Traffic moves along on Interstate 10 freeway approaching Interstate 405 freeway in Los Angeles, California. The measure, approved in 1978, was the inspiration for an antitax movement that has taken hold of the public discourse. Photographer: Jonathan Alcorn/Bloomberg

By Christopher Palmeri – Oct 16, 2011 9:01 PM PT

California voters approved Proposition 13 to rein in property taxes that had doubled in 10 years. More than three decades later, that rebellion has mortgaged the state’s future, saddling it with the nation’s highest debt and lowest credit rating.

The measure led to reductions that dropped per-student school spending from seventh to 29th nationally, prompted cities to pursue sprawling retail development to compensate for lost revenue, and pushed the state into budget gridlock, including a $705 million revenue shortfall announced Oct. 10, by requiring two-thirds approval for any tax increase.

“Proposition 13 set up an unfair and dysfunctional two- tiered system of property taxes,” said Kevin Starr, a history professor at the University of Southern California and the author of a series of books on the state. “It choked off a source of revenue, and the lack of that revenue has brought California to the edge.”

The measure, approved in 1978, was the inspiration for an antitax movement that has taken hold of the public discourse in Washington and in state legislatures throughout the country. It caps real estate levies at 1 percent of a property’s most-recent sale price. Before it passed, local governments could raise revenue as they saw fit.

Spread to Washington

In July, antitax fervor fed by the Tea Party movement led Republicans in the U.S. House of Representatives to dig in against any increase in the nation’s debt ceiling that included raising taxes. The compromise that resulted threatens automatic spending cuts across the government if a congressional supercommittee can’t agree on ways to cut the federal deficit by more than $1 trillion.

In his 1990 autobiography, “An American Life,” former President Ronald Reagan called Proposition 13 “a prairie fire” sweeping the nation. In just the past two years, New York and New Jersey enacted laws inspired by it. At least 20 states now have some sort of property-tax cap, according to the Lincoln Institute of Land Policy, a Cambridge, Massachusetts, foundation that researches property issues.

In California, where Proposition 13’s tax ceiling has long shaped public policy, the effect of that movement is clear.

Universities Cut

In addition to the effect on elementary schools, the most- populous state cut support for its public universities by 18 percent to $4.5 billion this year, according to the California finance department. The world’s ninth-largest economy’s general- fund backed debt has risen to $82.6 billion from $2.25 billion in 1978, state figures show. California carries more debt than any other state and ranks eighth on a per-capita basis, with $2,542 for each resident, Moody’s Investors Service has said.

Proposition 13 created disparities in tax payments that amaze Larry Stone, the assessor in Santa Clara County, home to Silicon Valley and companies such as Apple Inc. (AAPL) and Intel Corp. (INTC) Stone’s new neighbor in Sunnyvale will pay almost $18,000 in annual taxes and special assessments compared with the $3,000 Stone pays for the house he bought in 1975.

“You couldn’t invent a crazier system,” Stone said in a telephone interview.

The measure also created loopholes that businesses exploit to avoid paying their fair share, says San Francisco Assemblyman Tom Ammiano, a 69-year-old Democrat who has sponsored legislation to tighten rules on business-property transfers.

Dell’s Deal

For instance, billionaire Michael Dell structured the 2006 purchase of an ocean-view hotel in Santa Monica, a Los Angeles suburb, to avoid the automatic tax increase that comes with acquisition of more than a 50 percent interest in any property, Los Angeles County officials said in a statement filed in court.

The founder of Texas computer maker Dell Inc. (DELL) and his wife, Susan, bought shares in Ocean Avenue LLC, the corporation that owns the 302-room Fairmont Miramar hotel. They did it through a partnership, a limited liability corporation and a trust, none of which bought more than half of the hotel’s stock.

“This is emblematic of the cavalier way people try to skirt the law,” Ammiano said. “If you’re looking at a school that has to lay off teachers, if you care about elder care, money like this could make a real difference.”

The Los Angeles County Assessment Appeals Board ruled last year that the hotel had changed hands and the property’s value could rise to its $200 million purchase price from the previous assessed value of $85 million — that corresponds to an annual tax increase of about $1.3 million. Ocean Avenue is suing in state court to reverse the decision, while paying higher taxes as it pursues the matter. Todd Fogarty, a spokesman for Dell’s private investment firm, MSD Capital LP, declined to comment on the entrepreneur’s behalf.

Ballot Action

Proposition 13’s success had another effect as well: It inspired an explosion of ballot measures, from carving out part of the budget for schools to legalizing marijuana for medicinal purposes. Since 1978, the state has amended its constitution through initiatives 69 times, compared with 47 times in the previous 65 years, according to the Secretary of State.

That trend spread to other states such as Colorado, where voters in November will decide whether they want to raise income and sales taxes to fund schools where per-pupil funding ranked 39th in the U.S. in 2009, according to Census Bureau figures.

“It’s had a profound impact on multiple levels,” said Jean Ross, executive director of the California Budget Project, a nonpartisan research group in Sacramento. “The one that’s underestimated is the shift in decision-making from the local level to the state. All of our public systems have been affected by our seemingly perpetual budget crises.”

Demands for Change

In the years since antitax crusader Howard Jarvis led the Proposition 13 campaign, demands for changes to the law have become more vocal, if not more likely to succeed.

Los Angeles Mayor Antonio Villaraigosa, 58, like Assemblyman Ammiano, advocates creation of a “split roll” that lets levies on commercial properties rise more quickly than those for residences, so that business owners pay more.

“Prop. 13 has had the unintended effect of favoring commercial property owners at the expense of homeowners,” Villaraigosa said Aug. 16 at the Sacramento Press Club. “Let’s apply Prop. 13’s protections to homeowners and homeowners alone.”

Yet the measure remains popular for both businesses and homeowners. In a Sept. 23 Field Poll, 63 percent of California voters said they would support the measure if it were up for a vote again now. As for the split roll idea, Democrats endorsed it 53 percent to 37 percent, while Republicans opposed it 70 percent to 23 percent.

Businesses Benefit

It’s one of the initiative’s ironies that business people, who opposed the measure in 1978, have become its biggest beneficiaries. In Los Angeles County, where a quarter of the state’s $4.38 trillion in assessed property value is located, commercial and apartment buildings represented 60 percent of the tax rolls in 1975, while single-family homes accounted for 40 percent. Today that ratio is almost reversed.

In the late 1970s, tax-strapped homeowners were the driving force behind Proposition 13. Jarvis led five attempts to gather enough signatures to put the measure on the statewide ballot and finally succeeded, over the objections of Democrat Jerry Brown, 73, the governor then and now.

In the year after the measure passed, property-levy collections dropped 52 percent to $4.9 billion from $10.3 billion, according to the Board of Equalization, the state’s tax administrator.

Shifting Tax Base

Proposition 13 “effectively shifted the financing of portions of local government services and education from the property-tax base to the more volatile income- and sales-tax bases,” Standard & Poor’s said in a Sept. 8 report.

California has the 12th-highest sales tax rate in the country, with a combined state and local levy of 8.13 percent, according to the Tax Foundation, a non-partisan Washington-based research group. Its income tax collections placed it fifth in the nation in 2008, at $1,531 per capita.

Without the ability to boost local levies, Vallejo, a city of 116,000 in the San Francisco Bay area, in 2008 had to declare bankruptcy, the city’s former finance director, Robert Stout, told attendees at the Bond Buyer’s California Public Finance conference on Sept. 15. The process cost $12 million in legal bills and forced a one-third reduction in police staffing.

“I’ve worked for cities in Florida, New York and Connecticut,” Stout told the group. “We were always able to raise taxes.”

‘A Nightmare’

At the San Bernardino City Unified School District, the eighth-largest in the state with more than 50,600 students, revenue has fallen by $54 million, or more than 10 percent, in the past four years, as the state reduced funding. The district east of Los Angeles fired 68 educators, eliminated summer school and increased class sizes by a third, to average 30 students for each teacher.

“This is a nightmare,” said Mohammad Islam, San Bernardino’s assistant superintendent who has worked in school finance for 22 years. “It’s impossible what the state is doing to us.”

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