Budget woes, vouchers, and a legal fight in the mix for Texas schools

Rich Saskal

As Texas public schools gear up for the coming school year, some are facing financial pressures that have led to negative underlying rating actions, while competition for students could heat up with the advent of state-funded private and home school vouchers.

A legal battle over a state funding system aimed at addressing inequities between districts with high property values and those with low values is brewing as well.

Fitch Ratings reported last week that about 26% of public schools it rates in Texas had their outlooks revised or their underlying ratings downgraded, including some by multiple notches, since January 2025 due largely to deteriorating financial profiles. 

"Weaker finances are driven by enrollment pressures and limited and infrequent increases in the state's basic allotment to school districts that has often failed to keep pace with rising labor, benefits, and other operating costs," the rating agency said in a report. "This has resulted in narrowing or negative operating margins and lower reserves. Even districts with a longstanding strong fiscal track record are reporting weaker-than-expected results."

Last year, state lawmakers boosted funding by $8.5 billion, including raising the $6,160 per student basic allotment in place since 2019 by $55 per student — a less-than-1% increase seen as inadequate given the surge in inflation over that time period. 

The Republican-controlled legislature also created a $1 billion Texas Education Freedom Account program that launches with the 2026-27 school year. Nearly 106,660 students received accounts out of more than 274,000 applicants. Gov. Greg Abbott and legislative leaders have alluded to increasing funding for the program in Texas' next biennial budget. 

Fitch analysts said some districts report the impact from vouchers will be manageable given private schools are not required to provide special education services and some students with accounts already attend a private school. 

"It's kind of hard for them to predict, especially on the homeschooling side," Fitch analyst Brittany Pulley said. 

Other bond rating agencies have also taken negative rating actions, citing stagnant state funding as a contributor to districts' budgetary strains. 

Still, Texas school bonds are a safe bet for investors. Their voter-approved general obligation bonds carry triple-A ratings through the Texas Permanent School Fund's bond guarantee program.

About $18.3 billion of school bonds were approved in 2025's May and November elections, followed by nearly $11.2 billion this May, according to Texas Bond Review Board data. 

Districts are lining up bond requests for the Nov. 3 election. This month, Irving Independent School District, in the Dallas-Fort Worth region, placed a three-part, $952 million bond package on the ballot to replace schools, improve safety, update technology, and build three high school indoor multi-purpose facilities.

Fitch said districts are generally addressing credit pressure with "cost-containment efforts including staff reductions, program changes, campus consolidations, or deferred spending" to narrow budget gaps over time.

"We're giving them extra scrutiny to see how different districts are coping with the pressures," Fitch analyst Jose Acosta said. "Some are more proactive, and unfortunately, others are more reactionary."

Austin ISD, which received voter authorization for $2.44 billion of bonds in 2022, shuttered several schools at the end of the 2025-26 school year to help deal with financial challenges. Its school board approved an $887 million fiscal 2027 budget last month that included $205 million in operating cuts.

"As districts across the state, along with Austin ISD, grapple with deficit budgets, public education advocates are expected to continue vying for increased school funding when the legislative session opens in January 2027," a statement from the district said.  

It also noted that $630 million of its operating property tax revenue will be diverted as part of the state's so-called recapture program that takes "excess" tax revenue, which is determined under a legislatively approved formula, from property-rich districts and redistributes the funds to property-poor districts. Austin ISD said it is the biggest contributor among districts with about $8.3 billion recaptured between fiscal 2001 and fiscal 2025.

The constitutionality of the recapture system, which was enacted in 1993, was upheld by the Texas Supreme Court in 1995, according to a school funding litigation summary from the state comptroller's office. 

A new constitutional challenge to the system surfaced last week. Midland ISD's board of trustees approved litigation that claims changes made by the state through House Bill 3 in 2019, giving the Texas Education Agency the power to set districts' Tier One maintenance and operations property tax rates, violate the state constitution.

By setting the rate, mandating the levy, and dictating most of the spending, Texas has created an unconstitutional statewide state property tax that also violates a voter-approval requirement in the constitution, according to a draft of the lawsuit against Texas Education Commissioner Mike Morath and the state, which Midland ISD hopes other recapture-paying districts will join.

Under a state-set property tax rate, the west Texas district is sending about 25 cents of every dollar it collects in operating property tax revenue back to the state for a total of $83 million this year, according to School Board President Josh Guinn. 

"Midland County is property wealthy, our community is not," he said at last week's board meeting. "I believe we have almost 60% of our students that are economically disadvantaged, according to the state of Texas guidelines. If Robin Hood is truly doing what it was designed to do, why would you take money out of a school district that has 60% of its students economically disadvantaged?"

Texas Policy Research, a nonpartisan public policy organization, said the case could become the most significant legal challenge to the state's public school finance system since it withstood a constitutional challenge in a 2016 state Supreme Court decision.

"Midland ISD presents a comprehensive constitutional argument that House Bill 3 fundamentally changed the nature of Texas school finance by shifting meaningful authority over local property taxes from locally elected school boards to the state of Texas," a commentary by the group said. "The district argues those changes transformed what has historically functioned as a local property tax into a prohibited statewide property tax." 

The district, which won voter approval for $1.4 billion of bonds in 2023, received an underlying rating upgrade to AAA from Aa1 from Moody's Ratings in February 2025. 

While Texas has approved billions of dollars in state-funded relief from school property taxes, Abbott, who is running for a fourth term as governor, has proposed a short-on-details constitutional amendment to eliminate school property taxes for homeowners.

For tax year 2023, school districts collected an estimated $28.3 billion in maintenance and operations property taxes, as well as $11.2 billion in interest and sinking taxes, which are earmarked for bond payments, according to a November 2024 Texas Legislative Budget Board presentation.