Precedent may be set for property taxes: high court to review California's system.

WASHINGTON -- The Supreme Court yesterday agreed to review whether California's property tax system violates the commerce and equal protection clauses of the U.S. Constitution.

The court's decision in the case, expected by next year, could have a dramatic impact on property tax systems nationwide and may threaten the structure of California's 13-year experiment with Proposition 13, a property tax rollback spawned by a taxpayer revolt.

The case, R.W. Macy & Co. Inc. v. Contra Costa County, tests whether California can mandate taxes on new stores at current property values while taxing established businesses at older -- and presumably lower -- rates.

Dennis C. Graves, deputy county counsel in Contra Costa, said 70 years of Supreme Court tax precedent clearly provides that "states have leeway" in developing tax systems. He said the high court may have taken the case the enunciate that California's Proposition 13 falls squarely within that tradition.

Following voter approval of Proposition 13 in June 1978, California changed its property tax scheme from an ad valorem system, in which taxes paid on properties were linked to current market values, to an acquisition value system, in which taxes are based on the fair market values of a property at the time of a change in ownership.

Voters approved the change following a rapid escalation in real estate prices, when property values and assessments rose faster than inflation.

Under the new system, property taxes are limited to 1% of the lesser of fair market value for the value of the property on March 1, 1975 -- as long as the property remains under the same ownership. If new owners take over the property, the tax rate is increased to 1% of the fair market value on the date of the change in ownership.

The case stems from Macy's operation of a department store in a Contra Costa County mall, where it competes with other chains, such as J.C. Penney Co. and Sears Roebuck & Co. Until 1986, the three stores paid roughly equivalent property taxes. But in July 1986, Macy's underwent a corporate reorganization that resulted in a change a ownership.

Consequently, the store's 1987 assessment shot up from $21.43 per square foot to $57.50 per square foot. The Penney's store faced a $22.42 per square foot levy, while the Sears' store was assessed at $23.04 per square foot.

Macy's paid the tax bill, but then filed for a refund of $72,947, claiming the current market value system violates the equal protection and commerce cluases of the U.S. Constitution.

Calling California's tax system the "welcome stranger policy," Macy's said the tax as applied to businesses discriminates against new competitors through higher levies in violation of the commerce clause.

In addition, Macy's claims that because new firms are hit with higher taxes than their more established competitors, the state's policy violates the equal protection clause of the Constitution's 14th Amendment.

"California, the largest state in the union, has committed itself through its state constitution to a method of taxation that is inherently discriminatory against newcomers," Macy's said in its petition for Supreme Court review. Moreover, the firm alleges other states may decide to adopt similar systems.

"While the method lacks any rational basis in public policy, it has an almost irresistible political logic," the legal brief says. "There will always be a majority of voters who stand to gain, now or in the near future, by shifting the tax burden to relative newcomers."

But Mr. Graves said that to establish an equal protection claim, Macy's would have to show that the current market value tax does not rationally promote the goals of California's system. He said the goals of the tax -- predictability and protection against taxation on unrealized paper gains -- are clearly met.

The Supreme Court in a 1989 case, Allegheny-Pittsburg Coal Co. v. County Commission, struck down a Webster County, W.Va., assessors's attempt at crafting a current market value system. But there, the West Virginia Constitution mandates use of an ad valorem property tax, so a current value system could not possibly further the goals of the state constitution -- similar taxes for similar properties.

Assuming the court retains its rational basis test, the California system should remain intact, Mr. Graves said.

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