A Housing Plan for California

How it got so bad, and how we can fix it

S.H.

Oct 12, 2021

Introduction

California is, by many metrics, the most prosperous state in the U.S. California’s GDP is larger than almost every nation save Germany, Japan, the United States, and China. Many innovative companies such as Apple and Intel had their start in this state, and Hollywood in Los Angeles is a cultural powerhouse. However, despite all of this, California has the highest supplemental poverty measure of any state in the United States. The reason? The costs of housing in California are higher than those of any other state in the union.

California is facing a 3.5 million housing unit shortage. The effects of this severe housing shortage are obvious when one looks at rent burden (the percentage of one’s income they pay in rent). Typically, a household should spend under 30% of their income on rent or housing costs. California has the second highest rate of households spending >30% of their income on rent by state and is tied for first among households with severe rent burden (spending >50% of income on rent). As rent burden is heavily correlated with homelessness, California has one of the highest rates of homelessness in the United States.

Despite the extreme housing costs, people still love California and view this state as a land of opportunity. After all, the cost of housing would not be so high in California if there wasn’t a lot of demand for it. How did California’s housing situation get so bad, and, more importantly, how can we fix it?

Origins

The story of California’s housing affordability crisis cannot be told without understanding that it was not always this way. A typical single family residential house in Los Angeles used to cost around $180,000 in 1996, or around $320,000 adjusted for inflation. One can only imagine how much cheaper a house in LA must have been in the 50s and 60s. What happened so that the typical SFR house in Los Angeles now costs over $800,000?

Source: Greg Morrow and the UCLA Lewis Center for Regional Policy Studies

First of all, before the 1980s, Los Angeles had a zoned capacity for about 10 million people (with a population around 2.5 million people). That is, the zoning ordinances in LA would have allowed, at maximum capacity, as many as ten million people to live in the city limits. However, a series of downzonings passed in the 1960s and especially the 1970s dropped that value to under four million people.

One of the major problems with downzoning a city so that it’s close to the city’s population is that it creates major hurdles for newcomers. Think of a situation like this: say your city is has enough housing for 10,000 people, and a company with 400 employees is started there. If your city has a zoned capacity for 100,000 people, then the increased demand for housing from the employees can easily be built up in the city. However, if the city has a zoned capacity only for those 10,000 people, any new employees will either have to commute in or will displace existing residents.

Enlarge this phenomenon to a city like Los Angeles (let alone the entire Southern California region), and it’s reasonable to understand why LA’s housing prices have shot up so much over the last 30 years. LA is one of the greatest cities in the United States — it’s full of architectural marvels, has amazing weather, and has an incredibly diversified economy. However, the consequence of this series of downzonings has been to deny many people the opportunity to live in Los Angeles or any of the surrounding towns in its major metro areas.

It’s not just Los Angeles proper that downzoned in the 1960s and 70s. Practically all of LA’s suburbs dropped their zoned capacity immensely during the time period, as well as other major cities across the state, from San Francisco to San Diego, all of which attempted to freeze their cities in time under the false premise that rents would decrease while property values would increase. However, these downzonings did nothing but increase those cities’ housing costs in the face of a changing California.

Tax Laws

The ramifications of the downzonings in the 1970s and 80s were exacerbated by a series of tax revolts, culminating in the passage of the infamous Prop 13 in 1978.

In the 1960s, a series of tax assessment scandals, in which major county assessors would provide intentionally low assessments to their friends’ houses in an attempt to reduce their tax bills, prompted the state of California to change property tax assessments to be at market rate. This worked fine until the inflation of the 1970s, when house prices (and thus property taxes) started rising extremely quickly. Anger at rising property taxes was channeled by one Howard Jarvis into support for Proposition 13 on 1978’s June ballot.

Known as “The People’s Initiative to Limit Property Taxation,” Prop 13 did the following:

It set the base for property tax assessments at the sale price for the property or at the property’s value at 1975, whichever was more recent.
It limited property taxes to 1% of the property current value.
Assessments go up by either 2% or the California Consumer Price Index, whichever is lower. For reference, in 2020 the California CPI was 1.1036%, so that is how much assessed value went up by.
Properties are not reassessed when transferred to an heir, but when there are major improvements done to the property, assessments are redone to account for them.
A 2/3 vote in a local referendum is required for special taxes (such as parcel taxes).
This regime applies to office, commercial, industrial, and residential properties.

The effect of limiting property tax assessments to price of sale has led to extremely inequitable property taxes among similar houses in the same neighborhood. You can zoom around houses and commercial properties in the Bay Area at this website.

Another one of the effects of Prop 13 was that cities were incentivized to allow for lots of new commercial property (since it has a higher property value and therefore returns a larger amount of property taxes), but had a disincentive to allow for new housing (since it has a higher infrastructure cost compared to the revenue from property taxes).

With commercial property comes jobs (high paying ones at that), and despite all the new job creation and corresponding increase in income that has taken place in California, housing creation has not matched. The San Francisco Bay Area over the past ten years created more than 500,000 jobs, but fewer than 150,000 new housing units, for a job growth to new housing ratio of around 3.3. Generally, a jobs to housing ratio of around 1.5 reflects a healthy growth of housing in comparison to jobs.

Obviously, these (generally high paid) workers don’t just appear out of thin air — they undertake increasingly long commutes, driving from far flung areas like Brentwood, Tracy, and Stockton to their jobs in Mountain View and Palo Alto, or they crowd up in current housing units. The Bay Area has one of the highest rates of supercommuting in the country due to the extreme lack of housing growth in comparison to job growth.

Solutions

The problems that led to California’s housing affordability crisis in California are multi-faceted, and so their solutions are multi-faceted too. The current status quo of extreme housing unaffordability, super-commuting, and high rent burden is not sustainable, and will not be solved by trendy (but extremely dumb) ideas like a vacancy tax or expropriation of housing to the state.

The first item on the agenda is to end zoning exclusively for single family homes in many of our major cities. San Francisco, despite being one of the most transit-oriented cities in the United States, mandates low density single family homes on more than 70% of its land. Thankfully, we in California have made substantial reforms to allow more multifamily housing in our communities through Senate Bill 9, which allows homeowners to split their lot and build duplexes on each lot. SB 9 contains a few problems, though, such as an owner occupancy requirement and still requiring adherence to setback and floor-area ratio requirements.

A “souped up” version of SB 9 that allows exemptions from setback rules on lot splits (enabling small single family homes), an end to the owner occupancy requirement, and an end to FAR requirements, will allow far more dense middle housing to proliferate in lower density inner ring suburban job centers such as Mountain View and Palo Alto (in the Bay Area), and Santa Monica and Torrance (in Southern California).

In addition to allowing duplexes and fourplexes, cities must make attempts to reduce the separation between commercial and residential areas of cities. Allowing small scale commercial ventures in residentially zoned neighborhoods is perhaps the most important step. Accessory commercial units, mixed use development, micro-enterprise home kitchens, and corner stores all help decrease the distance between where people live and where amenities are located and enables people to walk or cycle to get essentials instead of having to get into a car.

Cities must also allow more housing to be built at higher densities near major metro, light rail, or bus rapid transit lines. Inherent in this requirement is an end to mandatory parking minimums and a set of upzonings near those public transit stations. Thankfully, California recently passed a law allowing cities to rezone areas near areas with transit for 10 units with relative ease (Scott Wiener’s SB 10). SB 10 allows cities to skip environmental review, mandatory community meetings, and other delays for upzoning near transit stops, though unfortunately the bill that would have ended parking minimums in the state (AB 1401), was killed in the State Senate.

Cities must embrace upzoning near public transit (without mandating parking) in order to decrease car usage, increase affordability, and reduce their carbon footprint.

Finally, our state must make efforts to reform our tax code to avoid privileging incumbents and commercial property over residential property. The best type of tax reform to make this happen is what’s known as the Land Value Tax, which would replace our current property tax. The idea behind the tax on land was set forth by Adam Smith, though its more famous proponent was the political economist Henry George. George argued that a tax on land was the most just tax since any accrual in value from land is due to its location, not the labor of the owner. In addition, the tax on land is the most efficient and equitable tax since you cannot create more land (meaning that its supply is perfectly inelastic), nor can you hide or move it, and rich people own the most valuable land. If you want a more complete understanding of Henry George’s theories surrounding taxation, I recommend checking out this post from Astral Codex Ten, or reading George’s Progress and Poverty.

Most relevant to our problem of housing affordability in California is that the tax on land does two things: it reduces the incentive to hoard valuable land and it incentivizes improvements and infill development. Under Prop 13, homeowners have an incentive to keep their house for as long as possible and avoid improvements or redevelopment since those would affect the tax base. Homeowners are also unable to move lest their property tax base resets due to buying a different house. Since the tax on land does not tax improvements to the land, the owner would be able to move to a location they desire (since land taxes would reduce the price of land and therefore housing) or undertake any improvements to the property they otherwise wouldn’t have made, such as SB 9 conversions.

Obviously one of the consequences of such a tax is that housing would no longer appreciate, and in the would likely depreciate over the time (as is the case in Japan). However, the capture of land value for the public good would also allow California to implement a universal basic income, and the diversion of productive capacity away from propping up land values allows people to use that money to invest or save or even retire. The money from the tax on land can be used to offset other taxes, finance public works projects, or be used to finance a social wealth fund similar to the Alaska Permanent Fund.

Aside from the tax on land, major CEQA reform is necessary in order to allow more beneficial projects to lift off the ground. Exempting upzoning, public transit expansions, bike lanes, infill housing, and so on from environmental review is crucial to allow more objectively environmentally beneficial projects to be completed. In addition to blocking such environmentally beneficial projects, mandating Environmental Impact Reports (EIRs) raises the barrier to entry for smaller firms in construction too, which restricts competition to those firms which have the connections necessary to complete sufficient EIRs. Increasing competition in property development by reducing barriers to entry also helps lower the price of creating housing, and allows more housing to be built.

And last, but definitely not least, cities must make an effort to streamline permitting as much as possible (expanding ministerial approval for more types of housing or even outright ending discretionary approval). Just as with CEQA, labyrinthine approval processes increase the barrier to entry in the housing development industry significantly, and thus reduce competition that could lower prices for buildings. If cities are serious about making housing more affordable, they should streamline their approval processes as much as possible.

So there you have it, a few reforms that will make quite a dent to make up for the housing shortage in California and allow California to thrive in the 21st century. As for which reforms should be prioritized over the others, I would place them as so (though you may prioritize these reforms differently):

Ending parking minimums and upzoning near transit
Expanding ministerial approval or outright ending discretionary approval for housing developments
Ending exclusionary zoning laws (such as FAR, minimum lot sizes, mandated setbacks, exclusive single family zoning, etc.)
CEQA Reform
Property Tax reform (shifting to land taxes)

These reforms all complement one another and ideally would all be implemented within a similar time frame. The magnitude of our housing shortage in California has been 50 years in the making, and it will take a Herculean effort to bring housing costs back to normal, but the alternative is far worse: ever increasing rates of supercommuting, higher and higher levels of rent burden, and more and more people who pass on the beauty that is California until we get together and accept that this is a problem not only worth fixing, but is fixable with a few simple (though politically difficult) reforms.

California Thoughts