DALLAS – With the Texas Legislature considering bills that would invest about half of the nearly $12 billion rainy day fund into bond programs for water and transportation, Gov. Rick Perry urged caution on how the fund should be used.

After earlier indications of support for the water and infrastructure investments, Perry this week proposed using $1.6 billion of the rainy day fund for tax breaks for businesses and suggested that lawmakers leave about $7 billion in the fund to handle emergencies and preserve the state’s credit rating.

In a statement after meeting with Republican legislative caucus, Perry called plans to use $6 billion for water and transportation “a little much.”  Keeping about $7 billion in the fund would provide emergency coverage for an event like “a Level 5 tornado” hitting Dallas, Perry said.

The governor made the statement just two days before a fertilizer plant explosion that destroyed a large section of the town of West near Waco.  After a trip to Chicago to urge businesses in Illinois to move to Texas, Perry quickly switched to the Texas disaster, mobilizing state agencies to provide relief.

Perry’s pitch to businesses in the home state of President Obama included a one-time deduction of moving expenses in the first year they pay the state’s franchise tax.  However, that proposal would require legislative approval.

Perry signed the franchise tax into law in 2006 under House Bill 3.  The business tax was designed to provide tax relief to homeowners, whose property tax goes largely to support schools in the state.  However, the franchise tax revenue has fallen short of expectations.

Tax breaks for businesses would come as Texas schools are clamoring for relief from $5.4 billion in funding lost from the 2011 session, the first cuts to education in the state’s history.  Looming over the discussions about how to use the rainy day fund is state district court judge John Dietz’s Feb. 4 ruling in Austin that funding for schools is unconstitutional.  While raising academic standards, lawmakers reduced funding.

“There is no free lunch,” Dietz said in issuing the ruling.

In the current session, lawmakers are again considering academic standards and ways to close underperforming schools while restoring about half of the funding lost in 2011.

While members of the Texas Tea Party are opposing any use of the rainy day fund, analysts for the ratings agencies have expressed concern about how the school funding issue will impact the state’s fiscal cushion.

After Dietz’s ruling, Moody’s Investors Service issued an opinion that the ruling was credit negative for the state “because it would cause increases in education spending funded by state and local taxpayers if the Texas Supreme Court upholds the ruling following a certain appeal.”

“His decision means that Texas legislators must essentially redesign the school finance system,” wrote Moody’s analyst Nick Samuels.

Fitch Ratings noted that the court’s ruling “may ultimately result an increased funding and financial flexibility for school districts in the state, strengthening their credit profile.”

“Any increase in school funding would be a positive credit consideration, as the legislature reduced the education budget by $5.4 billion for the current two-year funding cycle,” Fitch analyst Steve Murray wrote.

While Moody’s and Fitch rate the state triple-A, Standard & Poor’s marks it one notch down at AA-plus.  Outlooks are stable.

Fitch analyst Doug Offerman said that one of the strengths of Texas’ rainy day fund is that it is derived from a dedicated revenue stream from natural resources rather than surplus general funds.

"States that have a lot of natural resources tend to have larger rainy day funds," Offerman said.  "But there are negative surprises, too, as we saw with previous downturns in the oil and gas markets."

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