Property tax creates a state v. local tug-of-war in Texas
DALLAS — Substantial property tax changes under discussion in the Texas Legislature may have implications for bond issuers across the state.
David Medanich, head of public finance for Hilltop Securities, called attempts to limit property tax rate hikes the biggest issue in the state legislature for his local government clients.
“The vast majority see it as a problem,” he said. “It’s probably a larger problem for a growing entity.”
Identical bills in the state House and Senate represent further restraint by state lawmakers on local government autonomy, critics of the legislation say.
Advocates say the legislation is designed to protect property owners from rising tax bills that come from soaring values without any offsetting relief in the rate of taxation.
"We are going to solve school finance reform and property tax reform this session," Lt. Gov. Dan Patrick said when Senate Bill 2 was introduced. "People desperately need property tax reform, our businesses need property tax reform, and we have set out on this day a major piece of legislation to set the tone on this major issue."
The legislation is backed by Gov. Greg Abbott, who identified property tax relief as an emergency measure.
State Sen. Paul Bettencourt, R-Houston, who chairs the newly created Senate Property Tax Committee, said the state’s largest county, Harris County, which includes Houston, has experienced the heaviest increase in property tax burdens.
"The average homeowner in Houston has endured a 37% increase on their property tax bill in just four years," Bettencourt said. "As appraised values go up, tax rates must come down."
Under Texas’ truth-in-taxation law, most taxing units are required to calculate two rates after receiving a certified appraisal roll from the chief appraiser: the effective tax rate and the rollback tax rate.
The “effective tax rate” is a calculated rate that would provide the taxing unit with about the same amount of revenue it received in the year before on properties taxed in both years. If property values rise, the effective tax rate goes down and vice versa.
The “rollback tax rate” divides the overall property taxes into two categories: maintenance and operations and debt service, also called interest and sinking.
For local taxing entities that are not school districts, the rollback tax rate provides the taxing unit with about the same amount of tax revenue it spent the previous year for day-to-day operations, plus an extra 8% increase for operations and sufficient funds to pay debts in the coming year. If a taxing unit adopts a tax rate higher than the rollback tax rate, voters in the jurisdiction can petition for an election to limit the tax increase.
For all taxing units, the debt service portion of the rollback rate is the current year's debt payments divided by property values. The debt service rate is allowed to rise as high as necessary to cover debt service.
SB 2 and its companion House Bill 2 would reduce the rollback rate to 2.5% from the current 8% for local taxing units with combined annual property and sales tax revenue of at least $15 million. Taxing units below the $15 million threshold would retain the 8% rollback rate.
Sen. Kelly Hancock, R-North Richland Hills, called the term "rollback rate" confusing to people who aren't experts in tax policy. He proposed calling it the "voter-approved tax rate" instead.
Hancock traced the 8% rollback rate to 1981 when then Sen. Ray Farabee said the rate was necessary to combat rising inflation and that when the inflation rate fell, the Legislature should revisit the issue. The rate of inflation did fall, Hancock noted, from more than 10% in 1981 to 3.2% in 1983, but the state never lowered the rate.
"What we are doing today, what we will do with this committee, is not only reasonable, it's past due and necessary for our constituents back home," said Hancock.
School districts, which have separate operating tax rate constraints, are excluded from the proposed changes. The bills would also require a ratification election if any local taxing unit exceeds its rollback rate. The mandatory ratification election would replace the current voluntary rollback election that requires a voter petition.
“Local rollback petitions and elections historically have been relatively rare,” according to Fitch Ratings analyst Steve Murray.
“This legislation if enacted could negatively impact Fitch's assessment of certain local governments' independent revenue raising ability — a component of one of Fitch's four key rating drivers in its U.S. public finance tax supported rating criteria,” Murray wrote in a recent analysis.
In addition to the tax-rate cap, the bills would create a property tax administrative advisory board to recommend improvements to the effectiveness and efficiency of the property tax system, best practices and complaint resolution procedures.
It would also place information about the tax rates proposed by local taxing units online with a "real time tax rate notice."
Most local governments would retain the ability to increase non-tax revenues such as fines, service charges and fees, Fitch wrote. That could offset the impact of a lower rollback rate as it relates to revenue-raising ability.
“In addition, Fitch considers the amount that can be raised relative to expected revenue volatility in a typical downturn,” Murray said. “As a result, application of a uniform rollback rate limitation would not have the same effect on all governments.”
SB 2 remained in committee after its first hearing chaired by Bettencourt on Feb. 6.
“By their treatment of local government witnesses, the chair and most members of the committee clearly saw the passage of the bill as a foregone conclusion,” the Texas Municipal League said after the all-day hearing. “In fact, the chair stated more than once that he wouldn’t listen to suggestions from those who are opposed to the bill. He encouraged witnesses to change their testimony to neutral by stating that he would listen to their suggestions if they did.”
The league, which represents local government in legislative matters, noted that “some on the committee appeared to see city officials as a nuisance and treated them with disrespect and disdain.”
El Paso County Commissioner David Stout said he opposed the 2.5% cap even though the state’s westernmost county has not increased taxes by that much over the past five years. The issue for El Paso County is local control and the ability to respond to emergencies.
“Why are you even here?” Bettencourt asked after hearing Stout’s testimony.
Dallas chief financial officer M. Elizabeth Reich told the committee that the reforms would hurt the city’s ability to pay for public safety. Had the 2.5% cap been in place for the last decade, it would have reduced city revenue by $32 million, Reich said. That amount could be used to pay 358 police officers, she said.
While wealthy Collin County north of Dallas supports the tax bill, officials in the Collin County city of Frisco maintain that the legislation would threaten its bond rating. If the bill is signed into law, Frisco plans to end its 10% homestead exemption, officials told The Dallas Morning News.
While the Texas Constitution forbids a statewide property tax, lawmakers shift local property tax revenue across school districts to equalize funding for public school students. The process of balancing revenue between so-called "property wealthy" and "property poor" districts is known informally as "Robin Hood." Texas does not levy an income tax.
The TML maintains that the legislature’s failure to solve the state’s school funding problems lies at the heart of the property-tax battle. Instead of fixing the formula, lawmakers are putting pressure on cities and counties, the TML says.
Pointing to Gov. Greg Abbott’s mention in his State of the State address of school funding in the context of property tax reform, the TML said “it may be that our state leaders have finally embraced the idea that real property tax relief can come only from school finance reform.
“If school finance reform fails this session, and we sincerely hope it doesn’t, perhaps some state leaders will no longer think that quickly shifting the focus to cities will provide them any needed political cover from criticism that property taxes are too high.”