessed value as set (equal to its market value) that is less than its by Proposition 13. Absent any adjustment to this Proposition 13 assessment. For three years, the assessed value, the property would be taxed at a property is assessed at market value, which may greater value than it is worth. increase or decrease by any amount. By 2012, In these events, county assessors may the property’s market value once again exceeds automatically reduce the Proposition 13 assessed what its assessed value would have been absent Graphic Sign Off value of a property to its current market value. Proposition 8 (acquisition price plus the 2 percent If they do not, however, a property owner may maximum annual increase). In suSbesecqrueetnatr yyears, petition the assessor to have his or her assessed the property’s assessed value is deAtenramlyinsetd by its value reduced. These decline-in-value properties are acquisition price adjusted upwardD eiraechc tyoerar. often called “Prop 8 properties” after Proposition 8 Homeowners Are Eligible for a Property Deputy (1978), which authorizes this assessment reduction Tax Exemption. Homeowners may claim a $7,000 to market value. Figure 5 illustrates the assessment exemption from the assessed value of their primary of a hypothetical decline-in-value property over residence each year. As shown in “Box A” of the time. The market value of the property purchased sample property tax bill in Figure 1, this exemption in 1995 stays above its Proposition 13 assessed lowers the assessed value of the homeowner’s land and value through 2007. A significant decline, however, improvements by $7,000, reducing taxes under the Figure 5 Assessed Value Can Fall Below Proposition 13 Value $350,000 300,000 Market Value Increases or decreases based on local real estate conditions. 250,000 200,000 Proposition 13 Value Increases by a maximum of 2 percent each year. 150,000 Property Purchased Assessed at acquisition value. 100,000 Property Assessed at Market Value 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 12 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #120521 An LAO RepOR t 1 percent rate by $70 and reducing taxes from voter- other characteristics. Below, we discuss three of approved debt rates by a statewide average of $8. the most common categories of non-ad valorem Two Types of Property Are Assessed at Their levies: assessments, parcel taxes, and Mello-Roos Market Value. Two categories of property are taxes. In addition to these three categories, some assessed at their current market value, rather than local governments collect certain fees for service their acquisition value: personal property and state- on property tax bills, such as charges to clear weeds assessed property. (We provide more information on properties where the weeds present a fire safety about these properties in the nearby box.) hazard. These fees are diverse and relatively minor, Combined, these types of properties accounted for and therefore are not examined in this report. 6 percent of statewide-assessed value in 2011-12. Assessments. Local governments levy Most personal property and state-assessed property assessments in order to fund improvements that is taxed at the 1 percent rate plus any additional benefit real property. For example, with the approval rates for voter-approved debt. of affected property owners, a city or county may create a street lighting assessment district to fund Determining other Taxes and Charges the construction, operation, and maintenance of All other taxes and charges on the property street lighting in an area. Under Proposition 218 tax bill are calculated based on factors other than (1996), improvements funded with assessments must the property’s assessed value. For example, some provide a direct benefit to the property owner. An levies are based on the cost of a service provided assessment typically cannot be levied for facilities to the property. Others are based on the size of or services that provide general public benefits, a parcel, its square footage, number of rooms, or such as schools, libraries, and public safety, even Properties Assessed at Current market Value Personal Property. Personal property is property other than land, buildings, and other permanent structures, which are commonly referred to as “real property.” Most personal property is exempt from property taxation, including business inventories, materials used to manufacture products, household furniture and goods, personal items, and intangible property like gym memberships and life insurance policies. Some personal property, however, is subject to the property tax. These properties consist mainly of manufacturing equipment, business computers, planes, commercial boats, and office furniture. When determining the market value of personal property, county assessors take into account the loss in value due to the age and condition of personal property—a concept known as depreciation. Unlike property taxes on real property, which are due in two separate payments, taxes on personal property are due on July 3. State-Assessed Property. The State Board of Equalization is responsible for assessing certain real properties that cross county boundaries, such as pipelines, railroad tracks and cars, and canals. State-assessed properties are assessed at market value and, with the exception of railroad cars, taxed at the 1 percent rate plus any additional rates for voter-approved debt. (As part of a federal court settlement decades ago, railroad cars are taxed at a rate that is somewhat lower than 1 percent. The railcar tax rate varies each year and currently is about 0.8 percent.) www.lao.ca.gov Legislative Analyst’s Office 13 An LAO RepOR t though these programs may increase the value of Mello-Roos Taxes. Mello-Roos taxes are a property. Moreover, the amount each property flexible revenue source for local governments owner pays must reflect the cost incurred by the because they (1) may be used to fund infrastructure local government to provide the improvement and projects or certain services; (2) may be levied the benefit the property receives from it. To impose a in proportion to the benefit a property receives, new assessment, a local government must secure the equally on all parcels, by square footage, or by other approval of a weighted majority of affected property factors; and (3) are collected within a geographical owners, with each property owner’s vote weighted area drawn by local officials. in proportion to the amount of the assessment he or Local governments often use Mello-Roos she would pay. taxes to pay for the public services and facilities Parcel Taxes. With the approval of two-thirds associated with residential and commercial of voters, local governments may impose a tax development. This occurs because landowners on all parcels in their jurisdiction (or a subset of may approve Mello-Roos taxes by a special parcels in their jurisdiction). Local governments two-thirds vote—each owner receiving one vote typically set parcel taxes at fixed amounts per per acre owned—when fewer than 12 registered parcel (or fixed amounts per room or per square voters reside in the proposed district. In this way, foot of the parcel). Unlike assessments, parcel tax a developer who owns a large tract of land could revenue may be used to fund a variety of local vote to designate it as a Mello-Roos district. After government services, even if the service does not the land is developed and sold to residential and benefit the property directly. For example, school commercial property owners, the new owners pay districts may use parcel tax revenue to pay teacher the Mello-Roos tax that funds schools, libraries, salaries or administrative costs. The use of parcel police and fire stations, or other public facilities and tax revenue, however, is restricted to the public services in the new community. Mello-Roos taxes programs, services, or projects that voters approved are subject to two-thirds voter approval when there when enacting the parcel tax. are 12 or more voters in the proposed district. WHAT PRoPeRTIes ARe TAxeD? Property taxes and charges are imposed on and charges is different from the tax base for the many types of properties. These properties include 1 percent rate. This is because the 1 percent rate common types such as owner-occupied homes and applies uniformly to all taxable real property, commercial office space, as well as less common whereas other taxes and charges are levied at types like timeshares and boating docks. In the various levels and on various types of property section below, we describe the state’s property tax throughout the state (according to local voter or base—the types of real properties that are subject local government preferences). For example, if to the 1 percent rate and the share of total assessed a suburban school district levies a parcel tax on value that each property type represents. each parcel in a residential area, the owners of Due to data limitations, we do not summarize single-family homes would pay a large share of the the tax bases of other taxes and charges. We note, total parcel taxes. Accordingly, the school district’s however, that the property tax base for other taxes parcel tax base would be more heavily residential 14 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t than the statewide property tax base under the Distribution of the 1 percent rate (which applies to all taxable Tax Base for the 1 Percent Rate property). Owner-Occupied Residential. In 2010-11, there were 5.5 million owner-occupied homes What Properties Are in California with a total assessed value of subject to the 1 Percent Rate? $1.6 trillion. As shown in Figure 6, owner-occupied Although most real property is taxable, residential properties accounted for the largest the Constitution exempts certain types of real share—39 percent—of the state’s tax base for the property from taxation. In general, these are 1 percent rate. government properties or properties that are used Investment and Vacation Residential. for non-commercial purposes, including hospitals, Although the majority of residential properties religious properties, charities, and nonprofit are owner occupied, many others are investment schools and colleges. California properties that or vacation properties such as multifamily are subject to the property tax, however, can be Graphic Sign Off apartments, rental condominiums, rental homes, classified in three ways: vacant residential land, and vacation homes. Secretary • Owner-occupied residential—properties (We classify vacant residential land and vacation Analyst that receive the state’s homeowner’s homes as investment properties because they are Director exemption, which homeowners may claim an investment asset for the owner, even if he or Deputy on their primary residence. she does not receive current income from them.) In 2010-11, there were 4.2 million investment and • Investment and vacation residential— vacation residential properties. The assessed value residential properties other than those used as a primary residence, Figure 6 including The Distribution of California’s Property Tax Base multifamily Share of Assessed Value for Properties Subject to the 1 Percent Ratea, 2010-11 apartments, rental condominiums, rental homes, Commercial vacant residential Owner-Occupied Residential land, and vacation homes. • Commercial— retail properties, industrial plants, farms, and other income-producing properties. Investment and Vacation Residential a Excludes personal property and state-assessed property. www.lao.ca.gov Legislative Analyst’s Office 15 ARTWORK #120521 An LAO RepOR t of these properties was about $1.4 trillion, which What Factors may Have Contributed to represents 34 percent of the state’s total assessed Changes in the Property Tax Base? value. Various economic changes that have taken Commercial. In 2010-11, there were place over time probably have contributed to approximately 1.3 million commercial properties changes to California’s property tax base. For in California. This amount includes about example, investment in residential property has 600,000 retail, industrial, and office properties increased significantly since the mid-1970s. Newly (such as stores, gas stations, manufacturing built single-family homes have become larger and facilities, and office buildings). It also includes are more likely to have valuable amenities than 500,000 agricultural properties and 200,000 other homes built earlier. As a result, new homes are properties (gas, oil, and mineral properties and more expensive to build and assessed at higher the private use of public land). While commercial amounts than older homes. Over the same period, properties represent a relatively small share of the commercial activity in California has shifted away state’s total properties, they tend to have higher from traditional manufacturing, which tends to assessed values than other properties. Therefore, rely heavily on real property. Newer businesses, on as shown in Figure 6, these properties (which have the other hand, are more likely to be technology a total assessed value of $1.2 trillion) account for and information services based. These businesses 28 percent of the state’s property tax base. tend to own less real property than traditional manufacturing firms do. (Technology and Has the Distribution of the information services firms, however, rely heavily Property Tax Base Changed over Time? on business personal property—for example, There is little statewide information regarding computing systems, design studios, and office the composition of California’s property tax base equipment—that are taxed as personal property over time. Based on the available information, and not included in the distribution of the state’s however, it appears that homeowners may be paying real property tax base.) a larger percentage of total property taxes today It also is possible that Proposition 13’s than they did decades ago. We note, for example, acquisition value assessment system has played that the assessed value of owner-occupied homes a role in the changes to California’s tax base. has increased from a low of 32 percent of statewide Specifically, under Proposition 13, properties assessed valuation in 1986-87 to a high of that change ownership more frequently tend to 39 percent in 2005-06. (The share was 36 percent be assessed more closely to market value than in 2011-12.) It also appears likely that owners of properties that turn over less frequently. (Because commercial property are paying a smaller percentage properties are assessed to market value when of property taxes than they did decades ago. For they change ownership, properties that have not example, Los Angeles County reports that the share changed ownership in many years tend to have of total assessed value represented by commercial larger gaps between their assessed values and property in the county declined from 40 percent in market values.) It is possible that some categories of 1985 to 30 percent in 2012. In addition, the assessed properties change ownership more frequently than value of commercial property in Santa Clara County others and this could influence the composition has declined (as a share of the county total) from of the overall tax base. The limited available 29 percent to 24 percent since 1999-00. research suggests that investment and vacation 16 Legislative Analyst’s Office www.lao.ca.gov Graphic Sign Off Secretary Analyst Director Deputy An LAO RepOR t residential properties Figure 7 change ownership Property Tax Revenue Compared more frequently than With Other Major Revenue Sources commercial or owner- 2010-11 (In Billions) occupied residential $60 property, indicating that Other Taxes they may be assessed 50 and Charges closer to market value Voter-Approved Debt Rates than other types of 40 property. 30 How MucH 1 Percent Rate 20 Revenue Is collected? 10 In 2010-11, California property tax bills totaled Corporation Tax State and Local Personal Property Taxes $55 billion. As shown Sales and Use Tax Income Tax and Charges in Figure 7, this amount included $43.2 billion on the property tax bill. From various reports under the 1 percent summarizing local government finances, elections, rate and $5.7 billion from voter-approved debt and bond issuances, it appears that most of this rates, making ad valorem property taxes one of $6 billion reflects property assessments, parcel California’s largest revenue sources. taxes, and Mello-Roos taxes, though statewide data Comparatively little is known about the ARTWORK #120521 are not available on the exact amounts collected for remaining $6 billion of other taxes and charges each of these funding sources. HoW Is THe ReVenUe DIsTRIBUTeD? California property owners pay their property This section describes the distribution of tax bills to their county tax collector (sometimes revenue raised under the 1 percent rate and called the county treasurer-tax collector). The summarizes the limited available information funds are then transferred to the county auditor regarding the distribution of voter-approved debt for distribution. The county auditor distributes the rates and non-ad valorem property taxes and funds collected from the 1 percent rate differently charges. than the funds collected from the other taxes Revenue From the 1 Percent Rate Is and charges on the bill. Specifically, the 1 percent shared by many Local Governments rate is a shared revenue source for multiple local governments. The 1 percent rate generates most of the revenue from the property tax bill—roughly www.lao.ca.gov Legislative Analyst’s Office 17 An LAO RepOR t $43 billion in 2010-11. On a typical property revenue from the 1 percent rate is distributed to tax bill, however, the 1 percent rate is listed as counties, cities, K-12 schools, community college the general tax levy or countywide rate with no districts, and special districts. Until recently, indication as to which local governments receive redevelopment agencies also received property the revenue or for what purpose the funds are used. tax revenue. As described in the nearby box, In general, county auditors allocate revenue from redevelopment agencies were dissolved in 2012, but the 1 percent rate to a variety of local governments a large amount of property tax revenue continues within the county pursuant to a series of complex to be used to pay the former agencies’ debts and state statutes. obligations. More Than 4,000 Local Governments Receive Figure 9 shows the share of revenue received by Revenue From the 1 Percent Rate. All property each type of local government from the 1 percent tax revenue remains within the county in which rate and voter-approved debt rates. (As described it is collected to be used exclusively by local later in the report, however, these shares vary governments. As shown in Figure 8, property tax significantly by locality.) Property Taxes Also Affect the State Budget. Although the state does not receive any property Figure 8 tax revenue directly, the state has a substantial How Many Local Governments Receive Revenue From the 1 Percent Rate? fiscal interest in the distribution of property tax revenue from the 1 percent rate because of Type of Local Government Number the state’s education finance system. Each K-12 Counties 58 district receives “revenue limit” funding—the Cities 480 Schools and Community Colleges largest source of funding for districts—from the K-12 school districts 966 combination of local property tax revenue under County Offices of Education 56 the 1 percent rate and state resources. Thus, if Community college districts 72 Special Districts a K-12 district’s local property tax revenue is Fire protection 348 not sufficient to meet its revenue limit, the state County service area 316 provides additional funds. Community colleges Cemetery 241 Community services 201 have a similar financing system, in which each Maintenance 136 district receives apportionment funding from Highway lighting 117 local property tax revenue, student fees, and state County water 100 Recreation and park 85 resources. In 2010-11, the state contributed Hospital 64 $22.5 billion to K-12 revenue limits and community Sanitary 60 college apportionments, while the remainder Irrigation 46 Mosquito abatement 43 ($14.5 billion) came from local property tax Public utility 43 revenue (and student fees). Othera 400 State Laws Direct Allocation of Revenue Redevelopment Agenciesb 422 Total 4,254 From the 1 Percent Rate. The county auditor is a Thirty three other types of special districts report receiving responsible for allocating revenue generated from property tax revenue from the 1 percent rate. These include county sanitation, municipal water, memorial, water authority, drainage, the 1 percent rate to local governments pursuant and library districts. b to state law. The allocation system is commonly Dissolved in 2012. A portion of property tax revenue continues to pay these agencies’ debts and obligations. referred to as “AB 8,” after the bill that first 18 Legislative Analyst’s Office www.lao.ca.gov Graphic Sign Off Secretary Analyst Director Deputy An LAO RepOR t implemented the system— Figure 9 Chapter 282, Statutes of Most Ad Valorem Property Tax Revenue 1979 (AB 8, L. Greene). Is Allocated to Schools and Countiesa In general, AB 8 provides 2010-11 a share of the total property taxes collected Counties within a community to K-14 Districts each local government that provides services within that community. Each local government’s Special share is based on its Districts proportionate countywide share of property taxes during the mid-1970s, Redevelopment Agenciesb a time when each local Cities government determined a As a percentage of total revenue from the 1 percent rate and voter-approved debt rates. its own property tax rate b Redevelopment agencies were dissolved in 2012. Successor agencies will continue to use property and property owners paid tax revenue to pay former agencies' debts and obligations. taxes based on the sum of Redevelopment and successor Agencies More than 60 years ago, the Legislature established a process whereby a city or county could declare an area to be blighted and in need of redevelopment. After this declaration, most property ARTWORK #120521 tax revenue growth from the redevelopment “project area” was distributed to the redevelopment agency, instead of the other local governments serving the project area. As discussed in our report, The 2012-13 Budget: Unwinding Redevelopment, redevelopment agencies were dissolved in February 2012. Prior to their dissolution, however, redevelopment agencies received over $5 billion in property tax revenue annually. These monies were used to pay off tens of billions of dollars of outstanding bonds, contracts, and loans. In most cases, the city or county that created the redevelopment agency is managing its dissolution as its successor agency. The successor agency manages redevelopment projects currently underway, pays existing debts and obligations, and disposes of redevelopment assets and properties. The successor agency is funded from the property tax revenue that previously would have been distributed to the redevelopment agency. As a result, even though redevelopment agencies have been dissolved, some property tax revenue continues to be used to pay redevelopment’s debts and obligations. Over time, most redevelopment obligations will be retired and the property tax revenue currently distributed to successor agencies will be distributed to K-14 districts, counties, cities, and special districts. www.lao.ca.gov Legislative Analyst’s Office 19 An LAO RepOR t these rates. (The average property tax rate totaled significantly by TRA. For example, Walnut Creek’s about 2.7 percent.) As a result, local governments K-12 school district receives 33 percent of the that received a large share of property taxes in the growth in revenue within its TRA while Norwalk’s 1970s typically receive a relatively large share of school district receives only 19 percent from its revenue from the 1 percent rate under AB 8. (More TRA. As noted above, this variation is based largely detail on the history of the state’s property tax on historical factors specified in AB 8. allocation system—including AB 8—is provided in Some Revenue Is Allocated to a Countywide the appendix of this report.) Account—ERAF. Most of the revenue from the Revenue Allocated by Tax Rate Area 1 percent rate collected within a TRA is allocated (TRA). The county auditor allocates the revenue to the city, county, K-14 districts, and special to local governments by TRA. A TRA is a districts that serve the properties in that TRA. State small geographical area within the county that law, however, directs the county auditor to shift a contains properties that are all served by a unique portion of this revenue to a countywide account combination of local governments—the county, a that is distributed to other local governments city, and the same set of special districts and school that do not necessarily serve the taxed properties. districts. A single county may have thousands of The state originally established this account—the TRAs. While there is considerable variation in Educational Revenue Augmentation Fund the steps county auditors use to allocate revenue (ERAF)—to provide additional funds to K-14 within each TRA, typically the county auditor districts that do not receive sufficient property tax annually determines how much revenue was revenue to meet their minimum funding level. State collected in each TRA and first allocates to each laws later expanded the use of ERAF to include local government in the TRA the same amount reimbursing cities and counties for the loss of of revenue it received in the prior year. Each local other local revenue sources (the vehicle license fee government then receives a share of any growth and sales tax) due to changes in state policy. For (or loss) in revenue that occurred within the TRA example, Figure 10 shows that 20 percent of any that year. Each TRA has a set of growth factors that revenue growth within Norwalk’s TRA is deposited specify the proportion of revenue growth that goes into ERAF. It is possible that some or all of this to each local government. These factors—developed revenue could be allocated to a city or K-14 district by county auditors pursuant to AB 8—are in a different part of Los Angeles County. largely based on the share of revenue each local most Revenue From Voter-Approved government received from the TRA during the late Debt Distributed to schools 1970s. Figure 10 shows sample growth factors for Voter-approved debt rates are levied on TRAs in two California cities. As the figure property owners so that local governments can indicates, 23 percent of any growth in revenue from pay the debt service on voter-approved general the 1 percent rate in the sample TRA for Norwalk obligation bonds (and pre-1978 voter-approved would be allocated to the county, 7 percent would obligations). The state’s K-12 school districts receive go to the city, and the rest would be allocated to the majority of the revenue from voter-approved various educational entities and special districts. debt rates ($3.1 billion of $5.2 billion in 2009-10). The percentage of property tax growth allocated The amount received by cities ($520 million), to each type of local government can vary special districts ($470 million), and counties 20 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t ($320 million) is significantly less. The amount this source. We were not able to locate information of taxes collected to pay voter-approved debt on the statewide amount of parcel tax revenue varies considerably across the state. For example, collected by cities, counties, and special districts. the average amount paid by an Alameda County Mello-Roos Taxes. Mello-Roos districts are property owner for voter-approved debt rates is required to report on their bond issuance, which about $2 for each $1,000 of assessed value, while Figure 10 the average amount paid Allocation of Property Tax Growth in Sample Tax Rate Areas in some counties is less Percent Norwalk, Los Angeles Countya Share than 10 cents per $1,000 of assessed value. Los Angeles County 23% Educational Revenue Augmentation Fund 20 Norwalk-La Mirada Unified School District 19 Limited Information Los Angeles County Fire Protection District 18 About Distribution City of Norwalk 7 of other Property Norwalk Parks and Recreation District 3 Los Angeles County Library 2 Taxes and Charges La Mirada Parks and Recreation District 2 Less information Cerritos Community College District 2 Los Angeles County Flood Control District 1 is available about the Los Angeles County Sanitation District 1 statewide distribution of Greater Los Angeles County Vector Control —b the revenue from parcel Water Replenishment District of Southern California —b Little Lake Cemetery District —b taxes, Mello-Roos taxes, Los Angeles County Department of Education —b and assessments. 100% Parcel Taxes. Recent Percent Walnut Creek, Contra Costa Countyc Share election reports and financial data suggest that Mount Diablo Unified School District 33% Educational Revenue Augmentation Fund 17 parcel taxes represent a Contra Costa County 13 significant and growing Contra Costa County Fire 13 source of revenue for City of Walnut Creek 9 Contra Costa Community College District 5 some local governments. East Bay Regional Park District 3 Specifically, between Contra Costa County Library 2 2001 and 2012, local Central Contra Costa Sanitary District 2 Contra Costa County Office of Education 1 voters approved about Contra Costa County Flood Control 1 180 parcel tax measures Bay Area Rapid Transit 1 to fund cities, counties, Contra Costa Water District 1 Contra Costa County Water Agency —b and special districts, and Contra Costa County Resource Conservation District —b about 135 measures to Contra Costa County Mosquito Abatement District —b fund K-12 districts. The Contra Costa County Service Area R-8 —b Bay Area Air Management District —b most recent K-12 financial 100% data (2009-10) indicate a Percentages indicate allocation of the growth in property taxes in Los Angeles County tax rate area 06764. that schools received b Less than 0.5 percent. c Percentages indicate allocation of the growth in property taxes in Contra Costa County tax rate area 09025. about $350 million from www.lao.ca.gov Legislative Analyst’s Office 21 An LAO RepOR t provides some information about the types of local regions, as more than 60 percent of the bonds were governments that receive Mello-Roos tax revenue. issued by local governments in four counties— It is likely that local governments issuing a large Riverside, Orange, San Diego, and Placer. amount of Mello-Roos bonds also are collecting a Assessments. Most of the property large amount of Mello-Roos tax revenue. Between improvements funded by assessments are provided 2004 and 2011, cities issued about 50 percent of the by cities and special districts. In 2009-10, cities and bonds issued by Mello-Roos districts in California, special districts reported receiving $760 million followed by K-12 districts at about 30 percent. and $650 million, respectively, in revenue from During the same time period, the issuance of assessments. In contrast, counties reported Mello-Roos bonds was concentrated in specific $11 million in such revenues. WHy Do LoCAL GoVeRnmenT PRoPeRTy TAx ReCeIPTs VARy? The share of revenue received by each type of variation in local government property tax local government from the 1 percent rate varies receipts. We discuss these factors below. significantly by locality. County governments, for Variation in Property Values example, receive as little as 11 percent (Orange) and as much as 64 percent (Alpine) of the ad valorem California has a diverse array of communities property tax revenue collected within their county. with large variation in land and property values. As shown in Figure 11, revenue raised from the Some communities are extensively developed 1 percent rate also varies considerably by locality and have many high-value homes and businesses, when measured by revenue per resident. Orange whereas others do not. Because property taxes County receives about $175 per resident, while are based on the assessed value of property, four counties receive more than $1,000 per communities with greater levels of real estate resident. Although cities, on average, receive about development tend to receive more property $240 per resident in revenue from the 1 percent tax revenue than communities with fewer rate, some receive more than $500 per resident developments. For example, high-density cities and many receive less than $150 per resident. generally receive more property tax revenue than School districts also receive widely different rural areas due to the greater level of development. amounts of property taxes per enrolled student, Coastal and resort areas also typically receive with an average of just under $2,000. (As noted more property taxes due to the high property above, the state “tops off” school property tax values. Certain high-value properties—such revenue with state funds to bring most schools to as a power plant or oil refinery—also increase similar revenue levels.) Finally, special districts property tax revenue. Alternatively, localities also receive varying amounts of property tax with large amounts of land owned by the federal revenue, though data limitations preclude us from government, universities, or other organizations summarizing this variation on a statewide basis. that are not required to pay property taxes may Three factors account for most of this receive less revenue. 22 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t Prior Use of Redevelopment state Allocation Laws Reflecting 1970s Taxation Levels Prior decisions by cities and counties to use redevelopment also influences the amount of Finally, the amount of property taxes allocated property tax revenue local governments receive. to local governments depends on state property Prior to the dissolution of redevelopment agencies tax allocation laws, principally AB 8. As discussed in 2012, most of the growth in property taxes earlier in this report (and in more detail in the from redevelopment project areas went to the appendix), the AB 8 system was designed, in part, redevelopment agency, rather than other local to allocate property tax revenue in proportion governments. A large share of property tax revenue to the share of property taxes received by a local now goes to successor agencies to pay the former government in the mid-1970s. Under this system, redevelopment agencies’ debts and obligations. The local governments that received a large share of use of redevelopment varied extensively throughout property taxes in the 1970s typically continue to the state. In those communities with many receive a relatively large share of property taxes redevelopment project areas, the share of property today. Although there have been changes to the tax revenue going to other local governments is original property tax allocation system contained less than it would be otherwise. In places with in AB 8, the allocation system continues to be large redevelopment project areas—such as San substantially based on the variation in property tax Bernardino and Riverside counties—more than receipts in effect in the 1970s. 20 percent of the county’s property tax revenue may This variation largely reflects service levels go to pay the former redevelopment agencies’ debts provided by local governments in the 1970s. Local and obligations. governments providing many services generally collected more property taxes in the 1970s to Figure 11 Property Tax Receipts From the 1 Percent Rate for Selected Local Governments 2009-10 Property Property Property Taxes per Taxes per Taxes per Cities Resident Counties Resident Schoolsa Student Industry $2,541 San Franciscob $1,411 Mono $10,683 Malibu 559 Sierra 1,126 San Mateo 5,432 Mountain View 344 Inyo 876 Marin 5,213 Los Angeles 332 Napa 522 San Francisco 4,020 Long Beach 268 El Dorado 464 Orange 3,315 Oakland 250 Los Angeles 359 San Diego 2,760 State Average 242 State Average 320 State Average 1,960 San Jose 200 Alameda 301 Yolo 1,765 Fresno 183 Sacramento 286 Sacramento 1,344 Anaheim 167 Contra Costa 271 San Joaquin 1,163 Santa Clarita 140 San Diego 261 Los Angeles 1,142 Chico 129 Riverside 200 Fresno 810 Modesto 119 Orange 174 Kings 379 a Countywide average for K-12 schools. b San Francisco is a city and a county. www.lao.ca.gov Legislative Analyst’s Office 23 An LAO RepOR t pay for those services. As a result, those local fire protection, park and recreation programs, and governments received a larger share of property water services, typically receive more property tax taxes under AB 8. For example, cities and counties revenue than governments that relied on special that provided many government services, including districts to provide some or all of these services. ARe THeRe ConCeRns ABoUT HoW PRoPeRTy TAxes ARe DIsTRIBUTeD? While no system for sharing revenues among distribution. In other words, local officials have no governmental entities is perfect, the state’s system power to raise or lower their property tax share on for allocating property tax revenue from the an annual basis to reflect the changing needs of 1 percent rate raises significant concerns about their communities. As a result, if residents wish to local control, responsiveness to modern needs, and increase overall county services, they would need to transparency and accountability to taxpayers. We finance this improvement by raising funds through discuss these concerns separately below and then a different mechanism such as an assessment or address the question: Could the state change the special tax. allocation system? Limited Transparency and Accountability Lack of Local Control The state’s current allocation system also makes Unlike local communities in other states, it difficult for taxpayers to see which entities receive California residents and local officials have their tax dollars. Property tax bills note only that a virtually no control over the distribution of bulk of the payment goes to the 1 percent general property tax revenue to local governments. levy. Even if taxpayers do further research and Instead, all major decisions regarding property tax locate the AB 8 local government sharing factors allocation are controlled by the state. Accordingly, for their TRA, it is difficult to follow the actual if residents desire an enhanced level of a particular allocation of revenue because the fund shifts service, there is no local forum or mechanism related to ERAF and redevelopment complicate this to allow property taxes to be reallocated among system. local governments to finance this improvement. In addition to making it difficult for For example, Orange County currently receives taxpayers to determine how their tax dollars are a very low share of property taxes collected distributed, the AB 8 system reduces government within its borders—about 11 percent. If Orange accountability. The link between the level of County residents and businesses wished to expand government controlling the allocation of the tax county services, they have no way to redirect (the state) and the government that spends the the property taxes currently allocated to other tax revenue (cities, counties, special districts, local governments. Their only option would be and K-14 districts) is severed. For example, if a to request the Legislature to enact a new law— taxpayer believes the level of services provided by approved by two-thirds of the members of both an independent park district is inadequate, it is houses—requiring the change in the property tax difficult to hold the district entirely accountable 24 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t because the state is responsible for determining the public have recognized the limitations inherent in share of property taxes allocated to the district. the state’s property tax allocation system. Despite the large degree of consensus on the problems, Limited Responsiveness to modern major proposals to reform the allocation system needs and Preferences have not been enacted due to their complexity and An effective tax allocation system ensures that the difficult trade-offs involved. Because California local tax revenue is allocated in a way that reflects has thousands of local governments—many modern needs and preferences. In many ways, with overlapping jurisdictions—reorienting California’s property tax allocation system—which the property tax allocation system would be remains largely based on allocation preferences extraordinarily complex. Updating the AB 8 from the 1970s—does not meet this criterion. property tax sharing methodology would require California’s population and the governance the Legislature to determine the needs and structure of many local communities have preferences of each California community and changed significantly since the AB 8 system was local government. This would be a difficult—if not enacted. For example, certain areas with relatively impossible—task to undertake in a centralized sparse populations in the 1970s have experienced manner. Alternatively, the state could allow the substantial growth and many local government distribution of the property tax to be carried responsibilities have changed. One water district out locally, but there is no consensus about what in San Mateo County—Los Trancos Water process local governments would use to allocate District—illustrates the extent to which the state’s property taxes among themselves. Whether done property tax allocation system continues to reflect centrally or locally, any reallocation is difficult service levels from the 1970s. Specifically, this water because providing additional property tax receipts district sold its entire water distribution system to to one local government would require redirecting a private company in 2005, but continues to receive it from another local government or amending the property tax revenue for a service it no longer Constitution. In addition, any significant change provides. to the allocation of property tax revenue would require approval by two-thirds of the Legislature Changing the Allocation system Is Difficult due to provisions in the Constitution added by Over the years, the Legislature, local Proposition 1A (2004). (These issues are discussed governments, the business community, and the further in the appendix.) www.lao.ca.gov Legislative Analyst’s Office 25 An LAO RepOR t WHAT ARe THe sTRenGTHs AnD LImITATIons oF CALIFoRnIA’s PRoPeRTy TAx sysTem? For many years, California’s overall property criteria summarized in Figure 12 to objectively tax system—the types of taxes paid by property compare particular taxes. These criteria relate to owners and the determination of property owner how taxes affect people’s decisions, how they treat tax liabilities—has evoked controversy. Some different taxpayers, and how the revenue raised people question whether the distribution of the from taxes performs over time. In practice, all tax burden between residential and commercial taxes involve trade-offs. Sometimes the trade-offs properties is appropriate and whether the amount are between two tax policy criteria. For example, of taxes someone pays should depend, in part, on revenue sources that grow quickly may be less how long he or she has owned the property. Other stable from one year to the next than other revenue people praise the financial certainty that the tax sources. Other times, the trade-offs are between system gives property owners. From one year to tax policy criteria and other governmental policy the next, property owners know that their tax objectives that may not be directly related to one liabilities under the 1 percent rate will increase of the five tax criteria. For example, one such only modestly. In this section, we do not attempt trade-off might be that ensuring that a property to resolve this long-standing debate. Instead, we owner’s taxes do not increase dramatically from review property taxes by looking at how they one year to the next (a reasonable governmental measure according to five common tax policy policy objective) can result in a tax system in which criteria—growth, stability, simplicity, neutrality, the owners of similar properties are taxed much and equity. Using this framework, we highlight differently (contrary to the equity criteria of tax particular aspects of the state’s property tax system, policy). both its strengths and limitations, for policymakers Revenue Growth and other interested parties. Economists use the five common tax policy From government’s perspective, revenue sources that grow along with the Figure 12 economy are preferable Common Economic Criteria for Evaluating Tax Systems because they can provide resources sufficient to 9 Growth—Does revenue raised by the tax grow along with the economy maintain current services. or the program responsibilities it is expected to fund? This can help governments 9 Stability—Is the revenue raised by the tax relatively stable over time? avoid increasing existing 9 taxes or taxing additional Simplicity—Is the tax simple and inexpensive for taxpayers to pay and for government to collect? activities in order to meet 9 current service demands. Neutrality—Does the tax have little or no impact on people’s decisions The Property Tax about how much to buy, sell, and invest? Has Grown Faster Than 9 Equity—Do taxpayers with similar incomes pay similar amounts and do the Economy. Personal tax liabilities rise with income? income in California—an 26 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t What Factors Affect Property Tax Growth each year? Most of the annual change in property tax revenues is the result of large changes in assessed value that affect a small number of properties, including: • Recently Sold Properties. When a property sells, its assessed value resets to the purchase price. This represents additional value that is added to the tax base because the sale price of the property is often much higher than its previous assessed value. • Newly Built Property and Property Improvements. New value is added to the county’s tax base when new construction takes place or improvements are made—mainly additions, remodels, and facility expansions—because structures are assessed at market value the year that they are built. • Proposition 8 (1978) Decline-in-Value Properties. These properties contribute significantly Graphic Sign Off to growth or decline in a county’s tax base because their assessed values may increase or decrease dramatically in any year. A particularly large impact on assessed valuaStieocnr teetnadrsy to occur in years when a large number of these properties transfer from ProposAitnioanl y13s t assessment to reduced assessment. Director Deputy As shown by the dark bars in the figure below, recently sold, newly built, and decline-in-value properties typically account for more than two-thirds of total changes in countywide assessed value in Santa Clara County. Other properties, although they represent most of the properties in the county’s tax base, contribute less because the growth of these properties’ assessed values is limited to 2 percent per year. Components of Annual Change in County Assessed Valuation in Santa Clara County (In Billions) $25 Other Properties Due to Recently Sold, Newly Built, or Decline-in-Value 20 Properties 15 10 5 0 -5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 www.lao.ca.gov Legislative Analyst’s Office 27 ARTWORK #120521 An LAO RepOR t approximate measure of the size of the state’s Revenue stability economy—has grown at an average annual rate Revenue sources that remain relatively stable of 6.3 percent since 1979. Over the same period, from one year to the next help governments manage revenue from the 1 percent property tax rate has economic downturns, which tend to reduce revenue grown at an average annual rate of 7.3 percent. and at the same time increase demand for certain As we describe in the nearby box, much of the public services. Stable revenue sources also may help growth in property tax revenue depends on new governments plan more effectively for future needs, construction and property sales. including long-term investments in transportation, The Growth of Parcel and Mello-Roos Tax education, and public safety. Revenues Depends on the Structure of the Tax. The The Property Tax Is a Stable Revenue Source. terms of parcel taxes and Mello-Roos taxes vary by Despite being linked to the volatile real estate locality. Some local governments have taxes with market, the property tax is California’s most stable escalation clauses or other provisions that modify major revenue source. Since 1979, as shown in Figure the amount of the tax as local government costs 13, personal incomGer taaxp rhevicen Suei ghans bOeefnf three change. Other parcel taxes and Mello-Roos taxes are times more volatile, on average, than property tax Secretary set at fixed amounts per parcel. Depending on their revenue from the 1 percent rate. During the same Analyst structure, these taxes may or may not provide local period, statewide property tax revenue has declined Director governments with a growing source of revenue. in only three years, 1994-95, 2009-10, and 2010-11. Deputy The Property Tax Was More Stable Than Other Revenue Sources During the Recent Recession. As shown in Figure 14, revenue from the 1 percent property tax rate Figure 13 fared comparatively well Property Tax Revenue Is Much Less during the most recent Volatile Than Personal Income Tax Revenue recession. (In the nearby box, we discuss why the Annual Percent Change property tax is stable.) 30% Changes in property tax revenue tend to lag 20 economic trends by one or more years because 10 of the state’s acquisition value assessment system 0 and the lengthy period between when most -10 properties are assessed (January) and when Property Tax Revenue From the 1 Percent Rate -20 Personal Income Tax Revenue property tax payments are due (December of that year -30 and April of the next). 1980 1984 1988 1992 1996 2000 2004 2008 28 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #120521 Graphic Sign Off Secretary Analyst Director Deputy An LAO RepOR t Parcel Taxes and Figure 14 Mello-Roos Taxes Also Property Tax Revenue During the Recent Recession Are Stable. Because most Percent Change 2007-08 to 2008-09 parcel and Mello-Roos taxes are set at fixed Property Taxa amounts per parcel, there is minimal year-to-year fluctuation in the revenues that they raise. Sales and Use Tax Assessed Valuation in Some Counties, However, Has Declined Corporation Tax Significantly. Though statewide property tax revenue has remained Personal Income Tax comparatively stable throughout the recent -25% -20 -15 -10 -5 0 5 10 recession, some areas of a Revenue from the 1 percent rate. the state have experienced considerable declines What Factors Affect Property Tax stability? Acquisition Value Assessment SystAem RConTtriWbutesO to RReveKnu e #Sta1bil2ity0. Th5e m2a1in reason California’s property tax revenue is stable is that the assessed value of most properties increases each year by a maximum of 2 percent. In any given year, only a small fraction of properties are sold and reset to market value. This means that real estate conditions affect a relatively small portion of the tax base each year, insulating property tax revenue from year-to-year real estate fluctuations. Proposition 8 (1978) Decline-in-Value Properties Reduce Revenue Stability. As noted earlier in the report, county assessors may reduce a property’s assessed value in the event that its market value falls below its assessed value. Each year thereafter, the property is assessed at market value until it rises above what its assessed value would have been had it remained at its acquisition value adjusted upward each year at a maximum of 2 percent. During 2010-11, more than one in four properties in California was temporarily assessed to market value. Because these properties are assessed each year at market value, they link the property tax base more closely to the local real estate market than other properties, thereby reducing the property tax’s stability somewhat. www.lao.ca.gov Legislative Analyst’s Office 29 An LAO RepOR t in their property tax base. These counties tend per year. And, in most years, the assessed value of to have a large proportion of their properties real property grows automatically by a maximum under Proposition 8 decline-in-value assessments of 2 percent. Reassessments based on market value and have high foreclosure rates. For example, (which taxpayers are more likely to appeal) occur Riverside County had the second highest number infrequently for most property owners. of foreclosures (17,000) among counties and more The property tax assessed on personal property than 400,000 decline-in-value properties in 2011. is typically more administratively cumbersome Partly as a result of these trends, total assessed for owners and assessors. This is because personal value in Riverside County declined by 15 percent property is assessed annually at market value using between 2008 and 2011. complex depreciation schedules. These assessments, therefore, are more likely to be appealed, a process simplicity that can take more than a year to resolve. A well-designed tax system should be neutrality simple for taxpayers to understand and easy and inexpensive for governments to administer. Nearly all taxes alter taxpayer behavior to Complex tax systems can be expensive for some degree. Economists agree, however, that in governments to administer effectively and may most cases the ideal tax system is one that alters be confusing, time-consuming, and costly for decisions—about what goods to buy, what products taxpayers. to make, and where to work or live—as little as Most of the costs associated with administering possible. Economists prefer these “economically the state’s property tax system (ad valorem property neutral” taxes because they assume that people taxes, parcel taxes, and Mello-Roos taxes) reflect and businesses are in the best position to make the activities by county assessors, tax collectors, consumption, savings, and investment decisions and auditors. While comprehensive data on that meet their economic and personal needs. Tax these costs are not available, total property tax policies that influence what people buy and what administration costs likely are between 1.5 percent businesses produce tend to distance people and and 2 percent of collections, a somewhat higher businesses from their preferred choices, leaving level than that of state tax agencies that perform them less well off than they would be if the tax similar functions. A significant component of system were economically neutral. Policymakers the property tax’s administrative cost is from design some taxes, on the other hand, to influence counties’ responsibility to allocate property taxes taxpayer behavior in a way that promotes or to local governments pursuant to increasingly discourages particular activities. In general, complex state laws. County costs related solely these should be well targeted and have strong to determining property values, the other main justifications so that they achieve their policy component of administration, were slightly less goals with as little interference as possible in other than 1 percent of total revenues collected in personal decision making. Below, we describe how 2010-11—a percentage similar to that of state tax ad valorem property taxes may influence taxpayer agencies. behavior and then discuss the possible effects of From the taxpayers’ perspective, the property parcel and Mello-Roos taxes. tax is generally a simple tax with which to comply. Some Homeowners and Businesses May Tax payments are due in equal installments twice Move Less Frequently. California’s ad valorem 30 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t property taxes may affect an individual’s decision effective tax rates, the return on investment that to move because longer ownership results in a businesses receive from new improvements is lower lower effective property tax rate. (An effective and the taxes that homeowners pay on them are property tax rate differs from the 1 percent basic higher than they would be if all property—new rate in that it is the amount of property taxes and existing—were taxed uniformly. This may paid divided by the current market value of the lead some businesses and homeowners to invest property.) As shown in Figure 15, effective tax less than they otherwise would in new property rates can vary considerably. New Owner A, for improvements. example, has an effective tax rate of 1 percent Homeowners May Change Behavior in because the assessed value of his or her property Response to Assessment Exclusions. Voters is the same as its market value. Owners B and have approved ballot propositions that exclude C, who have owned their properties longer than some types of property transfers from triggering Owner A, have assessed values below their market reassessment to market value. (These exclusions are values because their market values increased by summarized earlier in this report in more than 2 percent each year (and therefore faster Figure 2.) For example, residential property than assessed values). As a result, most owners transfers between certain family members do not who have owned a property for many years pay trigger reassessment. These exclusions could alter an effective tax rate well below 1 percent. For decisions homeowners make about their property. those choosing to move, however, their effective For example, a homeowner might transfer property tax rate is reset to 1 percent, producing a moving to his or her child (thereby passing on his or her penalty that may influence some property owners’ low effective property tax rate) when, absent the relocation decisions. For example, established exclusion, the owner might have sold the property to firms that benefit from their comparatively low a nonrelative. In turn, that child could find it more effective property tax rates could be dissuaded economical to rent the property (and benefit from from relocating—decisions that, absent the moving the low effective property tax rate) than to sell (and penalty, could benefit the companies financially. forego the benefit of his or her low effective rate). (As we discuss below, differing effective tax rates equity also affect the equity of the property tax.) Homeowners and Businesses May Invest Less Equity relates to how taxes affect taxpayers in Property Improvements. When a property with different levels of income or wealth. undergoes improvements, the newly constructed Economists use two different standards of portion of the property is assessed at its full market equity—vertical and horizontal—to evaluate taxes. value. The existing property, on the other hand, Vertical equity occurs when wealthier taxpayers is typically assessed below its current market Figure 15 value, meaning that Hypothetical Effective Property Tax Rates for Three Property Owners improvements are taxed Year Market Assessed Property Property Effective at a higher effective rate Purchased Value Value Tax Rate Tax Paid Tax Rate than existing property. Owner A 2012 $300,000 $300,000 1% $3,000 1.0% Because improvements Owner B 2002 300,000 180,000 1 1,800 0.6 are subject to higher Owner C 1986 300,000 110,000 1 1,100 0.4 www.lao.ca.gov Legislative Analyst’s Office 31 An LAO RepOR t pay a greater amount in taxes than less wealthy often—military families, younger homeowners, taxpayers. Horizontal equity, on the other hand, or those with jobs that require them to relocate occurs when similar taxpayers—those with similar frequently—tend to have higher effective ad incomes or wealth—pay the same amount in taxes. valorem tax rates than homeowners who move less Under an equitable property tax system (1) owners frequently because newly purchased properties are of highly valuable property pay more in taxes than assessed at market value. Relocation decisions may owners of less valuable property and (2) the owners result from circumstances that households may of two similar properties pay a similar amount in not have foreseen, such as employment changes, property taxes. Put differently, an equitable system divorce, or other changes in family composition. would tax property owners at the same effective Under horizontal equity, in contrast, taxpayers rate. As we discussed in the previous section, pay similar taxes unless their household income, however, property owners often are subject to wealth, or consumption patterns differ. different effective tax rates. Therefore, California’s Fixed-Rate Taxes Do Not Meet Vertical ad valorem property taxes, parcel taxes, and Equity Standard. Parcel taxes and Mello-Roos Mello-Roos taxes often do not meet these standards taxes typically meet the criteria of horizontal of equity. equity but not vertical equity because property Equity Reduced by Acquisition Value owners typically are charged the same amounts— Assessment and 2 Percent Assessed Value regardless of their wealth or their properties’ value. Cap. California’s property tax system does not summary consistently meet the standards of horizontal or vertical equity. As discussed earlier in this report, Our comparison of California’s property tax two owners with identical properties may pay system with common tax policy criteria found different amounts of property taxes if one owner mixed results. The ad valorem taxes generally bought the property a decade before the other. In meet the goals of administrative simplicity and a tax system with horizontal equity, both owners providing governments with a growing source of would pay similar amounts. In relation to vertical stable revenue, but often do not meet the goals of equity, the tax system’s reliance on acquisition neutrality and equity. Specifically, California’s value and the 2 percent cap on assessed valuation ad valorem tax system (1) may influence decisions growth can result in owners of valuable property property owners make about relocations and paying less than owners of (recently acquired) less expansions and (2) treat similar taxpayers valuable property. In a tax system with vertical differently and wealthier taxpayers the same as less equity, owners of valuable property would pay wealthy taxpayers. more in taxes because owners of valuable property California’s other property taxes (parcel taxes generally are wealthier than owners of less valuable and Mello-Roos taxes) generally perform well property. relative to the goals of stability, administrative Homeowners Who Are Mobile Pay Higher simplicity, and horizontal equity, but may perform Effective Tax Rates. Homeowners who move less well in regard to the other objectives. 32 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t APPenDIx 1: THe HIsToRy oF CALIFoRnIA’s PRoPeRTy TAx ALLoCATIon sysTem California’s system Figure A-1 for allocating property History of California’s Property Tax Allocation tax revenue from the 1972 SB 90—Establishes school “revenue limit” funding system, giving the 1 percent rate among local state a significant fiscal interest in the allocation of local property tax governments is complex revenue. and has changed over 1978 Proposition 13—Voters cap the basic property tax rate at 1 percent and give the state new responsibilities for allocating property tax revenue. time. The most significant SB 154—State’s first law allocating property tax revenue. Amounts change was voter approval based on share of property tax received prior to Proposition 13, with of Proposition 13 in state providing grants for some of local revenue loss. 1979 AB 8—State changes property tax allocations in SB 154, establishes 1978, which shifted the system for allocating future growth in property tax revenue, and absorbs control over the allocation costs of some local programs. of property taxes from 1992 First ERAF Shift—State permanently shifts some property tax revenue from counties, cities, and special districts into a fund for K-14 districts. local communities to 1993 Second ERAF Shift—State permanently shifts additional property tax the state. Since that revenue into a fund for K-14 districts. time the state has made 2004 Triple Flip—State uses some local sales tax revenue to repay deficit-financing bonds. Reimburses counties and cities with property tax several major changes revenue from ERAF and K-14 districts. that affect the amount The VLF Swap—State permanently shifts some property tax revenue of property tax revenue from ERAF and K-14 districts to reimburse cities and counties for the state’s reductions to their VLF revenue. from the 1 percent rate Temporary ERAF Shift—State shifts some property tax revenue from distributed to counties, noneducational local agencies to K-14 districts for two years. cities, K-14 districts, and Proposition 1A—Voters restrict the state’s authority to shift property tax revenue away from cities, counties, and special districts. special districts. Some 2009 Proposition 1A (2004) Borrowing—State borrows $1.9 billion of of these changes have property tax revenue from cities, counties, and special districts as benefited the state fiscally authorized by Proposition 1A. (by indirectly reducing 2010 Proposition 22—Voters eliminate the state’s authority to borrow property tax revenue and to shift redevelopment agencies’ property tax state costs for education). revenue. Others have benefited 2012 Dissolution of Redevelopment Agencies—Redevelopment agencies are abolished. Over time, their share of the property tax will revert to local governments or other local governments. taxpayers. This appendix ERAF = Educational Revenue Augmentation Fund; VLF = vehicle license fee. describes the evolution of the state’s property tax allocation system. The key events are highlighted in Figure A-1, and described in more detail below. www.lao.ca.gov Legislative Analyst’s Office 33 An LAO RepOR t TAx ALLoCATIon PRIoR To PRoPosITIon 13 Tax Allocation Determined Locally Until of 1972 (SB 90, Dills), started an education finance 1978. Prior to voter approval of Proposition 13 in system in which the state guarantees each school 1978, each local government authorized to levy district an overall level of funding. For K-12 a property tax set its own rate (within certain districts, each district receives an overall level of statutory restrictions). Each local government funding—a “revenue limit”—from local property annually determined the amount of revenue taxes and state resources combined. Community necessary to finance the desired level of services college districts receive apportionment funding and set its property tax rate to collect that amount. from local property taxes, student fees, and state A property owner’s property tax bill reflected the resources. Thus, if a district’s local property tax sum of the individual rates set by each taxing revenue (and student fee revenue in the case of entity. Under this system, schools and community community colleges) is not sufficient, the state colleges received over 50 percent of statewide provides additional funds. If a district’s nonstate property tax revenue, counties about 30 percent, resources alone exceed the district’s revenue limit and cities about 10 percent. (At the local level, or apportionment funding level, the district does however, the share of property tax revenue not receive state aid and can keep the excess local supporting each type of local government varied. property tax revenue for educational programs Some communities, for example, provided a greater and services at their discretion. These districts percentage of total property tax revenue to schools are commonly referred to as “basic aid” districts and others provided more to their county or city.) because historically they have received only the Property Tax Allocation Linked to State minimum amount of state aid required by the Budget in 1972. Although local governments had California Constitution (known as basic aid). This control over the property tax during this period, system of school finance gives the state a significant property tax revenue had an effect on the state’s fiscal interest in the distribution of local property budget beginning in 1972. Chapter 1406, Statutes tax revenue. PRoPosITIon 13 AnD THe sTATe’s ResPonse Proposition 13 fundamentally changed bills: Chapter 292, Statutes of 1978 local government finance and assigned the state (SB 154, Petris) and then Chapter 282, Statutes responsibility for property tax allocation. Property of 1979 (AB 8, L. Greene). In general, these bills tax receipts fell by more than 60 percent because established methods for allocating the new lower Proposition 13 lowered the statewide property tax amount of property tax revenue and shifted certain rate to a constitutional maximum of 1 percent. county and school district costs to the state. Additionally, the measure required the state, First state Allocation system—sB 154 rather than local communities, to determine the allocation of property tax revenue among the Shortly after the passage of Proposition 13, local governments within a county. In response to the Legislature approved SB 154 in an effort to Proposition 13, the Legislature enacted two major avoid major local government service reductions 34 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t and significant fiscal distress from the decrease in Specifically, rather than continue the state block property tax revenue. Senate Bill 154 was the state’s grants included in SB 154, AB 8 increased the first attempt to allocate property taxes among base share of property taxes allocated to most counties, cities, special districts, and K-14 districts. counties, cities, and special districts by reducing Under SB 154, a local government’s share of the the base share going to K-14 districts. (Under the 1 percent property tax rate in 1978-79 was based on state’s school finance system, K-14 district losses the share of countywide property tax revenue going were in turn made up with increased state funds to that local government before Proposition 13. for education.) For cities and special districts, the For example, if a city received 10 percent of the increase in the base property tax allocation was property taxes collected by all local jurisdictions in derived from the block grant amount provided in the county prior to the passage of Proposition 13, SB 154. Cities received increased property taxes the city would receive 10 percent of the property equivalent to about 83 percent of their taxes collected in the county at the 1 percent rate. SB 154 block grant amount and special districts This was a significant change from the allocation of 95 percent of their block grant amount. Counties property taxes prior to Proposition 13, when a local received a combination of increased property government received property tax revenue only taxes, reduced expenditure obligations for health from the properties located within its jurisdiction. and social services programs, and a state block In addition, to partially offset the revenue loss grant for indigent health programs. The reduced resulting from the reduction in the property tax county expenditure obligations included complete rate, SB 154 used state funds to relieve counties of a state assumption of the costs for Medi-Cal and the portion of their obligation to pay for certain health State Supplementary Payment Program, as well and welfare programs and to provide block grants as an increased state share of costs for the Aid to to counties, cities, and special districts. Families with Dependent Children program (the predecessor to California Work Opportunities and The Current Property Tax Responsibility to Kids). (These changes resulted Allocation system—AB 8 in an increased share of property tax revenue for A year after enacting SB 154, the Legislature most counties. As discussed in the box on page 36, adopted AB 8, a long-term policy to allocate six counties ended up as so-called negative bailout property taxes and provide fiscal relief to local counties.) In summary, AB 8 shifted property governments. The legislation (1) directed county tax revenue away from K-14 districts in order to auditors to allocate 1979-80 property tax revenue provide cities, special districts, and most counties in a manner similar to SB 154 but with some with a greater amount of property tax revenue than modifications and (2) established a method for they received the previous year under SB 154. As allocating property tax growth in future years. shown in New Base Property Tax Allocation. Assembly Figure A-2 (see next page), this greatly reduced K-14 Bill 8 established a new base property tax allocation districts’ share of the statewide property tax. for 1979-80. The new base allocations in AB 8 New Method for Allocating Property Tax resembled those in SB 154—a local government’s Growth. Assembly Bill 8 also established a new share was based on the share of the countywide process for allocating growth (or decline) in property tax going to that local government property tax revenue in future years. In contrast to before Proposition 13—with some modification. the property tax allocation process in 1978-79 and www.lao.ca.gov Legislative Analyst’s Office 35 Graphic Sign Off Secretary Analyst Director Deputy An LAO RepOR t Figure A-2 Major Changes in Allocation of California Property Tax Revenuea SB 154, Permanent Triple Flip, 60% AB 8 K-14 Districts ERAF Shifts VLF Swap, Enacted Two-Year Counties ERAF Shift Other Districtsb 50 Cities 40 30 20 10 1976-77 1980-81 1984-85 1988-89 1992-93 1996-97 2000-01 2004-05 2008-09 a As a percentage of total revenue from the 1 percent rate and voter-approved debt rates. b Special districts and redevelopment agencies. Payments from redevelopment agencies to K-14 schools not included. ERAF = Educational Revenue Augmentation Fund; VLF = vehicle license fee. 1979-80 (that distributed revenue on a countywide tax it received in the prior year plus its share of basis without regard to where the property was any growth or decline in property tax revenue that located), the legislation specified that future growth occurred in its jurisdiction. ARTWORK #120521 in property tax revenue would be allocated only To ensure that each local government receives to those local governments serving the property the property tax growth from the properties it where the revenue increase took place. Accordingly, serves, each county is divided into tax rate areas beginning in 1980-81, AB 8 required that each local (TRAs). Each local government represented in a government receives the same amount of property TRA receives a share of the property tax growth What Are “negative Bailout Counties?” Assembly Bill 8 did not provide additional property tax revenue to six counties (Alpine, Lassen, Mariposa, Plumas, Stanislaus, and Trinity). Under the provisions of AB 8, the increased share of the base property tax allocation to counties was calculated as the value of the SB 154 block grant plus a small adjustment for the cost of the Aid to Families with Dependent Children program less the amount of the indigent health block grant. In these six counties, the value of the indigent health block grant was so great that it exceeded the value of the adjusted SB 154 block grant. In order for these counties to be treated in the same way as all other counties, the amount of property taxes allocated to these counties was reduced. Because these counties received a smaller percentage of total property taxes collected after implementation of AB 8 relative to their pre-Proposition 13 shares, these counties are termed negative bailout counties. 36 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t that occurs within that TRA. As required by it continued to receive 25 percent of the growth AB 8, county auditors developed a methodology to in property taxes in future years. As a result, the determine the percentage of property tax growth— distribution of property tax revenue among local known as TRA factors—to allocate to each local governments continued to closely resemble the government in each TRA. These TRA factors 1979-80 distribution until the first major changes were based largely on the 1979-80 base allocation to the AB 8 system occurred in the 1990s. established by AB 8 (including the shift of property In summary, the AB 8 property tax allocation tax revenue from K-14 districts to other local system provides each local government with the governments). In most counties, these TRA factors same amount of property tax revenue it received remain constant. Thus, if a city received 25 percent in the prior year (the base), plus its share of any of the property tax revenue growth generated in a growth or decline in property tax revenue that TRA in 1980-81 (the first year TRA factors were occurred in its jurisdiction in the current year. used to distribute property tax revenue growth), CHAnGes To THe AB 8 sysTem The state property tax allocation system set up no and Low Property Tax Cities in AB 8 continues to be the basis for property tax One change in property tax allocation relates allocation among local governments today. Since to so-called “no and low property tax cities.” Cities 1979, however, there have been some significant that did not levy a property tax, levied only a very changes to the original property tax allocation low property tax, or were not incorporated as cities system contained in AB 8. In most cases, the prior to the passage of Proposition 13 typically changes reflect the complex fiscal relationship received few property taxes under AB 8. During between the state and local governments. Because the 1980s the Legislature directed county auditors of the state’s role in allocating property tax revenue to modestly increase the amount of property taxes after Proposition 13 and in funding K-14 districts going to some of these cities by shifting a share of and other local programs, decisions regarding county property tax revenue to them. the state budget and other policy issues have led the Legislature and Governor to occasionally Property Taxes shifted to schools change how property tax revenue is distributed. Ongoing Property Tax Shifts Started in 1990s. We highlight the major changes in property tax In 1992-93 and 1993-94, in response to serious allocation below. It is important to note, however, budgetary shortfalls, the Legislature and Governor that these changes in property tax allocation do permanently redirected almost one-fifth of not explain the entire scope of the state-local fiscal statewide property tax revenue—over $3 billion in relationship—a relationship that also has involved 1993-94—from cities, counties, and special districts the realignment of many government programs and to K-14 districts. (The legislation also temporarily changes in other revenue sources such as the sales required redevelopment agencies to make payments tax and the vehicle license fee (VLF). Some of these to K-14 districts.) Under the changes in property decisions have benefited the state fiscally, and others tax allocation laws, the redirected property tax have benefited local governments or taxpayers. revenue is deposited into a countywide fund for www.lao.ca.gov Legislative Analyst’s Office 37 An LAO RepOR t schools, the Educational Revenue Augmentation local agencies (cities, counties, special districts, Fund (ERAF). The property tax revenue from and redevelopment agencies) to ERAF in 2004-05 ERAF is distributed to non-basic aid schools and and again in 2005-06. This temporary ERAF shift community colleges, reducing the state’s funding reduced the state’s funding responsibilities for K-14 obligation for K-14 school districts. districts to help address the budget shortfalls in The amount transferred into ERAF from each those two years. city, county, and special district was based on many Changes to eRAF factors, including the magnitude of the fiscal relief that the state provided the local government in The Triple Flip. In 2004, state voters approved AB 8 and, for counties, the level of taxable sales Proposition 57, a deficit-financing bond to address within its borders. As a result, individual local the state’s budget shortfall. The state enacted a government ERAF obligations varied widely. For three-step approach—commonly referred to as example, the ERAF shifts from cities formed after the triple flip—that provides a dedicated funding 1978 typically were lower than those for older source to repay the deficit bonds: cities because the newer cities did not receive any • Beginning in 2004-05, one-quarter cent AB 8 benefits. Similarly, counties with many retail of the local sales tax is used to repay the developments typically had larger ERAF shifts than deficit-financing bond. rural counties because the state anticipated that extensively developed counties would receive more • During the time these bonds are relief from the state’s primary ERAF mitigation outstanding, city and county revenue measure: a half-cent sales tax for local public safety losses from the diverted local sales tax are (Proposition 172, 1993). As shown in Figure A-2, replaced on a dollar-for-dollar basis with after the ERAF transfer of the early 1990s, schools property taxes shifted from ERAF. and community colleges once again received more • The K-14 tax losses from the redirection of than 50 percent of the state’s property tax revenue, ERAF to cities and counties, in turn, are while other local governments received less. offset by increased state aid. “Excess ERAF” Shifted Back. In the late 1990s, some county auditors reported that their ERAF The triple flip increases the amount of property accounts had more revenue than necessary to tax revenue going to cities and counties and reduces offset all state aid to non-basic aid K-14 districts. In the amount of ERAF provided to K-14 districts. response, the Legislature enacted a law requiring Overall, however, cities, counties, and K-14 districts that some of these surplus funds be used for do not experience any net change in revenue from countywide special education programs and the the triple flip. Cities and counties receive more remaining funds be returned to cities, counties, property tax revenue, but this revenue gain is offset and special districts in proportion to the amount of by the reduction in sales tax revenue. K-14 districts property taxes that they contributed to ERAF. The receive less property tax revenue, but this is offset ERAF funds that are returned to non-education with increased state aid. The flip of sales taxes local governments are known as excess ERAF. for property taxes ends after the deficit-financing Additional Temporary Property Tax bonds are repaid (currently estimated to occur in Shift. The 2004-05 budget package also shifted 2016). $1.3 billion of property taxes from noneducation 38 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t The VLF Swap. The VLF—a tax on vehicle remain after the county auditor (1) returns excess ownership—provides revenue to local governments. ERAF, (2) reimburses the triple flip, and In 1999, the state began reducing the VLF rate and (3) make payments for the VLF swap. This change backfilling city and county revenue losses from in priorities has a significant effect on the amount this tax reduction with state aid. The 2004-05 of ERAF available for school districts. In 2010-11, budget package permanently replaced the state for example, auditors in 33 counties reported using VLF backfill by diverting property tax revenue all ERAF resources for the first three priorities, from ERAF and, if necessary, non-basic aid K-14 leaving no ERAF for schools. districts to cities and counties. In 2004-05, cities Figure A-4 (see next page) displays the complex and counties did not experience a change in overall process county auditors follow to allocate ERAF revenue from the VLF swap, as the amount of and to reimburse cities and counties for the triple property tax shifted to them was equal to the VLF flip and VLF swap. This figure also shows that, backfill amount. In subsequent years, state law under certain circumstances, it is possible that the specifies that each local government’s VLF swap auditor could determine that there are not enough payment grows based on the annual change in funds to fully compensate cities and the county for its assessed valuation. As a result, most cities and the triple flip and/or the VLF swap. These funding counties benefit fiscally from the VLF swap because insufficiencies are referred to as “insufficient assessed valuation typically grows more quickly ERAF.” than VLF revenue. Similar to the triple flip, K-14 Step 1: Return Excess ERAF. As shown in the districts’ property tax revenue losses are made up figure, the first step is for each county auditor to with increased state aid. determine whether the funds deposited into the countywide account exceed the amount needed by Distributing eRAF all non-basic aid K-14 districts in the county, plus The triple flip and VLF swap further expanded a specified amount for special education. If so, the the use of ERAF and changed the priorities excess ERAF is returned to cities, special districts, governing how its resources are used. As shown in and the county in proportion to the amount Figure A-3, the original purpose of ERAF was to of property taxes they contributed to ERAF. supplement the property tax revenue of non-basic This calculation of excess ERAF was modified aid K-14 districts. Under current law, however, recently to reflect the increased revenue that K-14 funding K-14 districts falls to the fourth priority. districts and ERAF receive from the dissolution of As a result, non-basic aid school districts do not redevelopment agencies. Specifically, to maximize receive any ERAF resources unless additional funds the state fiscal benefit related to redevelopment Figure A-3 Uses of ERAF Listed in Priority Order Priority Early 1990s Late 1990s to 2004 2004 to Present First Fund non-basic aid K-14 districts Return excess ERAF Return excess ERAF Second Fund non-basic aid K-14 districts Reimburse triple flip Third Make payments for VLF swap Fourth Fund non-basic aid K-14 districts ERAF = Educational Revenue Augmentation Fund; VLF = vehicle license fee. www.lao.ca.gov Legislative Analyst’s Office 39 An LAO RepOR t Figure A-4 Process to Distribute ERAF and Reimburse the Triple Flip and VLF Swap County auditors shift property taxes from counties, cities, and special districts to ERAF. Does the amount in ERAF YES (1) Return excess exceed the total amount needed ERAF to counties, by K-14 districts? cities, and special districts. NO (2) Use ERAF to reimburse cities and counties for triple flip. NO Is ERAF sufficient to fully reimburse for triple flip? YES County is experiencing (3) Use remaining ERAF insufficient ERAF. to pay cities and counties for VLF swap. NO NO (4) Negative ERAF: Is E p R a A y F fo s r u V ff L ic F ie s n w t a to p ? fully fro a U m r s e e K n p - o 1 r t o 4 b p d a e i s r s i t t c y r i a c ta t id s x e t t h o s a t Ar ta e x p K e a - s y 1 s 4 fo u d r f f i V i s c L t i r e F ic n t s t p w to r a o f p p u ? e lly rt y pay for VLF swap. YES YES (5) Distribute remaining ERAF funds to End. K-14 districts. ERAF = Educational Revenue Augmentation Fund; VLF = vehicle license fee. ARTWORK #120521 40 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t dissolution, Chapter 26, Statues of 2012 (AB 1484, pay cities and the county for the VLF swap, the Committee on Budget) directs county auditors to county auditor redirects some property taxes from exclude property taxes related to the dissolution of non-basic aid K-14 districts for this purpose, as redevelopment agencies in the calculation of excess shown in step 4. The redirection of school property ERAF. taxes is commonly referred to as negative ERAF Step 2: Reimburse Triple Flip. Following the because it decreases K-14 property taxes rather calculation and distribution of excess ERAF, state than supplementing them (the original purpose of law directs county auditors to reimburse local ERAF). If the amount of property taxes deposited governments for their revenue losses associated in ERAF and allocated to non-basic aid school with the triple flip. This reimbursement is shown district is not enough to make the payments in the figure as step two. If the county auditor uses required under the VLF swap, then the county all available ERAF, but determines that the local has insufficient ERAF. In this situation, additional governments have not been fully reimbursed for state action is required for cities and counties to the triple flip, the county has insufficient ERAF. In receive the full VLF swap payment. In 2012-13, the this situation, additional state action is required if first time this issue came before the Legislature, cities and counties are to be fully reimbursed for the state included $1.5 million in the budget to the triple flip. compensate the county and cities in Amador Steps 3 and 4: Pay for VLF Swap. After County for insufficient ERAF. reimbursing the triple flip, the next use of ERAF Step 5: Distribute Remaining ERAF to K-14 is to make payments to local governments for Districts. Any funds remaining in ERAF after the the VLF swap. If the county auditor determines other uses have been satisfied are distributed to that ERAF resources are not sufficient to fully schools and offset state education spending. LImITs on THe sTATe’s AUTHoRITy oVeR PRoPeRTy TAx ALLoCATIon The state’s use of property tax shifts to help Proposition 1A (2004) resolve its severe budget difficulties—as well In 2004, voters approved Proposition 1A, as other actions affecting the state-local fiscal amending the State Constitution to prohibit the relationship—have been a source of considerable state from shifting property tax revenue from cities, friction between state and local government. counties, and special districts to K-14 districts. In response, local government advocates have The measure, however, provided an exception to sponsored initiatives to limit the state’s authority its restrictions. Beginning in 2008-09, the measure over local finances, including two constitutional allowed the state to shift a limited amount of local measures reducing the state’s authority over property tax revenue to schools and community property tax allocation. As a result, much of the colleges provided that the state repaid local authority granted to the state in Proposition 13 and governments for their property tax losses, with used to establish AB 8, ERAF, the VLF swap, and interest, within three years. The measure also the triple flip is now restricted. specified that any change in how property tax www.lao.ca.gov Legislative Analyst’s Office 41 An LAO RepOR t revenue is shared among cities, counties, and to make payments totaling $1.7 billion (2009-10) special districts must be approved by two-thirds and $350 million (2010-11) to K-12 school districts of both houses of the Legislature (instead of by serving students living in or near their redevelopment majority vote). For example, state actions that shift areas. Unlike the borrowing from cities, counties, a share of property tax revenue from one local and special districts, the state did not reimburse special district to another, or from the county to a redevelopment agencies for these required payments. city, require approval by two-thirds of both houses Proposition 22 (2010) of the Legislature. The state utilized Proposition 1A’s exception for In 2010, voters approved Proposition 22, shifting property tax revenue to provide state fiscal which, among other things, prohibits the state relief in its 2009-10 budget package. Specifically, the from redirecting property tax revenue as it did in state borrowed $1.9 billion of property tax revenue 2009-10. Specifically, Proposition 22 eliminates the from cities, counties, and special districts—revenue state’s authority to borrow property tax revenue equal to roughly 8 percent of each local agency’s from local governments as previously allowed property tax revenue. (Under Proposition 1A, the under Proposition 1A and prohibits the state from state was required to repay these funds by 2012-13. requiring redevelopment agencies to shift revenue to Companion legislation, however, allowed local K-14 districts or other agencies. As discussed in the governments to borrow against the state’s future nearby box, the prohibition on shifting redevelopment repayments so that local government budgets were funds contributed indirectly to the dissolution of not negatively affected in 2009-10.) The 2009-10 redevelopment agencies in February 2012. budget package also required redevelopment agencies The Dissolution of Redevelopment Agencies As discussed in our report, The 2012-13 Budget: Unwinding Redevelopment, redevelopment had the overall effect of increasing state costs for K-14 education. For this reason, the state frequently required redevelopment agencies to shift some funds to support K-14 education. Under Proposition 22 (2010), however, the state no longer had the authority to require redevelopment agencies to shift property tax revenue to school districts. Facing considerable fiscal constraints and not authorized to shift funds from redevelopment for state fiscal relief as it had done in the past, the Legislature took a new approach as part of the state’s 2011-12 budget. Specifically, the Legislature approved and the Governor signed Chapter 5, Statutes of 2011 (ABX1 26, Blumenfield), which dissolved all redevelopment agencies. They also approved Chapter 6, Statutes of 2011 (ABX1 27, Blumenfield), allowing redevelopment agencies to avoid dissolution by voluntarily agreeing to make annual payments to school districts. The Supreme Court later ruled ABX1 27 unconstitutional, meaning all redevelopment agencies were subject to ABX1 26’s dissolution requirement. Under the dissolution process, the property tax revenue that formerly went to redevelopment agencies is first used to pay off redevelopment debts and obligations and the remainder is distributed to local governments in accordance with AB 8. 42 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t LookInG FoRWARD Proposition 1A and Proposition 22 limit the • The End of the Triple Flip. We estimate state’s authority to change property tax allocation that the state’s deficit-financing bonds laws. Measures that reallocate property tax revenue will be paid off in 2016-17. At that time, among counties, cities, and special districts require the state sales tax rate will decline by a two-thirds vote of the Legislature and measures one-quarter cent and the local sales tax that change state laws to increase the percentage of rate will increase by one-quarter cent. property taxes allocated to schools are prohibited. Because the local sales tax rate is restored Even without additional legislative action, however, in full, the property tax revenue currently the distribution of property tax revenue will change used to backfill cities and counties for the in the near future for two reasons. loss in sales tax revenue will be allocated • End of Redevelopment. As the debts to K-14 districts. Although none of these entities will experience any change in and obligations of former redevelopment overall revenue, cities, and to a lesser agencies are paid off, property tax extent counties, will receive a smaller share revenue that previously was allocated to of the property tax than they do today. redevelopment agencies will be distributed In addition, the property tax revenue to K-14 districts, counties, cities, and allocated to K-14 districts will reduce the special districts. state’s education costs. www.lao.ca.gov Legislative Analyst’s Office 43 An LAO RepOR t APPenDIx 2: PRoPeRTy TAx AnD LoCAL GoVeRnmenT PUBLICATIons Property Taxes The 2012-13 Budget: Unwinding Redevelopment (February 17, 2012) Property Tax Agents at the Local Level in Reviews the history of redevelopment agencies, California: An Overview (June 20, 2012) the events that led to their dissolution, and the Discusses the role of property tax agents in process communities are using to resolve their appealing property assessments. financial obligations. Reconsidering AB 8: Exploring Alternative The 2011-12 Budget: Should California End Ways to Allocate Property Taxes Redevelopment Agencies? (February 8, 2011) (February 3, 2000) Examines the Governor’s proposal to end Examines the problems in the current property redevelopment. tax allocation system and discusses the tensions Ten Events That Shaped California State- and trade-offs inherent in five reform proposals. Local Fiscal Relations (December 16, 2009) Reversing the Property Tax Shifts Discusses key events and measures that (April 2, 1996) influenced state-local relations. Explains the mechanics of the Educational Overview of California Local Government Revenue Augmentation Fund shift and the (June 17, 2010) formulas which implemented it. Summarizes key issues related to local Local Finance government. Understanding Proposition 218 Major Milestones: Over Four Decades of the (December 17, 1996) State-Local Fiscal Relationship Examines the constitutional requirements (November 29, 2012) related to property assessments and fees. Provides a timeline summarizing major changes in the state-local relationship. Local Government Bankruptcy in California: Questions and Answers (August 7, 2012) Addresses some common questions about the Chapter 9 process for local governments. 44 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t www.lao.ca.gov Legislative Analyst’s Office 45 An LAO RepOR t 46 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t www.lao.ca.gov Legislative Analyst’s Office 47 An LAO RepOR t LAO Publications This report was prepared by Chas Alamo and Mark Whitaker, and reviewed by Marianne O’Malley. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 48 Legislative Analyst’s Office www.lao.ca.gov