California’s inflation-adjusted per-capita spending has been nearly flat for more than 30 years. The state’s deficits come not from a spending binge, but from tax reductions adopted without cutting spending. Neocons promoted this “Starve the Beast” strategy as a way to cut otherwise too-popular programs (eventually), and sometimes even scared Democrats into going along (Jerry Brown reacting to Proposition 13).
Tax reductions began in 1978 when Proposition 13 reduced local governments’ revenues by 57% and further limited property tax increases. The State back-filled this shortfall, and its budgets have been in trouble ever since.
Proposition 13 History
But why were property taxes such a focus of voter dissatisfaction?
- Revenue distribution changed: In 1976 the California Supreme Court mandated sharing local school revenues with poorer districts. Property owners in affluent districts no longer had the exclusive benefit of taxes they paid for their local schools.
- Budget surpluses: California government maintained surpluses resented by fixed-income voters who suffered during the housing bubble described below. Oddly, Republicans still say they want to collect a surplus even as the electorate suffers from the “Great Recession.”
- Inflation/housing bubble: The inflation of the 1970’s was the principal reason for Prop 13’s passage. Fixed-income homeowners received shockingly large (and growing) property tax bills because inflation increased their homes’ taxable values dramatically. “Save Grandma’s home” was an important part of the campaign for Prop 13.
Proposition 13 also limited real estate taxes on commercial property, like homes, raising tax rates only when they changed hands. But since businesses often own property through subsidiaries, no reassessment and no tax increase occurs if they sell not the property but the subsidiary, in pieces, over several years. Property transfers could take longer, but no change in the tax bill would occur even if the property value doubled.
The impact is not trivial. The California Tax Reform Association reports: “in virtually every county in the state, the share of the property tax borne by [residences] has increased since the passage of Proposition 13 in 1978, while the share of the property tax borne by non-residential property has decreased. Some examples: in Contra Costa County, the residential share of the property tax went from 48% to 73%. In Santa Clara, the residential share went from 50% to 64%, despite massive industrial/commercial growth. In Los Angeles, it went from 53% to 69%. In Orange, it went from 59% to 72%.”
The 1970s inflation that led to higher real estate prices and taxes came from energy price inflation that began in 1973, just two years after a peak in domestic oil production insured we would not be able to produce our way out of even a small shortfall in worldwide petroleum supply. Unhappy with U.S. support for Israel during the Yom Kippur War, Arabs decreased oil production and prices went up fivefold almost overnight, peaking in 1982 at $42/bbl (roughly double that price in current dollars). In 1971, oil cost less than $2/bbl.
Home prices in the 1970s increased along with gas prices because, besides of petroleum’s importance in producing other goods, people bought homes as an inflation hedge. Because mortgages magnify the effect of inflation (and as we’ve recently discovered, deflation), homes were a smart investment, until they became unsalable because of high mortgage rates (16 - 18% in 1982).
So the origin of California’s tax reductions, and even its current budget deficit, is arguably oil price inflation. If we want a stable economy, and government without deficits, we need to stop kidding ourselves that spending is at the root of our budget problems, and attend to our energy addiction.