How Shell Corporations Undermine Schools in California

September 30th, 2014

California spends about $8,500 per year to educate its public school students. That’s about $3,300 less than the national average. In fact, according to Education Week in a national ranking of states and D.C., California ranks near the bottom, at 49th, in terms of per-pupil spending. There are reasons to believe that one cause of this problem is the system of property taxation in California—and its loopholes.

The biggest player in property taxation and its policy in California is Proposition 13. Approved by California’s voters in 1978, Proposition 13 sets limits on the annual increases of assessed value of real property by an inflation factor. Proposition 13 also prohibits the government from reassessing a property’s new base year unless that property changes ownership. Broadly speaking, this means that in California, unless you sell your home, your property taxes cannot increase by more than a fixed percentage each year.

In fact, the market value of properties in California has significantly outpaced this fixed percentage, leading to a discrepancy between what Californians would have paid in property taxes without Proposition 13 and what they actually pay.

That’s not where the story ends, though. Both commercial and residential owners pay property taxes, but the total share of property tax paid in California by homeowners has increased, while the share paid by businesses has declined.

Specifically, the assessed value of owner occupied homes rose from 40% of statewide valuation in the period before Proposition 13 to 56% in 2009. Meanwhile, the owners of commercial properties now pay a smaller percentage of statewide property taxes. Commercial-industrial property accounted for 47% of the tax roll before Prop 13, and it now accounts for about 31%.

It is difficult to know if the assessed value of commercial properties is below its market value. The limited available evidence suggests it is, however. Because the state updates the value of a property when it changes ownership, properties that turn over more frequently are closer to their market values than those that turn over less frequently. The available research suggests that California’s turnover rate for is higher for homes than it is for commercial properties.

In part, this low turnover rate reflects a truly different market structure. However, there is also reason to believe that this reflects the fact that commercial property owners in California are able to use disingenuous means to prevent reassessment.  Specifically, commercial property owners can prevent reassessment associated with turnover by holding their properties in shell companies, which maintain the legal ownership of the property even after transferring ownership to a new owner.

Say, for example, the owner of a shopping mall wants to sell his property. Instead of selling the mall “cleanly” he could deed the mall to a shell corporation in Nevada, whose sole asset is that mall. The owner can then sell the mall to a third party, but leave the property technically deeded to the corporation. In the eyes of the law, the property has not changed hands, and so the government would not reassess the value of the mall for tax purposes.

This dynamic has significant implications for California’s budget and its ability to pay for public goods like schools and roads. School finance – which is heavily tied to property tax revenue – suffers in particular. In fact, many have argued that California’s particularly low spending per-pupil is a direct outgrowth of Proposition 13. To the extent that shell corporations allow commercial property owners to avoid taxes –and further reduce needed property tax revenues—they also undermine California’s ability to fund its schools.

I guess we can add that to the (already very long list) of ways that shell corporations hurt our society.

Written by Ann Hollingshead

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