Property Tax Reductions to Diminish as Housing Market Improves

Property Tax Reductions to Diminish as Housing Market Improves MAC TAYLOR • L E G I S L A T I V E A N A L Y S T • MAY 5, 2014 Executive Summary Property Tax Reductions for Millions of Properties Due to Real Estate Crisis. The real estate crisis that unfolded during 2007 and 2008 affected millions of California property owners and thousands of local governments. Alongside its broader economic effects, which included widespread foreclosures, reduced construction activity, and diminished household wealth, the decline in property values resulted in temporary property tax reductions for 3.2 million properties—about 2.6 million homes and 600,000 other properties. These property tax reductions were required by Proposition 8 (1978), which modified the provisions of Proposition 13 to explicitly allow for such reductions when property values fall. Local Revenues Reduced by Billions of Dollars. For homes that received property tax reductions in 2013-14, the average homeowner received a $1,600 reduction in his or her property tax payment. For other properties that received property tax reductions—mainly apartments, commercial buildings, industrial facilities, and agricultural land—the average owner received a $7,500 property tax reduction. In total, temporary property tax reductions depressed local government property tax revenues by an estimated $7 billion in 2013-14, amounting to a 15 percent reduction statewide. Real Estate Market Recovery Means Large Property Tax Increases for Many. The state’s real estate markets are recovering. Home values increased 12 percent during 2012, yet property taxes for most property owners were largely unaffected. This is because state law limits property tax increases for most properties to 2 percent each year. However, taxes on properties with temporary tax reductions under Proposition 8 can increase faster than 2 percent each year. Property taxes for these properties increase based on the property’s market value because these properties are assessed at market value each year that they receive a reduced assessment. Real estate improvements during 2012 resulted in property tax increases ranging from 5 percent to 20 percent for many of these properties in 2013-14. Looking ahead, property tax payments for many owners that received temporary property tax reductions during the real estate crisis could increase by more than 10 percent annually for the next several years. These increases likely will cause local property tax revenues to grow swiftly over the next several years as well. AN LAO BRIEF Introduction Property Taxes Also Affect the State Budget. Under the state’s education finance system, schools For many California taxpayers, the property receive a certain level of general purpose funding, as tax is one of the largest tax payments they make specified in the annual budget act. Schools receive each year. For thousands of California local this funding from a combination of local property governments—K-12 schools, community colleges, tax revenue and state General Fund revenues. If cities, counties, and special districts—property tax a school’s property tax revenue is insufficient to revenues form the foundation of their budgets each achieve the specified funding level, the state provides year. Despite the major role that property taxes General Fund revenue to meet this requirement. play in California finance, many issues related to Local property taxes therefore affect the state budget this system are complex and not well understood. because increases in local property tax revenue The purpose of this report is to highlight one allocated to schools typically offset state spending on such issue—reduced assessment properties education. under Proposition 8 (1978). This report describes Graphic Sign Off California’s property tax assessment system and How Does California’s Property details how it responded to the recent real estate Tax System Work? Secretary crisis. It also reviews how temporary property tax Analyst Most Property Taxed Based on Its Purchase reductions affected taxpayers, local governments, MPA Price. In California, owners of real property (land and the state. Lastly, it highlights how this system is Deputy and buildings) pay an annual one percent tax based responding to the recent and widespread recovery in on their property’s taxable value, or “assessed value.” real estate prices. Proposition 13 (1978) established the process county Property Taxes Are a Major Revenue Source for officials use to determine the assessed value of real Local Governments. The property tax is California’s second largest source of tax revenue. About $50 billion Figure 1 in property taxes each year is How Are Property Taxes Allocated Among Local Governments?a collected and distributed to local governments—including 2012-13 counties, cities, school and Counties Schools and community college districts Community Colleges (schools), and special districts. Figure 1 shows how property tax revenues were distributed statewide to these Former governments in 2012-13. Redevelopment Obligations Property taxes are collected by the county and distributed Special Districts to local governments within that county. The share of Cities countywide property taxes a Amounts shown reflect the percentage of total revenue from the 1 percent basic rate and each type of local government voter-approved debt rates. receives varies in each county. 2 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #140251 Template_LAOReport_mid.ait AN LAO BRIEF property. Under this system, when real property is and reassessed at that time to its purchase price of purchased, it gets an assessed value that is equal to $300,000. In this example, the property is assessed at its purchase price, or “acquisition value.” Each year its Proposition 13 value each year. thereafter, the property’s assessed value increases What Happens When a Property’s Value Falls by 2 percent or the rate of inflation, whichever is Below its Proposition 13 Value? When real estate lower. This process continues until the property is values decline, a property’s market value may fall sold, at which point it again is assessed to its most below its Proposition 13 value, which is based on the recent acquisition value. In other words, a property’s property’s most recent acquisition value. Without assessed value resets to market value each time it is an adjustment to its assessed value, the property sold. would be taxed based on an amount greater than In most years under this assessment practice, a it is worth. In these events, county officials reduce property’s market value is greater than its assessed the assessed value of a property by lowering it value. This occurs because assessed values increase from the property’s adjusted acquisition value Graphic Sign Off by no more than 2 percent per year, but market under Proposition 13 to its current market value. values tend to increase faster. Thus, as long as the Properties that receive lower assessed values are Secretary property does not change ownership, its assessed called Proposition 8 “reduced assessment properties” Analyst value increases predictably each year and is after Proposition 8, which explicitly allows for this Director unaffected by faster increases in its market value. assessment reduction. Due to the recent downturn Deputy For example, Figure 2 shows how a hypothetical in the state’s real estate markets, one-quarter of all property purchased in 1995 for $185,000 would be properties—about 3.2 million—have assessment assessed in 2012, after having been sold in 2002 reductions under Proposition 8 in 2013-14. Figure 2 Most Property Taxed Based on its Purchase Price $600,000 Market Value Increases or decreases based on local real estate conditions 500,000 Proposition 13 Value 400,000 Increases by a maximum of 2 percent each year 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 100,000 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 www.lao.ca.gov Legislative Analyst’s Office 3 ARTWORK #140251 AN LAO BRIEF Figure 3 illustrates the assessment of a Proposition 8 During the Real Estate Crisis hypothetical Proposition 8 reduced assessment Many Property Owners Purchased During property over time. The market value of the the Real Estate Boom. The recent real estate property purchased in 1995 stays above its crisis unfolded after several years of pronounced Proposition 13 assessed value through 2007. Then, real estate activity during the mid-2000s. a significant decline in its market value drops the Unprecedented new construction, home price property’s market value below its Proposition 13 increases, and home sales levels characterized this assessed value. At this time, the property boom. Figure 4 shows these trends for: (1) single- receives a reduced assessment that is less than its family homes built, (2) existing sGinrgalep-fhamicil yS ign Off Proposition 13 value. For three years, the property homes sold, and (3) the median single-family home is assessed at market value, which may increase or Secretary sales price each year. decrease by any amount. By 2012, the property’s Analyst One important outcome of this housing market value has risen to what its assessed value Director boom was that many Californians became recent would have been under Proposition 13. In later homeowners and most of them bDouegphut tayt or near years, the property’s assessed value is determined peak home prices. This interaction would have by its original acquisition price adjusted upward significant property tax consequences. As the each year by as much as 2 percent. In this example, housing crisis hit in 2007, many homeowners, the property is assessed at its Proposition 13 value especially recent buyers, had high acquisition in some years and its market value in others. values for property tax purposes. Also, because Figure 3 Property is Taxed at the Lower of Market Value or Proposition 13 Value $350,000 300,000 Market Value Proposition 13 Value Increases or decreases based Increases by a maximum of 250,000 on local real estate conditions 2 percent each year 200,000 Assessed Value Property Purchased 150,000 Assessed at acquisition value Proposition 8 100,000 Reduced Assessment Property assessed at market value 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 4 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #140251 Graphic Sign Off Template_LAOReport_fullpage.ait ARTWORK #140251 Secretary Analyst AN LAO BRIEF MPA Deputy Figure 4 Unprecedented Housing Activity During Mid-2000s Single-Family Homes Built 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Existing Single-Family Homes Sold 700,000 600,000 500,000 400,000 300,000 200,000 100,000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Median Single-Family Home Sales Price $600,000 500,000 400,000 300,000 200,000 100,000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 www.lao.ca.gov Legislative Analyst’s Office 5 AN LAO BRIEF they purchased near the peak, market values mid-2000s. Construction contractors, responding for these homes were similar to their assessed to price signals at the time, built significant new values. Many of these newer owners would receive commercial and residential developments in these Proposition 8 reduced assessments as the real estate areas. Figure 6 shows the relationship between crisis unfolded. home price declines and the onset of reduced The Number of Proposition 8 Properties assessments for counties with the highest shares Increased Dramatically During the Crisis. of reduced assessments. In particular, it shows (1) Figure 5 shows the number of properties with the decline from peak to bottom for median single- reduced assessments under Proposition 8. During family home sales price and (2) the percentage of the housing boom between 2002 and 2005, only properties in that county that received a reduced 3 percent of properties on average had reduced assessment in 2013-14. Figure 7 (see page 8), for assessment each year. As real estate values fell in comparison, shows a statewide perspective of the Graphic Sign Off 2007 and 2008, the share of properties with reduced share of properties in each county that received a Secretary assessments increased tenfold. At its peak in reduced assessment in 2013-14. 2012-13, about 3.7 million properties, or one-third Concentrated Among Single-FamAinlya Hlyosmtes. of all properties, had reduced assessments. Most of the Proposition 8 reduced assMesPsmAent Concentrated in Counties Hardest Hit properties are single-family homes. HDomepesu atynd by Housing Crisis. Not surprisingly, reduced condominiums make up about 80 percent of assessment properties were concentrated in properties with reduced assessments. The rest counties hardest hit by the real estate crisis, where consists mainly of apartments, commercial price increases had been greatest during the buildings, industrial facilities, and agricultural land. Figure 5 Number of Proposition 8 Properties Increased Dramatically During the Real Estate Crisis (In Millions) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 94-95 95-96 96-97 97-98 98-99 99-00 00-01 01-02 02-03 03-04 04-05 05-06 06-07 07-08 08-09 09-10 10-11 11-12 12-13 13-14 6 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #140251 Template_LAOReport_large.ait Graphic Sign Off ARTWORK #140251 Secretary Analyst MPA AN LAO BRIEF Deputy Figure 6 Proposition 8 Properties Concentrated in Counties Hardest Hit by Housing Crisis Median Single-Family Home Sales Price Percentage Decline Percentage of Properties With PEAK BOTTOM (Peak to Bottom) Reduced Assessments in 2013-14 Stanislaus 65% 51% $370K $130K Riverside 60% 44% $430K $170K San Joaquin 65% 43% $430K $150K Contra Costa 48% 42% $920K $480K Placer 53% 40% $530K $250K Fresno 58% 39% $310K $130K El Dorado 35% 38% $370K $240K www.lao.ca.gov Legislative Analyst’s Office 7 Graphic Sign Off Secretary Analyst MPA AN LAO BRIEF Deputy Figure 7 Reduced Assessments Are Widespread Del Norte Siskiyou Modoc Share of Properties With Reduced Assessments Less Than 20% Shasta Lassen Trinity Humboldt 20% to 30% Tehama 30% to 40% Plumas Mendocino More Than 40% Glenn Butte Sierra Nevada Colusa Lake Yuba Placer Sutter Yolo El Dorado Sonoma Napa Alpine SacramentoAmador Solano Calaveras Marin Contra San Tuolumne Mono Costa Joaquin San Francisco Alameda Stanislaus Mariposa San Mateo Santa Clara Merced Madera Santa Cruz San Fresno Benito Inyo Monterey Tulare Kings San Luis Obispo Kern Santa Barbara San Bernardino Ventura Los Angeles Orange Riverside San Diego Imperial Trinity County data is unavailable. Template_CA_County Map.ait ARTWORK# 140251 8 Legislative Analyst’s Office www.lao.ca.gov AN LAO BRIEF How Did Proposition 8 Affect assessment would have been had its market Property Owners During the Crisis? value never declined. Each year thereafter, the property’s Proposition 13 value cannot increase How Much Were Taxable Values Reduced? by more than 2 percent each year. The second way When owners receive a Proposition 8 assessment a property under reduced assessment returns to reduction, their property’s taxable value is reduced its acquisition-based value is when it is sold. This temporarily to its market value, which is some occurs because properties are assessed at their amount below its Proposition 13 value. The size of acquisition value (purchase price) when they this reduction varies for each property depending change ownership. Of the 500,000 properties that on (1) its initial acquisition value, (2) how much returned to their Proposition 13 value assessment that had increased over time under Proposition 13, in 2013-14, about 60 percent did so due to market and (3) how far below that value its market value value increases and 40 percent did so after being had fallen. We estimate that the average reduced sold. assessment for a single-family home under Proposition 8 was $140,000. This means that the How Did Proposition 8 Affect current market value for the average homeowner Governments During the Crisis? with a reduced assessment is $140,000 lower than In reducing property taxes for millions of what its Proposition 13 value would otherwise have owners, reduced assessments also affected local been. On average, single-family homeowners with government finances. For many of California’s reduced assessments received a $1,600 property 4,000 local governments, property tax revenues tax reduction for 2013-14. (In addition to the are the foundation of their annual budgets. Not 1 percent statewide property tax rate, some local surprisingly, Proposition 8 reduced assessments governments levy additional rates to repay voter- have affected the services these governments have approved infrastructure projects. Thus, property been able to provide. tax reductions are somewhat greater than 1 percent Proposition 8 Properties Reduced Local of reduced taxable value under Proposition 8.) Property Taxes by About $7 Billion. Based on Commercial properties—mainly apartments, limited data, we estimate that the 3.2 million retail stores, industrial facilities, and agricultural Proposition 8 reduced assessments in 2013-14 land—tend to be larger and more valuable than lowered local property tax revenue by about single-family homes. Thus, commercial properties $7 billion statewide. This amount is equal to with Proposition 8 reduced assessments received a a 15 percent reduction in total property taxes $650,000 reduction, on average, equal to a $7,500 collected in California. (As noted before, this reduction in property taxes. (These estimates rely estimate is an extrapolation of data from six large on property tax information from Los Angeles, counties.) Orange, Santa Clara, San Mateo, San Francisco, Reduced Assessments Also Increased State and Riverside counties.) Spending on Education. About 40 percent of How Do Proposition 8 Properties Return local property tax revenues go to schools. In most to Their Proposition 13 Assessments? A cases, property tax revenues that go to schools and property under reduced assessment returns to community colleges offset required state spending its Proposition 13 value in one of two ways. First, on education. As a result, most reductions in its market value increases faster than 2 percent school property taxes are made up by increases in each year until it exceeds the amount that its www.lao.ca.gov Legislative Analyst’s Office 9 AN LAO BRIEF state resources for education. Thus, the 3.2 million increases of 5 percent in 2013-14. Commercial Proposition 8 reduced assessments, which lowered properties with reduced assessments had their total local property taxes by about $7 billion, assessments increased, on average, by 9 percent. likely increased state education spending by about In Santa Clara County, assessment increases in $3 billion in 2013-14. 2013-14 for single-family homeowners with reduced assessments averaged 13 percent. For condominium Proposition 8 During the Real Estate Recovery owners, the average increase in assessed value was By official measures, the Great Recession ended much higher—20 percent. In Sacramento County, in 2009. California’s housing markets nevertheless assessments for reduced assessment properties continued to struggle. In early 2012, however, increased on average by 6 percent. localized real estate improvements spread and Proposition 8 Properties Contributed to the housing recovery gained momentum. Home Property Tax Growth in 2013-14. Proposition 8 values statewide climbed 12 percent in 2012. Below, properties reduced local property tax revenues we describe how this pronounced improvement during the real estate crises. As real estate markets affected property owners with reduced assessments recover and these properties begin to see large and how it has affected local government revenues. annual assessments increases, Proposition 8 has Number of Proposition 8 Properties Declined the opposite effect. This is because assessment in 2013-14. For the first time since 2006-07, the increases for these properties are not limited to number of Proposition 8 reduced assessment 2 percent; instead, they can increase or decrease by properties declined in 2013-14, from a peak of any amount, based on local real estate conditions. 3.7 million in 2012-13 to 3.2 million in 2013-14. In particular, annual assessment increases above As mentioned earlier, about 60 percent of this 2 percent contribute to growth in local property decline resulted from price appreciation, where taxes because this growth exceeds what would the 2013-14 market value of reduced assessment have occurred if the property’s assessment increase properties exceeded their original assessment remained limited under Proposition 13. In many under Proposition 13. Relatedly, because real estate counties, Proposition 8 property assessments markets have been strengthening, it is unlikely that increased in 2013-14 for the first time since the many additional properties received Proposition 8 recession began. reduced assessments in 2013-14. In Los Angeles County, for example, Many Proposition 8 Property Owners assessments for Proposition 8 properties increased Saw Increased Assessments in 2013-14. In by a total of $10 billion in 2013-14, generating general, areas where real estate values have additional property revenues of $120 million for increased recently have seen correspondingly local governments there. large assessment increases for properties under Assessment Increases Expected to Continue Proposition 8. In the near term, many of these and Perhaps Accelerate. Real estate prices owners will experience increases in their property improved in calendar year 2012. As a result, taxes that are much larger in percentage terms 2013-14 property tax assessments, based on than increases for owners whose property did not property values as of January 1, 2013, increased for receive a reduced assessment. For example, single- many reduced assessment properties. Most of the family homeowners with reduced assessments recent home price gains, however, occurred after in Los Angeles County saw average assessment January 1, 2013, and therefore are not included 10 Legislative Analyst’s Office www.lao.ca.gov AN LAO BRIEF in the 2013-14 assessment determinations. In for owners that received temporary reductions particular, California home values increased during the real estate crisis could exceed 10 percent 12 percent in 2012 (included in the 2013-14 annually for several years. These increases will assessment determinations), but went on to increase boost local property tax growth rates over the almost 20 percent in 2013. For 2014-15, mindful of next several years. At the same time, the number this timing, we expect large assessment increases— of reduced assessment properties will decline as as much as 10 percent or 20 percent in many assessment increases climb above their original cases—for properties that currently have reduced Proposition 13 assessment value and reduced assessments. Going forward, property tax increases assessment properties change ownership. www.lao.ca.gov Legislative Analyst’s Office 11 AN LAO B R I E F LAO Publications This brief was prepared by Chas Alamo, and reviewed by Jason Sisney. 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 brief 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. 12 Legislative Analyst’s Office www.lao.ca.gov