By Tom Wolfe, March 17, 2022
Commercial property taxes in Texas are burdensome due to a combination of high tax rates and a broad tax base. In 2021, the Legislature declined to extend the Texas Economic Development Act, found in Chapter 313 of the Tax Code (Chapter 313). Chapter 313 offers significant property tax breaks to companies re-locating to, or expanding in, Texas. To secure these tax breaks, companies are required to demonstrate that they create jobs and/or make large capital investments. Chapter 313 had many failings that emerged over the years. These failings, along with a strong sentiment against these types of economic development policies, led to a disagreement over its reform and extension that ultimately led to its expiration.
Some brief background on the program is in order. Chapter 313 permits school districts in the state to enter into agreements with companies under which the companies’ new property in the school district is limited to a fraction of its actual value for the purpose of calculating Maintenance & Operations (M&O) school district property taxes. This value limitation agreement stays in place for a 10-year period, after which the property is taxed at its then-fair value. The company is required to make a minimum capital investment in the area and create a minimum number of jobs (although as discussed below waivers of the job creation requirement are frequently granted). In addition, the Comptroller must determine that the tax break was a “determining factor” in the company’s decision to invest in Texas.[i] A particular point of interest about the program is that a company often agrees to make side payments, known as “payments in lieu of taxes,” or “PILTs,” to the school district during the agreement term.
Once Chapter 313 became law in 2001, businesses and school districts quickly took advantage of its offerings. As of June 2020, there were 509 active agreements in the state.[ii] Notably, the Legislature’s decision to not extend the program beyond the end of 2022 does not prevent companies and school districts from entering into agreements before December 31, 2022.[iii] Any such agreement will last for 10 years. Thus, it can be anticipated that companies will eagerly seek these “grandfathering” provisions by entering into Chapter 313 agreements before December 31, 2022.
Even if the analysis is restricted only to the agreements in place as of June 2020, approximately $10.8 billion in tax breaks have been, or will be, granted to companies over the life of the agreements.[iv] An aggregate tax break of this size—granted to a relatively small number of Texas companies—must be carefully examined. That examination highlights a number of flaws in Chapter 313.
First, a key flaw in Chapter 313 is its failure to provide broad property tax relief to all business owners. Indeed, its benefits flow primarily to large companies with the pre-existing ability to hire a large number of workers or make significant capital investments. The average small business owner, in contrast, simply sees his or her property tax bill climb year after year. Given the contributions that small and mid-sized businesses make to the state economy, Chapter 313 almost exclusively favoring larger companies raises fundamental questions of fairness in both the existence and application of such programs. Indeed, some industries are automatically excluded from Chapter 313; for example, restaurants and retail stores generally cannot qualify.
Second, the idea that companies receiving Chapter 313 tax breaks would not have expanded in Texas unless they were provided tax breaks has come into serious question. Although the Comptroller is tasked with verifying that a company applying for Chapter 313 tax breaks would not move to Texas without the breaks, there is no practical way for the Comptroller to determine this beyond taking the company at its word, and most companies give that word eagerly. In recent years, there have been news reports of companies breaking ground on projects in Texas and then subsequently claiming in their Chapter 313 tax application that they would not be relocating to Texas if it were not for the tax break. Nate Jensen, a professor at the University of Texas at Austin, estimates that 85 percent of the companies receiving Chapter 313 tax breaks would have expanded in Texas even without the tax break.[v] This suggests that the program is both unnecessary and, for the most part, wasteful.
Third, the idea that Chapter 313 is not necessary to entice many of its beneficiaries to move to Texas is bolstered by the practice of companies making side payments to school districts as part of the negotiated agreements. As the Comptroller notes, companies effectively give back an average of 13-20 percent of their received tax breaks to school districts.[vi] This kickback-like arrangement makes clear that Chapter 313 subsidies are more generous than necessary to attract businesses.
Fourth, throughout its history, Chapter 313 has had a poor track record of job creation. Notably, creating high-paying jobs was one of the original goals of the applicable statute. Eventually, even modest job creation demands on the part of the state (10-25 jobs being created per Chapter 313 project) were apparently too much. Many Chapter 313 projects, especially those in the renewable energy industry, routinely request and are granted waivers of the job creation requirement. Proponents of Chapter 313 will argue that these tax breaks generate all kinds of economic activity indirectly, but even if those claims could be verified, the same is true of any economic subsidy. The real question is whether the state’s taxpayers as a whole are getting value for the Chapter 313 subsidy.
Fifth, while there is no question that some school districts get a good deal from Chapter 313, they may do so at the expense of the state. Under the state’s funding formula for public schools, school districts can receive state aid if their taxable property values are low compared to their number of students. As the Comptroller noted in 2016, “Most of the local tax revenue the school district forgoes under Chapter 313 is replaced with state funding. Thus, the act uses state revenue to promote local economic development.”[vii] Compounding the “localization” of benefits, the side payments school districts receive from companies—unlike property tax revenue—are excluded from the state funding formula and thus are never at risk of being distributed by the state to other school districts.
Sixth, for those districts which do have a Chapter 313 agreement, an overlooked flaw of Chapter 313 is that, by the time a given valuation limitation agreement expires and a company’s property is placed on the tax rolls at its fair value, the property may have already depreciated considerably. To illustrate the problem, consider a case in which business equipment valued at $250 million at the time the agreement is signed is exempted from school district M&O taxes for 10 years, but at the end of that 10 years the property is worth only $30 million. Although the Comptroller is not supposed to approve Chapter 313 projects unless they will generate tax revenue over a 25-year period that offsets the forgone property tax revenue during the value limitation period, the Comptroller noted in 2016 that attempting to predict whether this will occur involves considerable speculation and uncertainty.[viii] To ensure that Chapter 313 projects generate tax revenue sufficient to offset the forgone revenue during the value limitation period, a “claw back’ tax could be applied to companies whose capital investment depreciates beyond a certain percentage by the time the property is fully on the tax rolls.
While the above flaws raise serious concerns about the wisdom of the Chapter 313 program, it is important to note that the program has arguably had some positive effects too. For example, the agreements in place as of June 2020 are estimated to have increased the I&S tax base throughout the state by more than $92 billion.[ix] And while some companies may exaggerate the importance of Chapter 313 in being a “determining factor” in their decision to set up shop in Texas, there is no question that Texas’s property tax system is unfriendly toward capital-intensive businesses. Given the fierce competition among states to attract business development—witness the nationwide bidding war for Amazon’s HQ2 project in 2018—Texas must re-think its property tax system.
An improved property tax system would recognize that the state’s current system is not welcoming to capital-intensive businesses, just as Chapter 313’s implementing statute so recognized. But unlike Chapter 313, a reformed property tax system would make sure that property tax relief is extended to all businesses, not just a handful of favored ones. And if any tax breaks are targeted at certain companies, the state has the right to demand specific, non-waivable job creation and capital investment commitment from the companies. Finally, a guiding principle of commercial property tax reform should be ensuring that interested parties are not playing with house money; the state should never be on the hook for agreements that local taxing units negotiate with businesses.
[i] Tax Code, Section 313.026(c)(2). [ii] Comptroller, Texas Economic Development Act Chapter 313 Summary Data, 2021. [iii] Tax Code, Section 313.171. [iv] Note ii, supra. [v] https://www.natemjensen.com/wp-content/uploads/2017/02/Jensen-Chapter-313-Policy-Brief-1.pdf [vi] Note ii, supra. [vii] https://comptroller.texas.gov/economy/fiscal-notes/2016/april/chap313.php#:~:text=Most%20of%20the%20local%20tax,to%20promote%20local%20economic%20development.&text=In%202001%2C%20Texas%20legislators%20argued,without%20competitive%20property%20tax%20incentives. [viii] https://comptroller.texas.gov/economy/fiscal-notes/2016/april/chap313.php [ix] Note ii, supra.