The excerpt below is from the 2020-2021 State Budget & Taxation Task Force Report, prepared by the Texas Conservative Coalition Research Institute (TCCRI).
Texas Conservative Coalition Research Institute
The 86th Legislature’s signature accomplishments were overhauling the state’s school finance system and implementing property tax reform that will cap the growth in local property taxes unless local voters authorize otherwise. These accomplishments, enacted through House Bill 3 and Senate Bill 2 (relevant portions of which are now codified in the Tax Code), were a much-needed response to the explosive growth of property taxes in Texas over the last two decades. In general, House Bill 3 caps the year-over-year growth of a school district’s M&O property tax revenue (excluding new property in the district) at 2.5 percent unless a local election is held and voters approve a greater increase. For most taxing units other than school districts (e.g., cities and counties), a similar cap of 3.5 percent on increases in M&O tax revenue applies, again subject to voters approving a greater increase in an election.[1] The respective 2.5 percent and 3.5 percent caps in HB 3 and SB 2 do not apply to I&S property tax revenue, but rather only M&O. This qualifier, however, does not minimize the accomplishment of enacting these two bills. Districts need flexibility to make capital investments which are paid off over time through I&S tax revenue. Additionally, on a statewide basis M&O tax revenue dwarfs I&S tax revenue and is thus a better target for providing property tax relief.
It is important to emphasize that the caps of HB 3 and SB 2 take into account not just property tax rates, but also property tax appraisals. A level tax rate from year-to-year (or even a declining one) can still result in a property owner facing rising property taxes if the value of the property increases each year. For example, assume a $400,000 property is subject to an aggregate 2 percent property tax rate. The owner will have to pay an $8,000 annual property tax bill, ignoring any applicable exemptions. If the aggregate property tax rate declines to 1.9 percent, but the value of the house increases to $470,000, the property tax bill will increase to $8,930- an increase of more than 11 percent. Indeed, many property owners in Texas in recent years have found themselves being forced to pay ever-growing property taxes even as nominal rates stayed relatively constant. HB 3 and SB 2 take this fact into account and focus, not on nominal tax rates, but rather on the dollars of revenue a given taxing unit is raising through property taxes.
It is difficult to overstate the importance of these two bills. While Texas is overall a low-tax state, its property taxes are among the highest in the country and have imposed a heavy burden on families across the state for too long. Although House Bill 3 and Senate Bill 2 were tremendous conservative victories, their benefits will be largely prospective. Prior to these bills being enacted in law, Texans faced some of the country’s highest property tax rates. A recent study by Attom Data Solutions found that Texas had the nation’s third-highest effective property tax rate in 2018.[i] While the bills will restrain future growth in property taxes, their effects on existing property taxes are relatively modest; owners of $250,000 homes on average were projected to save an estimated $200 in 2019 and an estimated $325 in 2021.[ii] With the COVID-related economic downturn putting stress on the budgets of political subdivisions, the 87th Legislature should stand firm in defending the previous legislature’s accomplishments while exploring ways to achieve further property tax reform.
Five further reforms to pursue are: (1) amending the provisions of the Tax Code (as modified by HB 3 and SB 2) to better address how they apply in a disaster situation such as COVID; (2) pursuing a revenue-neutral tax “swap” in which a higher state and/or local sales tax rate is imposed, with the revenue being used to “buy down” city and/or county property tax rates; (3) abolishing the business personal property tax, or if that cannot be accomplished, significantly increasing the base exemption to it and indexing it to inflation; (4) including taxing units’ payments on debt service relating to certificates of obligation in the voter-approval[2] rate calculation; and (5) requiring voter-approval elections for any property tax rates which increase property tax revenue to any extent.
1. General concerns with property taxes
Before discussing the five reforms listed above, it is helpful to consider why property taxes are such a concern in Texas. Despite landmark property tax reform in the 86th Session, a common complaint among Texans concerns the amount of their property tax bills. From 1997 to 2017, annual property tax collections in Texas soared more than $41 billion—an increase of 236 percent.[iii] In recent years, property taxes have played an increasingly prominent part of the overall tax burden on Texas residents. The property tax system should be a concern for conservatives everywhere for two reasons in particular. First, as a practical matter, property taxes are particularly onerous because of a liquidity problem they pose for taxpayers. That is, the tax burden on a taxpayer rises as the value of his or her property appreciates even there is no readily available means for the taxpayer to use the increased value of his or property to pay the increased tax.
For example, assume a taxpayer who earns $60,000 a year pays property taxes of 2.5 percent a year on a house and land worth $180,000, or $4,500 a year. If the taxpayer’s property appreciates at an annual rate of 5 percent, the taxpayer cannot readily pay the increased taxes out of the increase in the property value. In contrast, a taxpayer who is unable to pay sales tax on an item will not purchase the item in the first place and thus does not have to pay sales tax. But taxpayers who are faced with increasing property tax bills that exceed their ability to pay are sometimes forced to borrow from a property tax lender to keep their homes.[iv] One trade group representing property tax lenders claims that over $100 million in property tax loans were made in Texas in 2014.[v] A 2012 survey by the Texas Finance Commission indicated that the average rate on property tax loans exceeded 14 percent.[vi] Healthy demand for loans at high interest rates suggests that a great many property owners are struggling to pay their property tax bills. Owners who wish to avoid loans with such high rates, or who do not qualify for such loans, might be pressured into selling their homes to “downsize” and reduce their property tax bills.
The above liquidity problem does not affect only taxpayers whose property values are increasing faster than their salaries. Property owners who become unemployed- whether due to the Covid-related downturn, medical emergency, or other cause- can face a situation in which property taxes force them to sell their homes.
Second, and more fundamentally, property taxes are concerning to conservatives because they limit the value of private property rights. A person who labors for income owns that income outright after paying taxes on it. In contrast, if a person uses that income to purchase land or a residence, he or she must pay property taxes each year to the government or forfeit the property. Functionally, there is a strong similarity between a property tax system and a system in which taxpayers lease property from the government for an annual fee. If taxpayers must pay government on an ongoing basis for the use of their own property, they cannot be said to have true ownership of that property. Such a lease-like arrangement is difficult to reconcile with a high regard for private property rights.
Respect for private property rights and recognition of the liquidity problems which property taxes pose for taxpayers argue against raising revenue through a property tax system. If a property tax system cannot realistically be abolished, conservatives should focus on limiting property taxes and raising necessary revenue through more efficient and equitable means. The 87th Legislature should start its property tax reforms by making sure that the legislative intent behind HB 3 and SB 2 is not circumvented by reactions to the Covid epidemic.
2. Property tax reform in the context of COVID
On March 13, 2020, Governor Abbott declared a disaster in all of Texas’ 254 counties due to COVID.[vii] This disaster proclamation was an important development in light of the Tax Code’s provisions (as amended by Senate Bill 2 and House Bill 3) regarding a cap on the growth of M&O property tax revenue. Under the provisions of Section 26.04 of the Tax Code (as modified by SB 2), a taxing unit is subject to an 8 percent cap (subject to voters approving an even greater increase), rather than a 3.5 percent cap, if the governor or president declares a disaster in an area which encompasses part or all of the taxing unit.[viii] If it is applicable, this disaster-related exemption from the normal 3.5 percent cap continues until the earlier of (1) the second tax year in which the total taxable value of property in the taxing unit exceeds the total taxable value of property in the unit on January 1st of the tax year in which the disaster occurred, or (2) the third tax year after the tax year in which the disaster occurred.
The rationale for the disaster-related exemption in Section 26.04 is obvious. If the value of property in a taxing unit is severely damaged by a disaster such as a hurricane or flood, the revenue of the taxing unit will plummet if rates remain the same or change only a little, jeopardizing its ability to provide services and carry out necessary repairs. Crucially, the Attorney General issued an opinion indicating that a decline in property values due to non-physical damage such as that inflicted by Covid does not qualify for a disaster-related tax exemption in the Tax Code (Section 11.35).[ix] If property values are adversely affected by Covid but do not qualify for disaster-related tax exemptions, then the rationale for increasing rates in the aftermath of a disaster does not apply. This conclusion is bolstered by how Covid does not result in any physical repairs being carried out and how in some respects it has lessened the need for local governments to provide services and. For example, many libraries have closed due to Covid, which should result in savings for local governments due to lower utility usage and reduced staffing.
A key problem is that Section 26.04 does not limit the meaning of the term “disaster”; any event that is declared a disaster by the governor or president qualifies. However, definitions of “disaster” in similar provisions of SB 2 make clear that the Legislature intended for the disaster-related exemption to caps on property tax revenue growth to apply only in the context of disasters which cause physical damage. Section 26.07(b) of the Tax Code (as modified by SB 2) permits taxing units other than school districts to increase rates without a voter-approval election for the year following a disaster, if the taxing unit must increase expenditures to respond to the disaster.[3] “Disaster” for purposes of Section 26.07(b) includes “a tornado, hurricane, flood, wildfire, or other calamity, but… [does not include] a drought” (emphasis added). The exclusion of droughts is easily reconciled because, unlike the other listed disasters, droughts do not cause physical damage. The same logic should apply to the meaning of disaster in Section 26.04. Unfortunately, the Senate Committee on Property Tax found that over 25 cities and counties have increased property tax revenues by 8 percent post-Covid without an election pursuant to Section 26.04.[x] Imposing these revenue increases in excess of the standard 3.5 percent cap without holding an election circumvents the will of the people as set forth by their legislative representatives in SB 2. To correct his oversight, the Legislature should provide that a disaster inflicting purely non-physical damage (such as a drought or Covid) does not qualify as a disaster for purposes of Section 26.04.
3. Policy Recommendation: Provide that a disaster inflicting purely non-physical damage (such as a drought or pandemic) does not qualify as a disaster for purposes of Section 26.04.
Additionally, the exemption in Section 26.04 permitting the usual property tax caps to be exceeded without an election should apply only to the first declaration of a given disaster. As the Senate Committee on Property Tax notes, “While uncommon, some disaster declarations are renewed on a monthly basis for years after the severe weather event occurs….For example, although Governor Abbott has issued around 40 disaster declarations relating to Hurricane Harvey, a taxing unit should only be able to invoke [Section 26.04] based on the first disaster declaration affecting the taxing unit.”[xi] In the absence of such a provision, an area experiencing many disasters or a prolonged recovery from a disaster could face crippling property tax increases year after year without ever holding an election to gain the consent of voters to those tax increases.
4. Policy Recommendation: Provide that any second or subsequent disaster declaration for a given area which relates to a single weather event does not qualify as a disaster declaration for purposes of Section 26.04.
A final critical point regarding property taxes in the context of a disaster declaration such as that for Covid is the unused increment rates discussed in Section 26.013 of the Code (a provision enacted by SB 2). After SB 2 and HB 3, in general taxing units are permitted to raise M&O property tax revenue in excess of the previous year’s revenue, subject to 2.5 percent or 3.5 percent caps, as applicable (although voters can approve increases in excess of such caps). If a taxing unit increases M&O revenue year-over-year by an amount less than the voter-approval rate, it can “bank” the unused portion of the rate for future use. When setting rates for a given year, a taxing unit can use the sum of unused increments from the last three years (but not from any year prior to 2020) and add that to the standard 2.5 percent or 3.5 percent cap for the current year without holding a voter-approval election.
A key concern in the context of a disaster is that taxing units could in some circumstances set rates without an election such that property tax revenue increases by up to 8 percent year-over-year. If a taxing unit has this disaster-related ability but opts not to use it, it could bank a large unused increment for that year. This would permit it to raise rates very significantly without voter approval in subsequent years. An especially concerning scenario would involve a taxing unit that experienced disasters in consecutive years and banked large increments each year. In a subsequent year, voters could face a crippling tax increase without a voter-approval election. The Senate Committee on Property Taxes provided the example of a taxing unit which is in a disaster area for three consecutive years. Its year-over-year growth in M&O property taxes is capped at 8 percent due to the disasters (unless voters approve an even greater increase), but for those three years it increases revenue at only a 4 percent rate. In Year 4, it could take the “banked” aggregate 12 percent from the previous three years and add the normal 3.5 percent cap for Year 4. Thus, voters would be subjected to a rate which increases revenue by 15.5 percent in a single year, with no opportunity to vote on the matter.[xii] To address this concern, the statute should be amended to provide that a taxing unit’s unused increment for a given year is limited to the amount equal to the difference between the revenue percentage increase for that year and the standard cap of 2.5 percent or 3.5 percent, as applicable.
5. Policy Recommendation: Provide that a taxing unit’s unused increment for a given year is limited to the amount equal to the difference between the revenue percentage increase and the standard cap of 2.5 percent or 3.5 percent, as applicable (depending on whether the taxing unit is a school district).
B. Swapping Sales Tax Increases for City and/or County Property Tax Reductions
As mentioned above, in 2005, then-Federal Reserve Board Chairman Greenspan testified to the following economic benefits of consumption taxes: “…[M]any economists believe that a consumption tax would be best from the perspective of promoting economic growth… because a consumption tax is likely to encourage saving and capital formation.”[xiii] In contrast, property taxes can actually penalize a person who makes capital investments (see the discussion of the business personal property tax below) But sales taxes offer other advantages as well relative to property taxes. In contrast to property taxes, sales taxes capture revenue from out-of-state visitors who visit Texas and make use of taxpayer-funded resources (e.g., roads). They also have the advantage of transparency; consumers can easily calculate the tax that is due on a contemplated purchase, and receive a receipt showing the tax paid. There is also a well-established and straightforward compliance regime for sales taxes with which retailers are familiar and which simply requires them to collect the tax at the point of sale. In contrast, property taxes fluctuate annually depending on appraisals and various factors outside the property owner’s control (the applicable neighborhood’s amenities, quality of schools, crime rate, etc.). Property owners disputing appraisals which by their nature are imprecise must go through the hassle of appeals and possibly even litigation. Moreover, because property taxes are an annual obligation unlike the one-time sales tax, property owners whose property appreciates significantly over time can find themselves paying property taxes far beyond those which they contemplated when they acquired the property. In such cases, the property owner cannot readily translate the increased property value into cash without selling the house.
Sales taxes can be “regressive” in that they consume a higher percentage of a person’s income if that person is low-income, but that trait can be mitigated by granting exemptions for certain items, such as groceries (Texas currently exempts food for home consumption, among other items). In addition, consumers have the ability to decrease their sales tax burden by refraining from making purchases with their discretionary income, or by purchasing cheaper substitute goods. It is much less straightforward for people to minimize their property tax bills by selling their houses.
The Legislature should pursue an idea considered but not enacted during the 86th Session: increasing the state and/or local sales tax rate and dedicating the additional revenue to city and/or county property tax relief. It should be emphasized that such a proposal would not affect school district property taxes or the school finance system in any way. If the Legislature does pursue this idea of a tax swap, it could use House Bill 705 (86R, 2019) as a template. That bill would have permitted both cities and counties to impose a supplemental sales tax of up to 2 percent in lieu of the local city or county (as applicable) imposing an M&O property tax (testimony before the Ways & Means Committee on HB 705 indicated that that bill had to be modified to allow the substitution of a sales tax only for M&O property tax, not interest and sinking (I&S) property tax, to preempt objections by bondholders of local governments). If each of an overlapping city and county imposed such a supplemental sales tax, the maximum combined state and local sales tax rate in Texas would go from 8.25 percent to 12.25 percent.
If the 87th Legislature pursues a measure such as HB 705, it should do so with three qualifications. First, the bill was designed to be revenue neutral only in the first year it was in effect. After that, cities and counties could theoretically raise supplemental sales tax rates (subject to the aggregate 4 percent cap) such that the supplemental sales tax might bring in more revenue than M&O property taxes did. With city and M&O property taxes now more strictly subject to voter-approval elections after HB 3 and SB 2, policymakers should ensure that any swap of higher sales tax rates for M&O property tax cuts is revenue-neutral in the first year and that subsequently the supplemental sales tax is subject to voter-approval elections.
Second, HB 705’s provisions could be modified to allow for higher sales tax rates in exchange for reduced (rather than entirely eliminated) M&O property taxes, so long as revenue neutrality is achieved. This change would allow a partial tax swap, rather than a swap conditioned on a city or county imposing no M&O taxes whatsoever. Many cities and counties would need this flexibility; as the Legislative Budget Board stated in the fiscal note to HB 705, an estimated 535 cities and 36 counties could replace their M&O taxes with supplemental sales tax increases authorized by the bill. By allowing for a partial swap rather than a complete swap, the Legislature could ensure that cities and counties beyond those 535 and 36 (respectively)- which would likely include large cities with relatively high property tax appraisals- could offer their residents M&O property tax relief in lieu of higher sales tax rates.
Third, while House Bill 705 offers an intriguing idea worth pursuing, policymakers should be cautious about raising combined state and local sales taxes to a rate that is significantly greater than that of other states. This is particularly so with respect to surrounding states, since high sales tax rates in Texas could encourage Texas residents to make large purchases in surrounding states. Table 10 below shows how Texas compares to neighboring states in terms of its average tax rate (calculated by weighting local taxing jurisdictions by population) and its maximum combined state and local sales tax rate.
Source: Tax Foundation[xiv]
As the table shows, Texas compared to its neighbors has a lower cap on combined state and local sales tax rates, and it trails only New Mexico with respect to the average combined state and local sales tax rate. The Tax Foundation notes, however, that New Mexico has an unusually broad sales tax base in that it taxes certain business-to-business services. Thus, its listed average rate of 7.82 percent understates its effective sales tax rate.
Given the importance of maintaining low tax rates, if policymakers pursue legislation similar to HB 705 during the 87th Session, they may wish to cap the aggregate (i.e., combined city and county) supplemental sales tax rate at 2 percent rather than 4 percent. That said, while the state should be vigilant about maintaining its competitive sales tax rates, it should also take steps to lower its property tax rates, which are among the highest in the country.
1. Policy Recommendation: Permit cities and counties to raise sales tax rates beyond the current cap on aggregate local sales tax rates of 2 percent; provided, however, that any revenue raised is dedicated exclusively to property tax relief, and that any supplemental sales tax increases beyond the initial tax swap are, at minimum, subject to voter-approval elections.
C. Eliminate or at least Increase the Exemption from the Business Personal Property Tax
While Texas is a low-tax state overall, its property taxes- which are imposed by local governments rather than by the state- are quite high relative to most of the country. Texas had the sixth-highest property tax burden in the nation in 2016, according to the Tax Foundation.[xv] As noted above, recent study by Attom Data Solutions found that Texas had the nation’s third-highest effective property tax rate in 2018.[xvi] Over the years, Texas has made efforts to lower the property tax burden its residents face through such measures as a 10 percent cap on annual increases in the appraised value of homestead residences and, in the 86th Session, SB 2 and HB 3.
Part of the state’s heavy property tax burden is reflected in its broad general rule that tangible personal property used for the production of income, such as a business’s machinery, furniture, supplies, and inventory- is subject to local property taxes. This tax on tangible personal property tax used for the production of income is sometimes informally referred to as the “business personal property tax (“BPPT”).
1. Overview of the BPPT
Generally, taxpayers must submit a rendition statement of all tangible personal property used for the production of income that they own, or manage and control as a fiduciary, as of January 1st of a given year.[xvii] The rendition statement is filed with the appraisal district office in the county in which the property is taxable.[xviii] Taxable property is then subject to local governments’ standard property tax rates. There are numerous exemptions to the BPPT; the table below lists some of the larger or better-known exemptions. The figure adjacent to each exemption is the “cost” of the exemption, i.e., the property tax revenue forgone by local governments state-wide as a result of the exemption.
As the table below illustrates, the BPPT generates significant revenue for local governments. In 2019, business tangible personal property constituted 9.5 percent of the statewide property tax base and the BPPT generated approximately $6.4 billion in revenue.
Source: The underlying data is from the Comptroller, Biennial Property Tax Report, 2016 and 2017 and Biennial Property Tax Report, 2018 and 2019 (collectively, the “Comptroller’s Biennial Tax Reports”).
“BTPP” in the above table refers to business tangible personal property.
*This estimate is derived by summing the school district taxable values for Commercial Personal, Industrial Personal, and Special Inventory (categories L1, L2, and S, respectively) in the Comptroller’s Biennial Tax Reports.
**This estimate is obtained by dividing School District Taxable Value of Property in the State by Estimated School District Taxable Value of BTPP.
***This estimate is determined by adding together the property tax levies by school districts, cities, counties, and special districts, as they are set forth in the Comptroller’s Biennial Tax Reports.
****This estimate is calculated by multiplying the Total Property Tax Levy in the State by the Estimated Percentage of School District Taxable Value Consisting of BTPP. This number is approximate; because property tax rates vary by local taxing unit, total revenue from the BTPP is not necessarily the same as the number that is equal to the product of the Total Property Tax Levy in the state and the Estimated Percentage of School District Taxable Value Consisting of BTPP.
2. Economic dynamics of the current BPPT
Several aspects of the BPPT make it poor tax policy. First, it violates the principle of “horizontal equity”- the idea that similarly situated taxpayers should be treated equally. Under current Texas law, a business must pay property taxes on the tangible personal property it holds for the production of income (inventory, furniture, equipment, supplies, etc.). Intangible property, however, is generally exempt from the BPPT (although a few types of intangible property are taxable). A retailer, for example, potentially faces a significant burden under current law in that its inventory is subject to property tax. Similarly, a manufacturing business may face high taxes as a result of the machinery it uses in the manufacturing process. In contrast, service-oriented businesses, such as software companies and accounting and law firms, are far less likely to face significant property taxes on their property because the bulk of their assets are often intangible.
Second, the BPPT imposes compliance costs on businesses. In cases where taxation is appropriate policymakers should aim to minimize the transactional and compliance costs associated with the tax. However, property taxes are generally costly to administer and comply with when compared to other forms of taxation. Under the current BPPT system, a business must determine the value its tangible assets in preparing its rendition statement to the applicable appraisal district. Although a taxpayer may submit a good faith estimate of value, the taxpayer must be prepared to defend this estimate. Even a small business may have dozens of items for which a value must be reported, and determining what the value of an item can involve significant research by the taxpayer. Alternatively, a taxpayer may provide the historical cost of the item of property and the year in which it was purchased, but this requires a taxpayer either to keep records of his or her purchases for a long period of time, and in some cases to know what the previous owner of an item of property paid for it. A dispute between a taxpayer and the appraisal district over the value of the taxpayer’s tangible personal property must be settled at an appraisal review board hearing or in court. Many taxpayers opt to retain professional assistance in calculating or contesting their BPPT liability, which of course imposes further costs on them. As the Senate Finance Committee stated in an August 2020 report:
Industries that rely heavily on inventory have identified the business personal property tax as a significant burden. In addition, small business owners report difficulties in compliance, given the complexities involved in reporting and assigning values to their assets. Texas law requires business owners to report business personal property to the appraisal district for assessment and taxation. This process can be costly for both taxpayers and the appraisal district. (internal footnotes omitted).[xx]
The BPPT imposes compliance costs not just on taxpayers, but also on local governments. In 1995, the Texas Legislature passed House Bill 366 (74R), which, in conjunction with House Joint Resolution 31, established a $500 exemption for taxpayers subject to the BPPT.[xxi] HJR 31 provided in part that:
The Legislature may exempt from ad valorem taxation tangible personal property that is held or used for the production of income and has a taxable value of less than the minimum amount sufficient to recover the costs of the administration of the taxes on the property, as determined by or under the general law granting the exemption.
As the House Research Organization’s analysis of HB 366 explained, some counties were incurring administrative costs with respect to properties with little value that were subject to the BPPT, to the point that the administrative costs exceeded the revenue raised by the tax.[xxii] It should be noted that the $500 exemption is not indexed to inflation, even though that would be appropriate given the rationale for its creation.
A third aspect of the BPPT which makes it poor policy is that it applies to businesses even when those businesses are operating at a loss. Businesses often incur losses in their first several years of existence. Startups, struggling businesses, and capital-intensive businesses are especially vulnerable to shouldering a tax burden which is entirely disconnected from their profitability or their ability to pay the tax. Ideally, startups should be directing their cash flow into expanding their workforces and developing their offered products and/or services, rather than dealing with an administratively burdensome tax. The burden of the BPPT on small and new businesses is exacerbated by the lack of a cap on the tax; in contrast, annual increases in the appraisals of residential real property, for example, are generally capped at 10 percent.
Fourth, the BPPT distorts economic behavior. While all taxes affect behavior to some extent, policymakers should aim to disrupt the interactions of businesses and consumers as little as possible so that a free market can function most efficiently. In the case of the BPPT, businesses have an incentive to minimize their capital investment and inventory holdings. For example, a business considering a purchase of expensive machinery to produce goods more efficiently may opt instead to use less efficient manual labor in light of the BPPT. In turn, this decision results in lower productivity, stunting economic growth. As the Tax Foundation has stated, “There is evidence that the elimination of [the BPPT] increases investment in capital. In Ohio, policymakers exempted manufacturing equipment from the state’s [BPPT], resulting in greater capital investment and a shift from labor.”[xxiii] Similarly, a company may refrain from ordering additional inventory due to concern that its holdings will be subject to the BPPT.
3. Economic effects of increased exemptions to the BPPT
Repealing the BPPT should be the goal of the Legislature, but if that cannot be accomplished, increasing exemptions to the BPPT would still provide substantial economic benefits to the state. While a BPPT is flawed by its nature, there are several aspects about Texas’ version that make it particularly burdensome
First, as noted above, Texas has very high property tax rates relative to most of the country. Thus, all else being equal, an exemption from property tax in Texas is more valuable than in other states.
Second, Texas is the largest-producing state of both oil[xxiv] and natural gas.[xxv] Given the size of its oil and gas industry, Texas is an especially poor place in which to impose a BPPT, which by its nature burdens capital-intensive industries in particular. Third, according to the Tax Foundation, 43 states include tangible personal property in their tax base to at least some extent, but Texas is one of only eight states that fully taxes inventory (subject to exemptions such as the Freeport exemption).
Finally, and perhaps most importantly, Texas’ base exemption of $500 is trivial. Assuming a combined local property tax rate of 2.5 percent, the current $500 exemption is worth a meager $12.50 each year. According to the Comptroller, the total annual revenue forgone by local taxing units as a result of the $500 exemption is a mere $300,000. The inadequacy of Texas’ base exemption is apparent when comparing it the corresponding figures for many other states:
Source: All data is from the Tax Foundation, “States Should Continue to Reform Taxes on Tangible Personal Property,” (Aug. 2019), except for Indiana, which updated its statute in 2019.
“BTPP” in the above table refers to business tangible personal property.
*The five states with the exemption of “Full, except centrally-assessed BTTP“ exempt most tangible personal property except for certain centrally-assessed industries, such as public utilities or oil and natural gas refineries.
Increasing exemptions to the BPPT (or eliminating it altogether) would likely provide a net benefit to the state. A corollary of the BPPT’s distortion of economic behavior is that businesses have a strong incentive to operate in low-tax jurisdictions. Indeed, much of the “Texas Miracle” is credited to Texas government out-competing other states by welcoming migrating and new businesses through a combination of low taxes and light regulation.
Ohio is an instructive example; the state overhauled its tax system in 2005, which among other things eliminated its BPPT on new investment in manufacturing and phased out its BPPT on other business tangible personal property. For the next four years, Ohio won Site Selection Magazine’s “Governor’s Cup” award as the state with the most major business expansion projects.[xxvi] This success has been lasting; Ohio has earned the second-highest ranking in each of the last six years in terms of the number of expansion projects.[xxvii]
Texas is perhaps an even better example of how economically powerful reducing BPPT can be- it is the winner of the Governor’s Cup the last eight years.[xxviii] Although Texas has a BPPT, unlike Ohio, the state grants generous BPPT exemptions to many companies relocating to, or starting in, Texas. For example, the Texas Economic Development Act (sometimes referred to as “Chapter 313”) grants school districts the authority to enter into tax incentive agreements with businesses in exchange for promised economic development, such as capital investment and job creation. Under these tax incentive agreements, qualifying businesses are exempted from paying all or a portion of school district maintenance and operations (“M&O”) taxes that would otherwise be due on commercial buildings and non-inventory business tangible personal property over a period of ten years.
While Chapter 313 is a complex program with advantages and disadvantages, the Comptroller reports that, through 2019, companies receiving Chapter 313 tax incentives have invested $134 billion in the state.[xxix] The rationale for Chapter 313’s tax incentives also applies to increasing BPPT exemptions; businesses seeking expansion are likely to invest in jurisdictions with lower property tax burdens. Unfortunately, Chapter 313 is targeted exclusively at large investments by companies and does not offer property tax relief to most small businesses.
4. Fiscal effects of increased exemptions or elimination of the BPPT
Estimating the fiscal effect of increased exemptions to the BPPT is challenging. In the 84th Legislative Session, Senate Bill 763 would have exempted the first $50,000 of business tangible personal property from property taxes, a substantial increase to the current $500 exemption. Although the bill did not pass, its accompanying fiscal note projected that the increased exemption would reduce school district maintenance and operations property tax collections by $176 million in FY 2019 and city and county property tax collections by a combined $130 million.[xxx]While city and county property tax revenue declines must be borne at the local level, the state’s school finance formulas require the Legislature to make school districts whole from effects of increasing BPPT exemptions. Therefore, the biennial cost to the state was projected to be approximately $350 million.
More recently, Senate Bill 730 (85R, 2017) and Senate Bill 1006 (86R, 2019) would have increased the $500 exemption to $2,500. The former bill’s fiscal note estimated that in 2020 (the first year in which the bill’s full effects were felt), the state would have to make up $2.4 million of lost school district tax revenue and that cities and counties would sustain a total revenue loss of around $160,000 each. Senator Bettencourt’s statement of intent, however, explained that:
Since the cost of appraisal and collection of the business personal property tax [with respect to taxable values between $501 and $2,500] exceeds the tax revenue received, appraisal districts' and tax assessors' resources are ineffectively used to administer the business personal property tax…. The current $500 exemption amount was established in 1995 and has never been adjusted. The purpose of the increased exemption amount is to eliminate the net tax revenue loss related to appraising and assessing the business with tangible personal property worth less than $2,500.
Based on data from the Comptroller discussed above, elimination of the BPPT would cost local taxing units approximately $6.3 billion annually (with the forgone revenue increasing over time). Some of this loss (approximately 55%) would be borne by the state as a result of the school funding formula. This estimate, however, is not “dynamic”; in other words, it does not account for the economic benefits that would result from elimination of the BPPT. For example, businesses would have more funds for capital investment and for paying higher salaries, which (all else being equal) would likely increase state sales tax revenue collections as well as other related taxes.
5. Recommended changes to the law
The BPPT is a flawed tax that penalizes certain types of businesses, such as capital-intensive businesses and retailers, is administratively burdensome, applies to businesses regardless of profitability, and erodes the state’s competitive edge relative to other states. The Legislature should work toward the long-term goal of eliminating the tax in light of these inherent flaws.
The flaws of the BPPT bear a striking resemblance to those of the much-criticized franchise tax. One important difference between the two taxes is that the Legislature has acted to minimize the burden that the franchise tax places on small businesses in particular. Businesses with gross receipts below the current “no tax threshold” of $1.18 million, which is indexed for inflation, are exempt from paying the tax. In addition, taxpayers with a calculated tax liability of less than $1,000 are excused from paying the tax. In 2017, of the 1.3 million businesses potentially subject to the franchise tax, only 121,000 actually owed tax due to these exemptions.[xxxi]
In contrast, the base exemption for the BPPT is only $500 and therefore small businesses still feel the impact of the tax. If the Legislature is not able to repeal the BPPT, it should consider substantially increasing the exemption to $50,000 and indexing the increased exemption to inflation. Assuming an average combined local property tax rate of 2.5 percent, the $50,000 exemption would provide meaningful tax relief ($1,250) each year to small businesses. These recommendations accord with the Senate Finance Committee, which urges increasing the $500 exemption amount and reducing reliance on the BPPT as the budget allows.
Notably, because Article VIII, Section 1(g) of the constitution essentially requires that the property exempted from the BPPT be such that the cost of administering the tax on the exempted property would (but for the exemption) exceed the revenue raised by taxing it, a constitutional amendment (such as Senate Joint Resolution 36, 84R) would likely be necessary to increase the exemption to $50,000.
Finally, pursuing a similar approach to SB 730 and SB 1006 and raising the exemption to $2,500 would also have clear economic benefits. Both bills passed the Senate unanimously and this approach would represent a strong first step toward providing lasting and substantial relief from the BPPT.
6. Policy Recommendation: Eliminate the tangible business personal property tax. If that is not attainable, increase the exemption amount to the first $50,000 of tangible business personal property, or if that is not attainable, the first $2,500. In addition, index the increased exemption to inflation.
E. Including debt service payments on taxing units’ certificates of obligation in the calculation of the voter-approval rate applicable to that taxing unit’s M&O taxes
As discussed above in this Task Force Report, local spending in Texas has become a problem in recent years, as evidenced by the rapidly growing combined local debt burden across the state. As the Comptroller noted in 2017, “Texas state law generally requires our local governments to seek voters’ approval before issuing debt that will be repaid from tax revenues.”[xxxii] Thus, in a given year, many local governments hold bond elections in May or November. This requirement of voter approval is an important check on government’s ability to pay for services today on the backs of tomorrow’s taxpayers. In contrast to bonds, certificates of obligation (COOs) are debt instruments which often can be issued by local governments without voter approval; an election on the issuance of COOs can be held, but it requires a petition of at least 5 percent of the voters in a taxing unit. Although they have been authorized in Texas since 1971, COOs have become increasingly popular in the last 15 years. Between 2006 and 2005, annual issuance of COOs grew by an average of 36 percent.[xxxiii] The total value of COOs issued in 2011 was $1.35 billion; in 2019, it was more than $3 billion.[xxxiv]
COOs can be extremely useful, particularly in emergencies, when taxing units must act quickly and an election to obtain voter consent would result in delay. As the Comptroller has stated, “[COOs] provide local governments with important flexibility when they need to finance projects quickly, as with reconstruction after a disaster or as a response to a court decision requiring capital spending.”[xxxv] However, while COOs “often are associated with emergency spending…their use isn’t restricted to such purposes. They can be used to fund public works as part of standard local government operations.”[xxxvi]
Although COOs are a helpful tool for local governments, their growing popularity is concerning because revenue that taxing units use to service their COOs is not included in the 2.5 percent and 3.5 percent caps of HB 3 and SB 2, respectively. Issuing significant debt without voter approval is at odds with the long-established philosophy of limited government that is accountable to voters. To ensure that COOs are not being used in a fiscally reckless manner, the Legislature could either require voter approval of COOs, or require taxing units to include the revenue used to service COOs in their calculation of their 2.5 and 3.5 percent caps on the annual growth in M&O revenue, as applicable. Because a key advantage of COOs is that they can be issued quickly without an election, the Legislature should reject the former option but adopt the latter.
1. Policy Recommendation: Require taxing units to include the revenue used to service COOs in their calculation of their 2.5 and 3.5 percent caps on the annual growth of M&O revenue, as applicable.
F. Require elections for any taxing unit which increases revenue year-over-year (subject to certain exclusions)
As discussed above, the 86th Legislature made remarkable strides in restraining the future growth of property taxes in the state. The Legislature should continue to expand on the foundation laid by SB 2 and HB 3 by asking the fundamental question: why should voter approval of any year-over-year increase in M&O tax revenue not be required? Currently, growth in year-over-year M&O revenue (excluding revenue from new property) is capped at 2.5 percent or 3.5 percent. In addition, these caps are temporarily eased in the case of disasters. Although the property tax reforms in the context of disaster that are discussed above assume that the framework of SB 2 and HB 3 will remain in place, a strong argument can be made that any annual increase in M&O revenue (except for that attributable to new property) should require voter approval. The requirement of voter approval is already present to a large extent with I&S taxes because voters must approve the issuance of new bonds (but not COOs, unless a petition for an election is successful).
Allowing local governments to increase taxes every year without an election could lead to the presumed default that M&O revenue “should” increase to the capped amount every year. This presumption is counter to the idea that government should constantly be examining its expenditures and seeing how it can reduce taxes as technology progresses and society becomes wealthier (see the discussion of zero-based budgeting above). Proponents of allowing local governments to raise increased revenue without an election will point to inflation and how it erodes the value of money over time. This erosion, their argument goes, justifies small increases in annual revenue to keep spending in real dollars constant. This argument should be countered by two considerations. First, according to the Federal Reserve Bank of St. Louis, expected inflation over the next 30 years as predicted by the financial markets is just under 1.9 percent as of November 2020.[xxxvii] The 3.5 cap that applies to most taxing units other than school districts is 3.5 percent- almost double expected inflation. Second, Texas voters have shown a consistent willingness to approve the issuance of debt when local governments can provide a good reason for that issuance. As noted above in this Task Force Report’s discussion of local spending, “In November 2019, 97 local governments held 132 bond elections, 105 of which approved debt totaling $11.3 billion (a 79.5 percent passage rate.” Because revenue for current operations is even more critical to local governments’ functioning than long-term projects financed by debt, one would expect the voter approval rate for M&O revenue increases to be even higher than that for bond issuance. This consideration should ease concerns that the budgets of local governments will be reduced over time through inflation.
Texas has been an economic beacon to the rest of the country over the last few decades. It will continue to do so and property values across the state will continue to rise. Despite the reforms of SB 2 and HB 3, the Senate Committee on Property Tax has aptly summed up the current situation: “Taxpayers are in desperate need for additional property tax relief. As property values continue to increase, tax rates must fall. To that end, the tax code should be amended to require a vote on any rate increase over the no-new-revenue rate.”[xxxviii]
[1] A small number of taxing units, referred to as special taxing units (STUs), are subject to higher caps than those set forth in HB 3 and SB 2. Because of their relatively minor importance, this Task Force Report does not discuss STUs.
[2] In the 86th Session, the term “rollback” rate was replaced with the term “voter-approval” rate. Similarly, the old concept of “effective tax rate” has been replaced by “no-new-revenue rate.”
[3] School districts already had this power prior to SB 2. See Section 26.08(a). However, SB 2 added “wildfire” in the list of disasters set forth in Section 2608(a).
[i] Attom Data, “U.S. Property Taxes Levied on Single Family Homes in 2018 Increased 4 Percent to More Than $304 Billion,” (April 2, 2019), available at https://www.attomdata.com/news/market-trends/attom-data-solutions-2018-property-tax-analysis/ [ii] See Shannon Najmabadi, “Here's What We Know about the Legislature's Final Property Tax Reform Bill,” Texas Tribune (May 24, 2019), available at https://www.texastribune.org/2019/05/24/property-tax-reform-texas-legislature/#:~:text=For%20the%20owner%20of%20a,2020%20and%20%24325%20in%202021.&text=The%20final%20version%20of%20the,around%20the%20reduced%20election%20trigger. [iii] Legislative Budget Board, Fiscal Size-up 2020-21 (May 2020), available at https://www.lbb.state.tx.us/Documents/Publications/Fiscal_SizeUp/Fiscal_SizeUp_2020-21.pdf (p. 50) [iv] See “Property Tax Lenders,” Texas Office of Consumer Credit Commissioner, https://occc.texas.gov/industry/property-tax-lenders. [v] See “About Us,” Texas Property Tax Lienholders Association, available at https://tptla.org/about [vi] “Legislative Report Property Tax Lending Study,” Finance Commission of Texas (Aug. 2012), https://occc.texas.gov/sites/default/files/uploads/misc/ptl-2012.pdf. [vii] See Cassandra Pollock, “Gov. Greg Abbott on Texas Bars and Restaurants: Expect an Announcement Thursday,” Texas Tribune (March 18, 2020), available at https://www.texastribune.org/2020/03/18/texas-gov-greg-abbott-coronavirus-limits-expect-announcement-thursday/ [viii] Section 26.04(c-1), Tax Code. [ix] Attorney General Ken Paxton, “Opinion No. KP-0299,” (April 13, 2020), available at https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/2020/kp-0299_0.pdf [x] Senate Committee on Property Tax, “Interim Report” (November 2020), available at (https://senate.texas.gov/cmtes/86/c586/c586.InterimReport2020.pdf (PDF page 10 of 116). [xi]Ibid., at PDF p. 18 of 116. [xii] Ibid., at PDF page 12 of 116. [xiii] Federal Reserve Board, Testimony of Chairman Alan Greenspan (dated March 3, 2005), available at https://www.federalreserve.gov/boarddocs/Testimony/2005/20050303/default.htm [xiv] Janelle Cammenga, “State and Local Sales Tax Rates, 2020,” Tax Foundation (January 15, 2020), available at https://taxfoundation.org/2020-sales-taxes/ [xv] “Tax Foundation, Facts and Figures (2018), available at https://files.taxfoundation.org/20180411102900/Facts-Figures-2018-How-Does-Your-State-Compare.pdf (based on 2016 data). [xvi] Attom Data, “U.S. Property Taxes Levied on Single Family Homes in 2018 Increased 4 Percent to More Than $304 Billion,” (April 2, 2019), available at https://www.attomdata.com/news/market-trends/attom-data-solutions-2018-property-tax-analysis/ [xvii] Section 22.01(a), Tax Code. [xviii] Section 22.23, Tax Code. [xix] The freeport exemption applies to goods, wares, ores and merchandise other than oil, gas and petroleum products and to aircraft or repair parts used by a certificated air carrier. The freeport goods qualify if they leave Texas within 175 days from the date they are brought into or acquired in the state. For more detail, see Comptroller, “The Freeport and Goods In Transit Exemptions” (undated), available at https://comptroller.texas.gov/economy/local/transit-exemptions/ [xx] Senate Finance Committee, “Interim Report,” (August 2020), available at https://senate.texas.gov/cmtes/86/c540/c540.InterimReport2020.pdf (p. 23). [xxi] Codified as Section 11.145, Tax Code. [xxii] House Research Organization, Bill Analysis of House Bill 366 (April 12, 1995), available at https://hro.house.texas.gov/pdf/ba74r/hb0366.pdf#navpanes=0 [xxiii] Garrett Watson, “States Should Continue to Reform Taxes on Tangible Personal Property,” Tax Foundation (Aug. 2019), available at https://taxfoundation.org/tangible-personal-property-tax/#_ftnref28 [xxiv] United States Energy Information Administration, “Oil: Crude and Petroleum Production Explained” (undated), available at https://www.eia.gov/energyexplained/oil-and-petroleum-products/where-our-oil-comes-from.php [xxv] United States Energy Information Administration, “Frequently Asked Questions” (undated), available at https://www.eia.gov/tools/faqs/faq.php?id=46&t=8 [xxvi] Site Selection Press Release, “Ohio Wins Site Selection Magazine's Governor's Cup Award for 2009” (March 3, 2010), available at https://siteselection.com/press/releases/100303.htm?_ga=2.227949405.1516866566.1575299989-913645058.1575299989 [xxvii] Business Wire, “Ohio Leads Site Selection’s Governor’s Cup Rankings for Fifth Consecutive Year,” (March 4, 2019), available at https://www.businesswire.com/news/home/20190304005646/en/Ohio-Leads-Site-Selection%E2%80%99s-Governor%E2%80%99s-Cup-Rankings; and https://siteselection.com/issues/2020/mar/the-2019-governors-cups-cover.cfm (showing results for 2019). [xxviii] “The 2019 Governor’s Cups,” Site Selection (March 2020), available at https://siteselection.com/issues/2020/mar/the-2019-governors-cups-cover.cfm [xxix] Comptroller, Report of the Texas Economic Development Act, 2021. [xxx] Fiscal Note to Senate Bill 763 (March 1, 2015), available at https://capitol.texas.gov/tlodocs/84R/fiscalnotes/pdf/SB00763I.pdf#navpanes=0 [xxxi] Texas Taxpayers and Research Association, “Texas Franchise Tax” (July 2018), available at https://ttara.org/wp-content/uploads/2018/11/FranchiseTaxReport_Final.pdf [xxxii] Comptroller, “Certificates of Obligation,” Fiscal Notes (January 2017), available at https://comptroller.texas.gov/economy/fiscal-notes/2017/january/co.php [xxxiii] Ibid. [xxxiv] Senate Committee on Property Tax, “Interim Report” (November 2020), available at (https://senate.texas.gov/cmtes/86/c586/c586.InterimReport2020.pdf (PDF page 15-16 of 116). [xxxv] Comptroller, “Certificates of Obligation,” Fiscal Notes (January 2017), available at https://comptroller.texas.gov/economy/fiscal-notes/2017/january/co.php [xxxvi] Ibid. [xxxvii] Federal Reserve Bank of St. Louis, “30-Yeaer Breakeven Inflation [as of November 2020],” available at https://fred.stlouisfed.org/series/T30YIEM [xxxviii] Senate Committee on Property Tax, “Interim Report” (November 2020), available at (https://senate.texas.gov/cmtes/86/c586/c586.InterimReport2020.pdf (PDF page 18 of 116).