The Effect of Proposition 13 on California Municipal Finances and Taxation

Abstract

Proposition 13, which was passed in California in 1978, reduced property taxes to one percent, capped valuation increases to the lesser of inflation and two percent per annum, limited reassessments to change-in-ownership events, and reset property valuations to 1975 levels. This paper investigates the tax-setting response of local governments following a negative tax shock by exploiting the change in the property tax scheme of California. Results indicate material and statistically significant changes at the county level in jurisdictions’ reliance on intergovernmental transfers. The paper undertakes three methods of analysis in order to understand the magnitude and significance of these responses: synthetic difference-in-difference at the state and local level; a dose-response difference-in-difference analysis within California using a constructed property tax exposure metric; and a cross-border analysis of bordering counties in Oregon, Nevada, and Arizona. The analysis provides significant results for the first two and mixed results for the third. The conclusions herein illuminate the dynamics of local government responses following the passage of Proposition 13 as well as the relationships between layers of governments in systems of fiscal federalism like the United States.