Great post.  Couple comments:

- On the capital gain tax, you could simply allow people to increase their cost basis by CPI (would allow this also for assets like stock) so that you’d pay any capital gain tax on inflation equity. 

- Wouldn’t you consider Prop 13 a cause of the bubble in California versus other higher priced but higher taxed states?  For example here in Northern NJ we don’t have prop 13 but taxes average around 1.75-2% of your houses value.  And these go up at least at inflation rate.  Now this is a high (but deductible) burden and I don’t enjoy paying it and with high prop tax you can’t qualify for as much debt with FNMA conforming DTI ratios and can’t assume minimal rises  

- I’d suggest the max deductible interest should be based on FNMA conforming limits…this allows some regional differences based on prices.

IR, this is a very useful post.  Several comments:

1.  The tax benefit goes towards zero if you lose your income. I think few people consider this potential during a recession.  The cost of living goes up as your income declines.

2.  Tax benefits that encourage more debt are designed to steal from the poor and give to the rich. Money is funneled from the poor via taxes, asset inflation, and indebtedness.

I like the idea of CPI adjusted basis for all asset classes. You shouldn’t pay a tax on inflation as you are not benefited by it.

IMO, Prop 13 did not do much to cause the bubble. There may have been some people who thought to buy in order to lock in a low property tax basis in a rapidly rising price environment, but compared to the greed of making money on appreciation, tax considerations are minor.

The only problem with linking the tax basis to the GSEs conforming limits is that it is not uniformly applied across the country. IMO, Federal taxes should not recognize regional differences.

It will be interesting to see what tax legislation comes out of this Congress. As you noted, “Tax benefits that encourage more debt are designed to steal from the poor and give to the rich.” Our entire economy has become debt dependent, and this recession is a result of it. The best thing we could do long term is to reduce our debt loads. However, the best thing for the economy in the short term is for us to increase our debt loads. The short-term encouragement of debt has stimulated our economy for so long that we created this monster of a problem we are facing now. Will Congress do what is in our long-term best interest? Will they do what is immediate and politically expedient? I would guess the latter.

I agree, no question, it will be the latter.  The scary part is that the debt levels will need to go up in many countries around the world, not just the US.  This will create a larger dichotomy between debtor nations and creditor nations.  World War could be the end game if things do not work out.

I guess if you have the capability to go double or nothing at will, eventually you will break even.  I think that’s the idea.  Just like the loser in vegas, eventually you get cut off.

I too would like to see capital gains taxed at a rate which is based on the length of the holding period.  Originally, this is how it was done - by allowing a deduction from the gain equal to a percentage of the gain which rose in proportion to the holding period.  Later, in response to the Wall Street and real estate lobbies, the deduction percentage was set at 50% and the holding period was lowered to just one year.  In 1986 the deduction/exclusion device was removed and the maximum rate on capital gains was set at 28%.  Currently it is 15%, but even this low rate is usually avoided by the fiction of the “like property exchange” or, more drastically, by dying.

In my opinion this is an unwarranted, and socially harmful, subsidy to investment over production and is in part responsible for our current economic mess.  A return to the original scheme of a larger deduction (or a lower rate) in proportion to the length of the holding period would be fairer and would have a number of beneficial side effects, including encouraging investment for the long term. simplier record keeping, etc.

“...Tax benefits that encourage more debt are designed to steal from the poor and give to the rich…”

You can’t “steal” a dollar from someone who doesn’t have a dollar. Now, I do agree that most housing tax policy greatly favors wealthier taxpayers.

The government (i.e. other taxpayers) heavily subsidizes our home. However much it should be discounted (IR’s discounted it 10% above), our marginal rate is 42.3% (33 + 9.3). We were itemizing before we bought because our state income taxes were so ridiculously high. So, by buying, we were able to add property taxes and mortgage interest resulting in an amount of itemized deductions doubling the average household income (the AMT takes some of the “benefit” back).

My ramble was an attempt to illustrate how much housing tax policy benefits high earners as compared to lower earners. I certainly wouldn’t have agreed to buy a home had tax policy not shifted about $1,500 of the cost from my taxes to my mortgagee.

In the end, housing tax policy results in a much more reasonable federal tax rate for us - TurboTax calculates it as 15% for 2008 (still 9.3% for CA!!!). So, absent a complete overhaul of the entire tax code simplifying it, I wouldn’t support a targeted housing tax policy revision.

“...Proposition 13 opponents point to the deterioration of California’s public schools since its passage as a big reason it should be repealed…”

This is a vile argument repeatedly offered by CA dems. CA taxpayers spend more per child, adjusted for inflation, today than we did prior to Prop 13’s passage.

IR,

Your analysis is always spot on, but I have to take a contrarian view when it comes to Prop 13. Every time this subject comes up it puts the focus on the wrong side of the State’s budget problems.

The State does not have an income problem, it has a spending problem. The State has profited quite handsomely from this bubble, just like it has from every previous bubble, whether it be housing or tech. What percentage of homes have been held on to since the 70’s, and would reassessing these homes solve the State’s problems?

It seems to me that the vast majority of homes have traded hands, many repeatedly, thereby negating any effects from Prop 13. There are now new housing developments all over the State that have turned low tax ag land into currently assessed residential lots. Close to home we have the new developments in Ladera Ranch, Talega, Quail Hill and the converted military bases adding to the tax rolls. The current housing bubble was not created because nobody wanted to sell their property to maintain their tax base.

The other argument I often hear is how “unfair” it is that someone is paying so much more than their neighbor. Again this view is from the wrong side. The buyer knew full well what the taxes were going to be when he signed on the dotted line. The neighbor on the other hand had no say in the transaction, so why should his taxes go up simply because some fool overpaid for the house next door? Are people under the impression that if the neighbor had to pay more that their taxes would go down? When has that ever happened? If you feel the tax man has his hand too deep into your pocket, it won’t make you feel any better to to shove his hand deeper into your neighbor’s pocket.

Again, the State has a spending problem, not a revenue problem. No matter how much we give them it will never be enough. We passed the lottery in order to supplement the schools, how well has that worked out? The tech boom and then the housing bubble was a huge windfall for the State, what do we have to show for it besides debt? The solution is to elect government officials who are financially responsible and who can think beyond the next election. Well I can dream.

I have seen an interesting discussion that Prop 13 aggravates any bubbles because it makes properties people have lived in for a while less available.  It is like saying that homes people have lived in for a while have a higher price.  You need a higher price to compensate the current owners for the below market property taxes they are paying.

We will have a natural experiment on this theory.  For homes purchased from about 2002 onward, there was a big property tax savings vs moving from about 2004-2008.  In 2009 a vastly larger portion of homes will have property tax value = market value.

I know LAUSD rather well.  Their mismanagement has been reported on extensively over the years.  Even some of it’s own board members think it can’t be fixed, it must be broken up.

Breaking up LAUSD would have some interesting effects on home prices.  Around the perimeter of the current district, houses just outside of LAUSD are worth far more than a few blocks away where children go to LA Unified schools.  If the District was broken up, most (if not all) of the smaller districts would be better managed.  With better local schools, home prices would rise in the new district.  However, home prices would probably fall in places like Santa Monica, Calabasas, and Burbank.

For whatever reason, standardized test scores in California’s schools took a dive after the passage of Prop 13. We may be spending more than we did, but on a per-student basis, we spend less than most other states. This probably contributes to the relative lowering of test scores.

The question I always raise when confronted with the “we need to spend more on education” argument is: What is the limit? How much are you willing to spend on each child’s education per year? $10K? $20K? $100K?

The Growing Foreclosure Crisis

“One oft-repeated assertion no longer holds true. Those in trouble are not, primarily, lower-income borrowers. The foreclosure crisis has become a wave, afflicting neighborhoods of every stripe—but particularly communities created by the boom itself.”

Wow! What a surprise.

“The question I always raise when confronted with the “we need to spend more on education” argument is: What is the limit? How much are you willing to spend on each child’s education per year? $10K? $20K? $100K?”

A good place to start might be the elevated home price for a house in Irvine versus a similar house in a surrounding area with lower quality schools.

Do the parents and kids create the quality? or is it money?  Psychotic parents play a part in the Irvine home prices.

IrvineRenter,

As usual, I appreciate your thoughtful analysis and the time you take to create these explanatory postings. 

Couple of quick comments on the use of 25% for the tax shield related to mortgage interest.  That may be a good general average, but there are also people who can reap the full marginal tax benefit of 34.7% (for 28% filers) or higher (for 33% Federal filers).  Certainly, at the lower-end, the overlap factor would come into play.

When running my own numbers, I’ve been using my true marginal tax rate (28.0% + 9.3% = 34.7%).  Since you can deduct state tax from federal tax, you can’t just add the two together (as a previous comment did).

That said, I find that for reasonably sized mortgages (which produce, say, no more than $25,000 in interest and property taxes), there are fairly realistic conditions where one would save at the full 34.7% rate.  This is because (1) the federal standard deduction for a single person is $5,450 for 2008 and CA income tax on $90,000 is about $6k.  So anyone single making decent money is going to typically itemize anyway in California.  You’ve overrun the value of the standard deduction at just $90,000 of taxable income in California.

Since the top bracket starts at about $47,000 for singles in CA and the Federal 28% bracket starts at $79,000 for singles, a single person making about $120,000 could deduct quite a bit and earn a true 34.7% savings on each dollar deducted, since the full span of that deduction would keep income to-be-taxed within the 28% Federal bracket.

Now, that said, an interesting follow-on is that a single person making high income should thus value owning a property more than a lower-income married couple, since they truly would be losing the benefit of the standard deduction.  The $120k/year earning single person will actually pay less, net of tax shields, than the $80,000/year earning family—for the exact same property. 

Perhaps this is actually an economic incentive to “live below your means.”  If I buy cheap enough, I keep my deduction within my highest bracket, and I derive more value from the same asset than a person of lower income would.

Perhaps we will also see the bottom of the market first supported by high-income, now-renting singles.  Of course, that group should wisely wait until we are at a bottom (or at least until cost-to-own is well below rental parity) so as to not lose any tax savings on the depreciation.

Fiddle with prop 13 at your own peril.

California’s fiscal irresponsibility has maxed out it’s income tax charge card and it’s sales tax ATM. Doesn’t this kind of imply that in the absence of prop 13 that property taxes would already have been maxed as well?

People seem amazingly foolish when it comes to taxes, assuming that they’re just some force of nature. I guess with the present one party system in California that may be close to the mark.

Visualize a frugal spending state government. Visualize low taxes.

Actually you steal the dollar he is “supposed to have in future” through plunging him into debt .

Man almost this WHOLE POST is about just taking MORE from the producers and giving it to the nonproducers… a shock coming from this blog.
Mr. B is absolutely correct.  Give the state more tax money and they’ll just spend more, not use it to increase productivity in any way.
LAUSD “gives” me a check every month (I KNOW LAUSD) and let me assure you California’s schools are “failing” primarily as a result of Californians’ wacky insistence on educating another country’s children.
Thes state doesn’t need more money.  It needs to spend less- way less.  Currently a huge percentage of American citizens’ money is going to housing, feeding, and educating the citizens of another country who live here almost unobstructed and are a major cause of the vicious unemployment our citizens are currently suffering.
Where in the Constitution is THAT allowed???
what part of THAT were all those guys in WW2 fighting and dying for???

I so agree with your post DR but what came first the over pay of our government employees or the too expensive to live here because of the high prices of homes. What caused the higher than average cost of homes—that is where you will find the true grit of our problems. A million dollar home became the norm for Irvine.

And we so need a fair property tax for all who live here. Right now it’s only fair for those who bought 10 years ago or longer. And our schools benefit all of CA—not just homeowners with chilren.

CA needs to cut excess spending and learn to get down to reality with their budget and pensions.

It’s the Asians, stupid.

Indeed, Prop 13 is NOT the cause of the deterioration of our schools.  It’s the gross mismanagement for our school administrators and State Government that is.

As it now stands, in California we pay both high income and sales taxes.  Our RE taxes are reasonable.

In other states, they may have higher RE taxes but they don’t have high income/sales taxes.

For example, WA has no income tax but high RE and sales tax.  OR has no (very low?) sales tax but high RE and income taxes.

What the Dems want to do in California is to have all three taxes high:  RE, sales and income.  With such a mix you might as well close shop because the only people left here will be the poor, the illegals and Hollywood.

Hmpphr…

Nothing to do with Prop 13.

The State Gov never bothered to fix the distribution of funds. 

Are you aware that OC school districts are considered “rural” and so get less money per capita than “urban” districts like LAUSD?

Yeah, LAUSD that blew 2BIL on a High School that they can’t use because it’s built on a toxic dump.

Of course, the State committees in charge of the distribution of school money are controlled by large “urban” districts and are not keen on righting a wrong…  After all, this way they can keep their wasteful jobs.

Prop 13 is more than just a financial gain… it impacts our society in other ways.

By encouraging long term residency, it creates better and more stable neighborhoods.

Californians already are very mobile.  Imagine if Prop 13 wasn’t around, then people would move.

And, given the amazingly stupid and corrupt Government sector at ALL levels, the incredible number of illegals, the high income and sales taxes, if it weren’t for Prop 13, cities like Irvine would have not been possible because most of us reading this blog would have long ago moved to Nevada, Arizona, Oregon, Washington or even Texas!

Without Prop 13, California today would be like Haiti.  A banana republic without bananas.

this quote hits the head on the nail

“Now the county is a case study of what can happen when the only industry in town is growth itself.

“These economies were self-feeding off the housing boom. And when the boom went bust, there was no safety net to fall back on,” said Sean Snaith, an economist at the University of Central Florida’s business school. ”

I grew up in a well off community with a large tax base. All the $ my high school raised was funneled to a very poor neighboring high school in the same district. That ‘poor’ school had an insane amount of resources & had brand new labs/books/facilities. At my ‘wealthy’ school, everything was old & rundown (I had a math book older than me!).

Despite the lack of funding at my school, our test scores were consistently (& tremendously) higher than the poorer school’s scores.

My point is, no matter the school funding…it’s the demographics/nature of the students that affect the test scores & performance of the school.

Three years ago, Byrd bought a home for $525,000, in the city of Riverside, getting a no-money-down mortgage. Back then, she was selling 50 homes a year and earning roughly $350,000 annually. “

so why did she not pay off the home when she was making this kind of money?????

THANK YOU!

I grew up in bilingual classrooms and at home I only spoke Spanish.

At school the classroom did both English and Spanish. We learned everything half as fast as other classes because a single subject was gone over twice. How stupid was that!

It’s no wonder test scores are low when you only get to cover half the material…and I’m sure it costs taxpayers more too because you need twice as many books and the teachers are probably paid a premium for doing it.

No other country (besides Canada) would do something foolish like that.

Irvine Renter,

You’re writing is always a delight to read.

A few thoughts on taxes and Irvine:

- Irvine schools are short changed as compared to other towns, because Irvine was categorized as “rural” when funding formulae were devised.

- Prop 13 is a source of the State’s crisis because municipalities, and educational districts have been forced to chronically use debt to finance current expenditures due to the inability to raise taxes.  We are coming to the end of that process now.

- It would be worthwhile to revisit the origins of Prop 13, which was misrepresented as consumer oriented when, as the NYT wrote:
“The biggest beneficiaries of Prop. 13 were not homeowners but businesses. The law curtailed assessments on all property, not just homes, and there is considerably more commercial property than residential. According to the sociologist Clarence Lo, author of a forthcoming book on tax revolts, California homeowners received just one-third of total tax relief in the first five years under Prop. 13. A whopping 57 percent of benefits went to owners of commercial and industrial property.”
see: “The Curse of California’s Proposition 13 - New York Times”
As often happens in public affairs, the real beneficiary (commercial real estate) disguised the benefits of their initiative as a populist victory.

- I hope the O.C. voices who still believe, as a matter of faith, that tax cuts will solve our problems will now yield the public forum to those of us in the Reality-Based Community.

The school opened this academic year.  It is the Roybal Learning Center formerly Belmont High School.  The Roybal Learning Center cost $400 million to build.

About education and school performance, There is no way a child is going to do well without the love and support of a parent or close adult, especially in poorer communities.  Many times in low income areas both parents are working and sometimes they are working 2 or even 3 jobs.  Although they may want the best for their children, they do not have the life skills or personal education themselves to make a difference.  A few kids make it out but most don’t.  The teachers teach the basics to test but it is impossible for the schools to bridge the gap between school and home if only one side is working towards the same goal.  Constant educational reinforcement at home as well as building up a child’s self esteem is the best way for a succesful happy student. This is why Irvine schools perform well and Santa Ana schools don’t. You can keep funneling money into poorer schools but unless there is a huge social and personal responsibility adjustment among the families, nothing will change.  I see it where I teach in Fountain Valley.  The more involved the parent, the happier and more productive the student.

Its not the funding.  Its the parents and the culture of failure that they raise their children in.  I doesn’t matter how much money you throw at a kid, if he doesn’t care, cause his parents don’t care, he’s not gonna learn.  A motivated kid with a a 5 dollar library card wins every time.

You guys are falling for the old Dem Switcheroo…  The truth is what we pay very HIGH taxes in California: sales and income.

The legislature should have LONG ago addressed this by funneling taxes from the sales and income to the schools.  Instead they kept their spend ways and tried to convince people that it was not their fault and that Prop 13 is the problem.

Jeez, folks…  We pay some of the highest taxes in the country but our State Legislature is incompetent.. and has been for 20 years.

The main problem with the hypothesis that tax policy contributed to the housing bubble is that the bubble also happened concurrently in Australia, Spain, Ireland, the Untied Kingdom, and may Asian countries.

Overall, great discussion of the topic though.

oc_analyst, thank you very much for your post!  I didn’t become aware until last year, when I started doing more research on the possibility of buying a home, that state income taxes were deductible on your federal return.  I am single and have been making over $90K for a while now, so I guess I’ve been throwing away a lot of money by not itemizing.  Ouch.  I always heard that itemizing was only for people with mortgages, self-employed people with a lot of deductible expenses, etc.  Of course a tax advisor would have told me this, but I thought I was in a situation where I’d only be wasting money to go with one.

I certainly wish our educational system had a good financial education as a requirement, including detailed info on the tax system at the college freshman level.