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May 26,1 978
Limiting Property Taxes____
Two well-publicized proposals to limit
property taxes will face California voters in the june 6 electioh. Actually, the
voters will have their choice of three
different alternatives. They can vote
on Proposition 13, the jarvisGann Initiative. The can vote
on
Proposition 13 and
on Proposition 8, allowing the legislative substitute, the Behr Bill, to take effect in
place of jarvis-Gann. Alternatively,
they can vote
on both propositions, defeating both measures and
leaving property taxes where they
were. The Behr Bill has already been
signed into law, but it would not become effective unless both Proposition 8 passes and Proposition 13 is
defeated (or is declared unconstitutional by the courts). This article outlines some of the essential features of
the two proposals and discusses how
they might affect the market for California state and municipal debt.
The two measures on the june ballot
are certainly not the first attempts by
California voters to restrict taxes and
public spending. In 1968 and again in
1972, the state's voters rejected the
Initiatives,N which would
have limited property taxes to 1
percent of market value. In 1973, they
re jected Proposition 1, which would
have done even more and limited state
taxes and spending in general to a
fixed maximum percentage of state
personal income. Although the 1973
proposition was defeated, similar initiatives are now gaining momentum
elsewhere in the country. Just this
spring, Tennessee voters approved a
measure of this type, while Michigan
and Colorado voters launched petition drives to accomplish the same purpose.
_
Essentialsof proposals
Although both jarvis-Gann and Behr
aim at restricting public spending by
limiting property taxes, Jarvis-Gann
goes much farther in this regard. InitialIy, it would roll back taxes on all property to 1 percent of the market values
stated on 1975-76 tax bills. This
change could result initially in a $7-billion (60 percent) reduction in California property taxes - one-third
applicable to owner-occupied homes
and the rest to rental and non-residential properties. Tax rates would then
be held constant while assessed market values could rise no more than 2
percent per year - except that properties when sold (or newly constructed)
would be reassessed at current market
values.
jarvis-Gann also would attempt to prevent other taxes from rising to offset
the lost property-tax revenues. First, it
would require that State tax increases
be passed by a two-thirds vote of all
members (not just those voting) of
both houses of the legislature. Second,
it would require that local tax increases gain the approval of two-thirds
of all
electorsN(i.e., registered voters) in the affected municipality. These added stipulations may be
unconstitutional, but if enacted they
would severely restrict futur'e tax increases, particularly at the local level.
The Behr Bill takes a less drastic approach. Initially, it would cut the tax
rate on owner-occupiedhomes by 30
percent (without rolling back assessed
values), while leaving unaffected the
rates on other real properties. Increases in property-tax revenuesthe combined effect of tax rates and
assessed values - thereafter would
(continued on page 2)
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Opinions expressed in this nevv'sletter do not
necessarily reflect the views of the management of the
Federal Reserve Bank of San Francisco, nor of the Board
Federal Reserve System.
of Goverilors of
not be allowed to exceed the genCial
rate of inflation. The bill also would increase the renter income-tax credit
and increase both home-owner and
rental assistance for senior citizens.
The bill would require the state to reimburse local districts for revenue
losses from the 30-percent homeowner tax cut, but it would also set limits on future state tax-revenue
growth. Starting with fiscal year 197879, state revenues would be allowed
to grow by no more than 1.2 times the
percentage increase in state personal
income. For example, if California income grew by 10 percent, state tax
revenues could grow at most by 12
percent. Thus, state revenues would
not face a very tight ceiling, and there
is even some ambiguity in the bill's
wording such that the limit could be a
good deal less restrictive.
Major issues
The two major issues at stake in this
complex campaign are property taxes
in particular and the size of government in general. The complexity of this
situation arises partly from the fact
that the authors of both propositions
attempted to deal with both issues together, instead of separating them.
Both proposals focus on the homeowner property tax that has escalated
with skyrocketing California property
values, but they also attempt to curb
the size of state and local government.
Consider the first issue in isolation,
with other taxes being increased to fill
the revenue gap left by a cut in property taxes. With increases in local sales
taxes and state income taxes, properties subject to lower property taxes
2
and thus would rise in value. In contrast, other types of spending subject
to the salestax, and work and financial
saving subject to the income tax,
would become less attractive. Given
such a shift in tax structure, individuals
would have added incentive to invest
in homes rather than in financial assets - especially since in the latter case,
interest and dividends are taxable income and capital-gains taxes are payable with each transfer. Indeed, in
view of the past decade's rise in inflation and nominal interest rates, existing tax structures have already steered
savers away from taxable-incomegenerating forms of saving and into assets like homes, for which
is
taken in kind and capital-gains are deferrable.
Consider the alternative case, where a
ceiling is imposed on total taxes and
spending, but without any reference to
specific taxes such as the property tax.
This is the approach proposed in California in 1973 or approved in Tennessee in 1978. This method would have
left room for a more flexible shift to
smaller government and for tax cuts
not solely directed to property owners. As it is, voters must approve (or reject) the shift from property taxes and
the limitation on government in tandem.
Municipal-finance issue
The complex debate over the two
propositions is already creating some
ramifications in the market for California state and municipal debt - the debt
of California's cities, counties, school
districts and other special districts. Although many kinds of bonds exist,
two categories are of special interest
here:
obligation'" bonds,
which are secured by the municipality
and paid out of general tax revenues;
and
allocation'" bonds, which are
normally secured by the tax base of a
redevelopment project and paid out
of taxes generated from rising property values. jarvis-Gann, and to a lesser
extent the Behr Bill, would affect both
kinds of municipal debt, but particularly the latter debt.
Neither proposal threatens the value
of existing general-obligation bonds,
because taxes needed to pay principal
and interest are specifically exempted
from the tax limitation. However, new
general-obligation debt could become
scarce under jarvis-Gann, because related spending would require the twothirds approval mentioned earlier. Under Behr the limit on such debt would
not be so severe, although it is difficult
to predict the bill's effect on the risk
premium in the interest rate. The ceiling on revenues and the disappearance of budget surpluses would tend
to increase the risk of default and
hence raise the interest rate necessary
to attract investors - but on the other
hand, the
conservatism'" imposed by spending limits might have
the opposite effect. For example, the
State's Aaa bond rating might be jeopardized if a large part of the current $3billion surplus were used to fill the revenue gap left by declining property
taxes - yet further surpluses might be
amassed if the voters chose to press
for conservative spending under either of the two proposals.
Both proposals would have a much
greater impact on tax-allocation than
on general-obligation bonds. Tax-allocation bonds are normally used for urban redevelopment. Their principal
and interest are financed out of the rising property values that result from redevelopment, and thus they are selffinancing. jarvis-Gann, with its rollback
3
on existing valuations and its 2-percent
lid on annual assessment increases,
might render this self-financing feature
unsustainable, threatening existing
debt. The 2-percent lid and inability to
raise property tax rates will also make
new debt of this type exceedingly difficult to issue. Consequently, the two
major rating services have begun to
look skeptically at such issues.
Moody's has suspended rating these
bonds until the situation becomes
clearer, while Standard and Poor's has
been reviewing ratings on a case-bycase basis. The Behr Bill apparently
would exert a smaller impact on such
bonds, because its assessment rollback
applies only to owner-occupied
homes, and because its ceiling on
property-tax increases moves upward
with the inflation rate.
Bond dealers and analysts argue that
individual bonds differ depending
upon the financial condition of the
municipality and the'security and revenue source of the bond. Current evidence supports this view. Although the
ballot proposals have had varied effects on individual bonds, in general
they have had little effect on general-.
obligation bonds and a substantial impact on tax-allocation bonds (and
some revenue bonds). For example,
many redevelopment districts are
floating debt now because of a belief
that financing would be almost impossible to obtain in the wake of jarvisGann. Yet bidding is very thin and net
interest costs are very high (often in excess of 8 percent).
In sum, jarvis-Gann and Behr represent
large departures from the status quo.
They raise fundamental issues about
the tax structure and the size of government, and if passed, will have uneven effects among municipalities.
Already, the financial markets indicate
that bond analysts are keeping a wary
eye on the polls.
Jack Beebe
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BANKINGDATA-TWElfTH fEDERALRESERVE
DISTRICT
(Dollar amountsin millions)
SelectedAssetsand liabilities
large Commercial Banks
Loans(gross,adjusted)and investments*
Loans(gross,adjusted)- total
Securityloans
Commercialand industrial
Realestate
Consumerinstalment
U.s. Treasurysecurities
Other securities
Deposits(lesscashitems)- total*
Demand deposits(adjusted)
U.s. Government deposits
Time deposits- total*
Statesand political subdivisions
Savingsdeposits
Other time deposits:}
LargenegotiableCD's
Weekly Averages
of Daily Figures
Member Bank ReservePosition
ExcessReserves(
+ )/Deficiency (-)
Borrowings
Net free(+)/Net borrowed (-)
FederalFunds-Seven large Banks
Interbank Federalfund transactions
Net purchases(+ )/Net sales(-)
Transactionswith U.s. security dealers
Net loans (+)/Net borrowings (-)
Amount
Outstanding
Change
from
5/10178
110,821
88,123
1,878
27,164
29,554
15,531
8,226
14,472
107,702
29,493
424
76,015
7,283
31,489
34,425
16,202
5/3178
+
+
-
+
-
+
+
+
-
+
+
+
+
+
42
87
121
1
144
16
109
64
1,164
850
301
596
32
14
422
440
Changefrom
year ago
Dollar
Percent
+ 14,483
+ 14,206
52
+
+ 3,279
+ 6,328
+ 2,889
558
835
+
+ 13,274
+ 2,814
51
+
+ 10,160
+ 1,441
- 599
+ 8,302
+ 6,977
Week ended
Week ended
5/10178
5/3178
+
+
+
+
+
+
-
+
+
+
+
+
+
-
+
+
15.03
19.22
2.85
1"3.73
27.25
22.85
6.35
6.12
14.06
10.55
13.67
15.43
24.67
1.87
31.78
75.63
Comparable
year-ago period
+
54
148
94
+
22
66
44
4
8
12
+
903
+
1695
248
427
+
+ 63
*Indudes items not shown separately.:}lndividuals,partnershipsand corporations.
+
214
Editorial comments may be addressedto the editor (William Burke) or to the author. ...
Information on this and other publications can be obtained by calling or writing the Public Information
Section,FederalReserveBankof SanFrancisco,P.O. Box 7702,SanFrancisco94120.Phone(415) 544-2184.
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