Texas lawmakers tighten revenue cap on cities, spend more on schools

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Texas cities will face a new challenge to their ability to finance operations while school districts across the state adjust to a new funding formula.

Two major overhauls of state and local funding contained in Senate Bills 2 and 3 are expected to become law, absent any successful court challenges. Gov. Greg Abbott praised passage of both measures, which he identified as “emergency items” in the 2019 legislative session that ended May 27.

“The Texas legislature took a meaningful step in reinforcing private property rights by reining in the power of local taxing entities, providing more transparency to the property tax process, and enacting long awaited appraisal reforms,” Abbott said after passage of SB 2.

SB 2 would reduce property tax revenue increases without voter approval to 3.5% from the current 8% annually on existing properties. Voter approval to override the limitation requires a simple majority.

The restriction applies only to revenue for government operations and does not restrict revenue for debt service. The legislation offers some flexibility by allowing local governments to “bank” up to three years of unused margin for an increase greater than 3.5% in a year.

The new law represents a negative credit factor for local governments, according to Moody’s Investors Service.

“With Senate Bill 2 set to take effect in fiscal 2021, local governments have time to adjust budgets, though most have already begun to prepare,” analyst Gera McGuire wrote in a post-session comment. “The bill will mostly affect budgets that take effect in August and September of 2020.”

In Texas, property taxes are set based on two legally separate rates that combine to form an overall governmental unit’s levy known as an “operational rate,” and a “debt service rate,” which is not subject to the limit.

“Given that the debt service levy is legally separate from the amount restricted under the 3.5% Senate Bill 2 limit, local governments will maintain direct control over the rate necessary to service debt,” McGuire noted.

In Texas, most school and municipal utility district debt carries a general obligation unlimited tax (GOULT) pledge, while city and county debt has a general obligation limited tax (GOLT) pledge.

“The new legislation stands to reduce individual tax burdens minimally but hurt local governments substantially,” McGuire said.

With the median home price in Texas at $150,000 and a median operational tax rate of $4.30 per $1,000 of assessed value, the new law would result in minor savings for homeowners, Moody’s said.

Based on existing formulations, “the homeowner's cumulative savings over 10 years would be just $2,260,” analysts said.

Under House Bill 3, lawmakers approved $11.6 billion for school finance that includes $6.5 billion in additional education funding and $5.1 billion to lower property taxes and shift more of the school funding burden to the state.

The legislation lowers “recapture” payments by $3.5 billion that wealthier districts make under the state's “Robin Hood” system for redistribution, which is part of the property tax reduction promoted by Gov. Greg Abbott, who has until June 16 to sign the bill.

"In my inaugural address I said that this will be the session we enact historical school finance reform by putting more money into the classroom, paying our teachers more, reducing recapture and cutting property taxes,” Abbott said. “Without a court order, the legislature did just that by passing one of the most transformative educational bills in recent Texas history.”

HB 3 was carried in the Senate by Education Committee Chair Sen. Larry Taylor, R-Friendswood, who said the bill would put $4.5 billion more into Texas classrooms.

He said it represents groundbreaking reform for an education system that has lagged behind the changing needs of Texas schoolchildren.

Teachers would see salary increases but not the even, across-the-board $5,000 originally included in the Senate version. Instead, it would create a mechanism by which teacher pay would increase whenever the legislature ups the basic allotment, the fundamental variable in school formula funding. HB 3 would raise that more than $1,000, to $6,160, of which nearly a third must go towards salaries for non-administrative public school employees.

Districts would also have the option of developing a system to identify their best teachers and pay them more, but that system couldn't factor in results from state accountability tests. There are also incentives for teachers who are willing to teach at high-need or rural campuses. Administrators will have flexibility in how these funds get distributed, so the actual amount of increased pay will vary district to district. In all, the bill puts about $2 billion towards teacher and other public school salary increases.

The bill would also reduce local school property tax rates by an estimated 13 cents per $100 valuation by 2021, providing more than $5 billion in property tax relief within 2 years, lawmakers said. It also seeks to rein in rate growth by requiring districts to seek voter approval if they wish to exceed a 2.5% rate increase in any year.

SB 2, authored by Sen. Paul Bettencourt, R-Houston, would create a similar limit for most municipal tax rates, at 3.5%. If voters approve no rate increases above these new limits, it would save an estimated $980 million in property taxes statewide by 2024.

"This is astonishing tax relief," Bettencourt said of the two bills.

Moody’s called the new funds “credit positive for schools because they provide districts with more financial flexibility as annual costs to educate students continue to rise. Simultaneously, shifting more costs to the state exposes school districts to potential state budget cuts in future economic downturns, especially since the new funding is financed with expected economic growth.”

Under the legislation, the minimum basic state aid allotment per student would increase by 20% to $6,160 for schools in fiscal 2020, after remaining essentially flat since 2010.

Districts would have to use at least 30% of the increased funding on additional compensation for full-time employees, including teachers, counselors and nurses. Since school districts’ pension contributions to the Teacher Retirement System of Texas are set as a percentage of salaries, the increased salaries would lead to additional retirement benefit payments.

The legislature also passed a pension reform bill, Senate Bill 12, to increase districts' contributions to the Teacher Retirement System of Texas’ pension plan by 10 basis points per year until reaching 2% of compensation in fiscal 2024 (the current level is 1.5%).

“Despite the increased levels, contributions are likely to remain a manageable percentage of school districts' budgets given the state's significant support of annual pension costs,” Moody’s said.

The state budget under House Bill 1 provides $164.2 billion in state money to pay for services through 2021, including the tax and education reforms passed in SB 2 and HB 3.

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State budgets Public school funding State and local finance Property taxes School bonds Texas