Jan052016

California legislators want to tax businesses through real estate

A proposed real estate tax will be passed through to businesses across California, failing to tax the people it’s aimed at.

California-Robin-Hood“Take from the rich and give to the poor.”

The legend of Robin Hood resonates with those who believe the unequal distribution of wealth is a social problem best solved by forcibly taking from those who have and giving to those who have not. It appeals to our notions of social justice, particularly when we perceive the rich obtained their wealth through nefarious or equally forceful means. During Medieval times when wealth was afforded only to those who took it from working peasants by force, the selfless Robin Hood was a hero who balanced the equation.

In our modern world, we still often feel taken advantage of by powerful with less than noble behavior. The raping of the America by the financial elites during the last two decades is a classic example of the kind of injustice that leads to a populist revolt where the poor come after the rich with pitchforks and torches.

Eager to take advantage of populist discontent (and class envy and greed), the political left finds support for policies that appear to take from the rich and provide benefit for the poor — and perhaps in today’s political and economic climate where the rich have done well and the poor struggle mightily, such policies are warranted.

However, if targeting the rich to benefit the poor is the goal, the policy needs to actually accomplish its goal. California’s legislators are proposing a “Robin Hood” policy that won’t target the rich, but will instead be paid by nearly every business in California, rich or poor.

Poverty plan offers a wealth of bad ideas

Donations flowing to statewide initiative that would impose surcharge on pricey properties

By Steven Greenhut | 2:44 p.m. Dec. 30, 2015dumb_idea

Sacramento — As legislators return to the Capitol in January, there’s little question the issue of poverty will be high on the agenda. Legislative Democrats have been dismayed that the governor held the line on new social-welfare spending last session and are eager to step up public funding for new and existing programs. And news reports suggest a major new anti-poverty initiative, backed by some charitable organizations, already is garnering serious donations.

Expect poverty to be “big” this year. Even legislative Republicans haven’t resisted too much. They’ve generally been OK with new spending proposals – provided they’re funded without raising taxes.

Democrats like to characterize Republicans as heartless when they oppose unbridled social spending, but doesn’t it seem reasonable to ask that it be paid for? On a national level, the Republican party seems bent on choking off all forms of social spending by cutting taxes on the rich and high wage earners. In California, the Republican party is merely trying to hold the line against runaway spending, huge increases to State budgets, and ever-increasing taxes. Nationally, Republicans are too far right, and in California, they aren’t far enough to the right.

That initiative is one of several possible tax-hike intiatives on the ballot, and proponents appear ready to start collecting signatures. It would impose what supporters call “a sensible and fair surcharge on properties with values of over $3 million” that keeps “all Proposition 13 property tax protections against reassessments … in place.”

As the official state summary explains, “Surcharge based on a sliding scale ranging from three-tenths of one percent for real property assessed at $3 million to eight-tenths of one percent for real property assessed at $10 million or more.”

The resulting cash flow – between $6 billion and $7 billion a year, based on a Legislative Analyst’s Office estimate – would fund anti-poverty programs.

Untitled Robin Hood AdventureDoesn’t this sound like a Robin Hood tax that only impacts the rich? Based on that little information, 98% of the people in California would see no reason to oppose a tax that doesn’t impact them, but that isn’t how it would actually work.

Even California has only a limited number of high end houses, so this measure becomes a new tax on many commercial properties. As a result, critics say it’s a tax on job creation.

This is not a tax on a very few wealthy property owners. Most businesses in California will end up paying this tax, but understanding how requires a brief primer on commercial real estate.

Proposition 13 and Commercial Real Estate

Shortly after Proposition 13 locked in property tax values, nearly every commercial property in California was put into an entity (generally an LLC). People who buy and sell commercial real estate in California don’t trade in properties, they trade the LLCs that own the properties to avoid triggering a Proposition 13 reassessment of the property. Many commercial properties in California are still assessed based on their 1978 values (with modest adjustments); thus property tax revenues from commercial real estate declined relative to residential.

prop_13

This is the kind of tax ripoff designed to benefit the wealthy that leads to Robin Hood taxes; however, the financial interests who benefit from this arrangement are willing to spend millions to preserve it. Reformers know taking on Proposition 13 is nearly impossible, so they are using this proposal as a workaround.

Opponents are still analyzing the details, but we can expect a vigorous “no” campaign. Supporters need more than 585,000 signatures to qualify it for the ballot.

cram_downI spoke with a California ballot campaign manager a few years ago who told me that winning a ballot initiative in California required crafting a measure that doesn’t have big money on the “no”. When big money is on the “no”, they run misleading propaganda campaigns to promulgate lies and frighten people into voting no, even if that vote isn’t in their best interest. You can be sure that if this proposal gets on the ballot, opponents will scare old people by claiming this will tax them out of their homes even thought that’s complete nonsense.

How Commercial Real Estate Leases Work

Most commercial real estate in California is not owned by the tenants who occupy the space, so most business in California operate out of rented space concentrated in large office or retail centers. Despite the low basis from 1978 locked in on most of these properties, the large commercial and retail centers have values will in excess of $10 million, so most of the $6 billion and $7 billion a year in new tax revenues will come from these properties.

But who pays that? The owners? Nope.

Most commercial real estate is leased on a triple-net basis. In a triple-net lease, the tenant pays the property taxes. This is a tax that will hit most businesses in California, whether they can afford it or not because it’s not a tax based on sales or profits, but on existence. If the business is marginal, this measure will probably push them out of business, hurting employment.

Inequality of tax burden

residentia_versus_commercialThis is also a tax that would not be borne evenly by California businesses. I just signed a commercial lease, but I am in a small property that is worth less than $10 million, so my property taxes probably won’t go up much at all. But what about some other businesses?

When I was looking at retail space, one of the properties I considered was the second floor at the Forum Carlsbad. The rent on an upstairs space there is $2.50 per square foot, but the triple net costs are $1.25 per square foot because it is relatively new construction with a tax basis from 2000 rather than 1978. Property taxes are approximately $1 of the $1.25 triple net costs. A tax increase from 1% to 1.8% is an 80% tax increase, bringing the property taxes from $1 to $1.80. A $0.80 increase per square foot on a typical 1,200 SF retail space is $960 per month, or $$11,520 per year. This is a tax that will be paid by tenants in Forum Carlsbad, but won’t be paid by me because I didn’t rent in a newer large, expensive property. Is that fair?

Impact on commercial real estate values

The market will only bear so much for commercial real estate lease revenue. If the State takes more, by necessity the landlord must take less. As new leases are negotiated, either rents will be lower, or they won’t rise as much as the new tax is absorbed by the market (much like higher interest rates will be absorbed by the residential market). This will lower the cashflow from these properties and thereby lower the value.

Over the long-term, this proposal would have the same impact as reforming Proposition 13, a decline in commercial real estate values, a problem most people won’t lose any sleep over. IMO, the big problem with this proposal is the immediate and unequal impact it has on existing business owners.

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