LOS ANGELES -- California's tax-exempt bond issuers may face increased uncertainty and disclosure pressures as a result of the Supreme Court's decision Monday to hear a challenge to the legality of the state's property tax structure.
Market participants said the high court's review of Proposition 13, the property tax measure approved by voters in 1978, will require additional disclosure language for official statements on California's municipal bonds.
Many speculated that a court decision could result in revenue impacts on local and state governments, but at least one underwriter noted that municipal entities do not rely as heavily on property tax revenues as in pre-Proposition 13 days.
"It will certainly be necessary to update the description of pending litigation on Proposition 13 matters in official statements," said Roger L. Davis, chairman of the public finance department at Orrick, Herrington & Sutcliffe in San Francisco. "Beyond that, I don't think additional disclosure will be required until the case is heard."
Under Proposition 13, home owners and businesses pay a 1% annual tax on the 1975 assessed value of their property, and then adjust it for inflation. But for homes bought since 1975, the property tax is assessed on current values. The California Supreme Court in 1978 upheld Proposition 13 as a rational basis for setting property tax rates.
The Supreme Court said it will hear a case filed by Stephanie Nordinger, a Baldwin Hills, Calif., resident who says she pays five times as much as her neighbors in property taxes because she is a new home owner.
The Nordlinger case argues that California's property tax system violates the equal protection clause of the U.S. Constitution because it assesses new buyers at their home's purchase price while freezing assessments for long-term homeowners at 1975 rates.
While the trend in the court is toward greater state's rights, at least one California lawyer said that the court's decision to take the case must mean there is something in California's tax structure on which the court may rule.
Uncertainty surrounding the court's decision puts some local issuers in limbo. Some market participants say the potential disruption of government services and the economy could be significant. But other participants, noting a shift to different revenue sources by many local governments after their property tax was slashed by Proposition 13, predict the impact of the system being declared unconstitutional will be not dramatic.
"We'll find a way to deal with whatever the Supreme Court hands us," said David E. Hartley, a partner of Stone & Youngberg in San Francisco. "Property taxes represent a lot less of a percentage of the budget of local govenrments, particularly cities, than in pre-Proposition 13 days," Mr. Hartley said.
Mr. Hartley predicted that disclosure language on the Nordlinger case will be included in new issues that his firm underwrites.
"Clearly, as we go into a structuring meeting and develop official statement for new issues, we will be adding disclosure language," he said.
Thomas R. Mueller, a lawyer for Jones, Day, Reavis & Pogue in Los Angeles, agreed, saying "it would be misleading to describe Proposition 13 tax funding mechanisms in an official statement without disclosing that the rules of the game may change."
Other challenges to Proposition 13 have been submitted. Earlier this year, the Supreme Court agreed to review R.H. Macy & Co.'s case challenging. Califonia's tax structure. In June, however, the case was withdrawn by R.H. Macy & Co. because of concern it might antagonize taxpayers and harm its relations with customers.
Recently, California legislators have looked into what type of tax structures could replace the tax law if it is overturned. The Assembly Office of Research this week released a study entitled, "Legal Challenges to Proposition 13: Implications for California."
"A court ruling invalidating Proposition 13 would have a jolting impact on California's taxpayers and public agencies," Ellen Worcester, a consultant with the Assembly Office of Research, wrote in the report.