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California Initiative Could Provide Template to Target Commercial Real Estate

Big things often have the power to create their own environments. For example, Boeing built the largest factory building in the world in Everett, Washington, and it ended up generating its own weather system indoors.

Likewise, California’s population and economy are so large that the state sometimes seemingly creates its own environment. It has been noted that, were it a country, California would have the world’s fifth-largest economy.  So it’s easy to see why ideas formed there have had the power to influence policies in other states, or even nationally.

That is why NAIOP members across the U.S. should pay attention to a California ballot initiative that will be on the docket in 2020. The California Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative would change California’s constitution (as amended by Proposition 13, which was passed in 1978) so that existing taxpayer protections would no longer be afforded to commercial real estate. The ballot initiative would lift existing taxpayer protections and specifically target commercial real estate in California for tax increases.

Recently, NAIOP hosted a webinar for members to discuss property tax policy. The presentation opened with a background discussion explaining how states and local governments rely on property taxes as a revenue source. Michael Lucci, vice president of state projects at the Tax Foundation, the nation’s leading independent tax policy nonprofit that provides research and analysis to inform tax policy at the federal, state, and global levels, noted that there are key aspects to property tax across the U.S.:

  • It’s an old tax: The financing of local governments usually relies on it.
  • It’s an efficient tax: Governments are taxing assets that are impossible to move and difficult to hide.
  • It’s a disliked tax: Property owners hate getting their assessments, in part because (unlike with payroll withholding, where money is removed before you see it) they see exactly what they’re going to have to pay.

Lucci said that a 10% increase in property taxes has been associated with a 1-2% decrease in investment in particular states. He added that structure matters. The way the tax is imposed can attract or drive away business and economic growth.

With that background in mind, Robert Gutierrez, president and chief executive officer of the California Taxpayers Association, zeroed in on the ballot initiative in California. In an attempt to generate more revenue for education, the initiative would create a “split roll” system, protecting residential property owners but focusing any increases on commercial properties.

Gutierrez pointed out that in 1978, California voters passed Proposition 13 in an attempt to control the growth of property taxes for both residential and commercial properties. Before the measure passed there could be massive, frequent and arbitrary jumps in property tax bills.

Proposition 13 gives certainty and predictability to owners in three primary ways: 1) It limits property taxes to no more than 1% of the assessed value. 2) It caps assessment increases at no more than 2% per year. 3) It establishes a fair market value for property at the time it was sold or substantially improved.

If passed, the split roll ballot measure would remove these protections for commercial real estate, and could lead to an estimated $11 billion tax increase on commercial real estate. Commercial property would be assessed to its current value, and then reassessed every three years.

Much of the increase in costs would likely be passed on to tenants, many of which are small businesses that could be forced out of business by an exploding tax bill. Out-of-state owners of commercial properties in California would also have to contend with the higher costs of owning property in the state.

The commercial real estate industry as a whole should be concerned when it is singled out as a revenue source to solve matters with little nexus to its activities. Gutierrez told webinar attendees that commercial real estate already pays a higher share of property tax (63% of real property tax revenues) in California than it did before Proposition 13 passed (58%), and yet the industry is continually targeted for harmful tax increases. 

If the ballot initiative in California succeeds, it will be a signal to states and localities across the country that dramatically raising taxes on commercial real estate is a politically safe option to fund additional spending. The effects of change in California could inspire property tax increases far beyond its borders, something that everyone in commercial real estate should keep in mind during the next year.

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