LOS ANGELES -- A California advisory commission yesterday denounced the effects of Proposition 13 on the state's property tax system and called for reform.

"The very existence of a $17 billion tax system in California that operates unfairly is reason enough to offer improvements to it," the panel said in a new report. The $17 billion represents the statewide tax base.

The 18-member commission, appointed by the state Senate, listed changes it thought should be made in Proposition 13 even if it is not struck down by pending court challenges.

If the tax law is overturned, the commission said, California should use full market value as a basis for levying property taxes.

The citizens initiative caps property taxes at 1% of assessed value and rolled back tax assessments for existing homeowners to 1975 levels. But, once sold, property can be reassessed and taxed on the basis of the new purchase price.

Approved by voters in 1978, the initiative was upheld later that year by the California Supreme Court as a rational basis for setting property tax rates.

In 1989, however, some Californians launched new legal challenges to the initiative, citing a U.S. Supreme Court decision that struck down a West Virginia county's method of taxing longtime property owners at levels less than new ones.

The California system has created huge disparities in taxation of similar properties. Those differences spurred a closely watched lawsuit by a new home owner in Baldwin Hills, Calif., who argues that it is inequitable for her to pay property taxes as much as six times greater than those of neighbors living in comparable homes since the state law took effect.

The U.S. Supreme Court earlier this month agreed to hear a separate challenge by R.H. Macy & Co. that alleged the tax system is discriminatory because it forced Macy to pay much higher taxes than longtime competitors.

On June 7, however, Macy abruptly dropped its lawsuit, citing concern that it was inappropriate for a department store to be the agent for change on such an important public policy issue.

Following the decision by the high court to hear the case, Macy faced intense lobbying and boycott threats from taxpayer and business groups that feared a huge tax increase if Macy won.

Ann Carlson, a lawyer for the Baldwin Hills home owner, vowed last week to continue pursuing her client's Proposition 13 challenge. Legal observers believe the U.S. Supreme Court will hear that case or another challenge to settle the question of the initiative's constitutionality.

The bipartisan California Senate commission -- which included legislators and business leaders -- recommended in its report that California return to full market value in setting property taxes if the current method is overturned by the high court. Such a change might lower taxes for recent property buyers at the expense of increases on long-standing owners.

But the commissioners were divided over the best way to avoid severe hardship if property taxes were adjusted suddenly. Some panel members suggested a phasing-in period, while others suggested a split tax roll in which commercial property pays more than homes.

Seven of the 18 commissioners also argued that Proposition 13 is so unfair that it should be changed regardless of how the high court rules. Short of a court decision, modifying the initiative requires two-thirds voters support.

The commissioners also favored giving local voters the authority to increase property taxes with a simple majority, rather than the two-thirds threshold required now. The two-thirds requirement has made it difficult for local entities -- such as school districts -- to authorize general obligation bonds.

The panel's report could serve as the basis for possible legislative action.

Ms. Carlson said at a state taxpayers conference last year that she hoped any successful legal challenge to Proposition 13 would leave governmental finances unchanged. It is uncertain, however, if changes would be revenue neutral.

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