Prop 13 as Original Sin

Give credit to David Crane. Unlike the pundits and would-be tax reformers who moan about California state government's boom-and-bust revenues, Crane, who was economic advisor to former Gov. Schwarzenegger, is brave enough to state the obvious: Prop 13 is the original sin.

Why are state revenues volatile? Because over the last 35 years California voters and policymakers cut the taxes that vary least with economic conditions, leaving governments increasingly dependent on the ones that vary the most.

The first and biggest whack, as Crane notes, was the 1978 Jarvis-Gann Prop 13, which cut and capped the property tax, a revenue source that declines only in the most dire economic moments, such as the Great Depression and the bursting of the housing bubble in the Great Recession. It was followed by the 1982 initiative eliminating state gift and inheritance tax and Schwarzenegger's 2003 cut in the vehicle license fee (which, perhaps not surprisingly, Crane fails to mention). Even more than the property tax, these were stable revenue sources, death and driving being inevitable features of the California scene.

But when they cut taxes, Californians didn't mean they wanted fewer public services. They have filled the void, partly by raising sales tax rates (since Prop 13 the combined uniform state-local rate has gone from 6% to 7.5% plus locally approved add-on levies for transportation or general city services); and partly from the rising yield of the personal income tax, which delivered more and more dollars because of the enormous shift of income to the wealthy that has taken place over the past several decades. Now, with the higher rates on the rich enacted last year in Prop 30, the yield will be even greater.

But it will also be episodic. Income tax collections swing with capital gains in the markets, and taxable sales swing with the economy (they fell 18 percent from 2007 to 2010).

As Crane argues, the right cure for this volatility would also be good for the state's economy. I think he exaggerates the risk that California's current taxes will cause the rich to flee, but he's right that our current tax balance—high taxes on work and investment, low or no taxes on property and oil—is "crazy." From an economic perspective, property taxes are, in the words of conservative economist Milton Friedman, "the least bad tax there is." If you tax land, you don't have to worry that you will cause people to produce less of it. If California imposes an oil severance tax, as every other oil-producing jurisdiction in the world does, you don't have to worry about the oil disappearing or oil prices rising, because oil prices are set by a global market, in which California tax policy is but a blip. Shifting taxes toward land, oil, and carbon and reducing them on work and investment would strengthen the economy while providing a more stable base for public services.

Crane cautions that, before changing Prop 13, "governments would first need to reduce pension and health-care liabilities." But here he has it backward. As we show in California Crackup, it was Prop 13 and the governing system it created that made the out-sized pay and pensions of local government workers possible and perhaps inevitable. Getting rid of them is the necessary condition for creating a local taxpayer counterweight to public employee power in city and county politics.