I was born in San Francisco and raised in Los Angeles. Back then, California was a golden state that was going places. California’s leaders had a very simple vision; we were going to be the best at everything.
I went to Claremont McKenna College. It was created by Southern California businessmen as an alternative to the more liberal small colleges on the east coast. Although it is only one year older than me, today US New and World Reportsmagazine ranks CMC as the 9th best National Liberal Arts College in America. [1]
Back then, Stanford was a very good regional university. Today, Stanford is tied with Columbia as the 5th best National University in America.[2] The University of California at Berkeley is ranked as the best Public National University in America.[3]
While California is now the sixth largest economy in the world[4], it faces serious challenges that stem from a Strategic Inflection Point in 1978. In addition, it now has suffocating rules and regulations have turned it into the state with America’s worst business climate. As a result, residents and small and medium sized business owners are fleeing the state.
California is becoming an economically segregated state. According to the Sacramento Bee “every year from 2000 through 2015, more people left California than moved in from other states. This migration was not spread evenly across all income groups, a Sacramento Bee review of U.S. Census Bureau data found. The people leaving tend to be relatively poor, and many lack college degrees. Move higher up the income spectrum, and slightly more people are coming than going.
About 2.5 million people living close to the official poverty line left California for other states from 2005 through 2015, while 1.7 million people at that income level moved in from other states – for a net loss of 800,000. During the same period, the state experienced a net gain of about 20,000 residents earning at least five times the poverty rate – or $100,000 for a family of three.’
It didn’t have to be this way, but California’s politicians have steadfastly refused to put on Ugly Baby Glasses. To this very day, they are in denial about the impact that the Strategic Inflection Point called Proposition 13 has had on California.
“A Strategic Inflection Point is a time in the life of business [or a country] when its fundamentals are about to change. That change can mean an opportunity to rise to new heights. But it may just as likely signal the beginning of the end.”[5]
Strategic Inflection Points are hard to identify. Strategic Inflection Points are not your garden variety business cycle event. They are monumental, catastrophic changes in the very essence of your firm or country’s existence.
You know that you are inside a Strategic Inflection Point when the competitors you used to worry about are no longer relevant, and those that you ignored are eating your lunch. You know that you are inside a Strategic Inflection Point when the rules of thumb about how things are “supposed to work” don’t explain anything.
Andy Grove said “what is common to all [Strategic Inflection Points] and what is key is that they require a fundamental change in business strategy, and that’s almost a definition of a Strategic Inflection Point. A Strategic Inflection Point is that which causes you to make a fundamental change in business strategy. Nothing less is sufficient. Almost always it hits the corporation [or country] in such a way that those of us in senior management are among the last ones to notice.”[6]
On June 6th, 1978, nearly two-thirds of California’s voters passed Proposition 13, reducing property tax rates on homes, businesses and farms by about 57%. It was a political earthquake that heralded the beginning of a new American “property tax reform” revolution that has not ended.
“Prior to Proposition 13, the property tax rate throughout California averaged a little less than 3% of market value. Additionally, there were no limits on increases for the tax rate or on individual ad valorem charges. (“Ad valorem” refers to taxes based on the assessed value of property.) Some properties were reassessed 50% to 100% in just one year and their owners’ property tax bills increased accordingly.
Under Proposition 13 tax reform, property tax value was rolled back and frozen at the 1976 assessed value level. Property tax increases on any given property were limited to no more than 2% per year as long as the property was not sold. Once sold, the property was reassessed at 1% of the sale price, and the 2% yearly cap became applicable to future years. This allowed property owners to finally be able to estimate the amount of future property taxes, and determine the maximum amount taxes could increase as long as he or she owned the property.[7] “
I was the State Bar of California’s Director of Legal Services in 1978. California’s economy was booming and the state Treasury was flush with tax dollars. The state used this money to subsidize a whole host of activities. If you were a California resident, your annual tuition and fees for attending the University of California totaled $630 per year[8]. Today, that number is 2,133% higher at $14,068.[9]
I spent part of my time lobbying in Sacramento, California’s capitol city. I could tell that we were entering a Strategic Inflection Point, but none of the politicians wanted to listen. They believed that they had a better idea of what to do with taxpayer’s dollars than the taxpayers themselves. The Strategic Inflection Point that they were ignoring was that the impact of property tax increases on retirees and other homeowners. The Strategic Inflection Point that they created was Proposition 13.
Many people who had retired and were living on fixed incomes were being forced to sell their homes, even though their mortgages had been paid off for years, because they couldn’t afford the skyrocketing property taxes.
The leaders of the Proposition 13 movement pleaded with California’s politicians to pass laws that would give senior citizens property tax relief. The politician’s response was “there is so much to do in this state, we need all the money we can get. Anyway, there is no way you can get voters to pass Proposition 13.”
The politicians were wrong. Californians were furious about explosive property taxes. But even after Proposition 13 passed with nearly two-thirds of the votes, California’s politicians refused to admit that they had lost touch with the voters. They tried to replace lost property tax revenue with increases in state income taxes. The voters forced term limits on them, but the politicians still refused to listen to them. Eventually, the state was so close to bankruptcy that on October 7, 2003 Governor Gray Davis was recalled in favor of Arnold Schwarzenegger.[10]
Even before Governor Schwarzenegger was sworn in, Warren Buffett said that the only way to restore fiscal sanity to California was to repeal Proposition 13. Schwarzenegger told Buffet to never say that again. And with that, a great opportunity to right California’s financial ship was lost.
What made Proposition 13 a second, destructive Strategic Inflection Point is that when homeowners realized how good of a deal it was to live with a 2% property tax increase cap if they didn’t sell their homes, supply dried up. When that happened, the price of houses exploded. It was all about supply and demand . . . and house price increases were so robust, that supply has lagged demand since the early 1980s. So it is not surprising that builders have focused on putting high end housing instead of affordable housing.
Proposition 13 has destroyed the social fabric of California. It created two classes of citizens. Those who had owned property before Proposition 13 passed were suddenly sitting on a gold mine. Those who came after them found the price of a home spiraling out of their reach.
I purchased a house in the Oakland Hills for $70,000 in 1976. That house is now on the market for $2,000,000. If I still owned it, my property tax bill would only be $10,811 a year.
Homes are so expensive in Silicon Valley, that their middle class has been priced out of the market. Palo Alto has a fire captain who commutes 147 miles each way because he cannot afford to raise his family given stratospheric housing prices. “It’s middle- and lower-income workers — teachers and firefighters, security guards at tech campuses, waiters at restaurants —have been priced out of the Peninsula and are spending much more time in traffic.”[11]
It used to be that normal, hardworking people could afford to live in San Francisco. Not anymore. If you are not rich or in tech, you better be on welfare. Because it is impossible for teachers, nurses, bus drivers and restaurant workers to buy a home in SF.
One of the most destructive the impacts of Proposition 13 is that it has created a state of takers. Today, California has 34% of America’s welfare recipients even though only 12% of Americans live in the state.[12] The top 1% of state taxpayers are responsible for 48% of California’s income tax revenue and the top 20% pay 89% of the state’s income taxes.[13]
In spite of this, in 2012, voters passed a “temporary” surcharge on the income taxes of “rich” Californians who make more than $250,000(singles) or $500,000 (families). That temporary tax surcharge was supposed to expire in 2019, but in 2016, it was “temporarily” extended to 2030.[14]
When I was growing up, the California was place with great schools, great infrastructure and great dreams. Today, California faces crushing debt while it is still trying to fund a welfare state that it can’t afford. It has more bankrupt cities than any state in the nation. Its unfunded public sector employee pension and medical program liabilities are so great that they threaten the financial viability of Los Angeles and many other cities and counties.
If California is to avoid hurtling off a fiscal cliff, it must replace Proposition 13 with a more reasonable property tax system. In Texas, property tax increases are capped at 10% a year and are frozen when one turns 65. A tax system like Texas has would quickly bring economic sanity back to the supply and demand of housing in California.
Some believe that it is too late for California to change Proposition 13 because so many have a vested interest in preserving the status quo. But I don’t agree. I still have fond memories of the California of my youth when we had business and political leaders who were not afraid of making hard decisions. It is my hope that the children of those leaders will stand up to save California before it is too late.
[1] https://www.usnews.com/best-colleges/rankings/national-liberal-arts-colleges
[2] https://www.usnews.com/best-colleges/rankings/national-universities
[3] https://www.usnews.com/best-colleges/rankings/national-universities/top-public
[4] http://www.reuters.com/article/us-california-economy-idUSKCN0Z32K2
[6] http://www.intel.com/pressroom/archive/speeches/ag080998.htm
[7] https://www.californiataxdata.com/pdf/Prop13.pdf
[8] http://www.dailycal.org/2014/12/22/history-uc-tuition-since-1868/
[9] http://financialaid.berkeley.edu/cost-attendance
[10] https://ballotpedia.org/Gray_Davis_recall_(2003)
[11] http://blog.sfgate.com/inthepeninsula/2016/04/06/silicon-valley-long-commutes-cost-of-living/
[12] http://www.sandiegouniontribune.com/news/politics/sdut-welfare-capital-of-the-us-2012jul28-htmlstory.html
[13] http://www.sacbee.com/news/politics-government/capitol-alert/article74271532.html
[14] https://en.wikipedia.org/wiki/California_Proposition_30,_2012
Last modified: January 23, 2018
