Texas Conservative Coalition Research Institute
Comments to the House Committee on Ways & Means
September 14, 2020
Regarding the Committee’s Charge:
Interim Charge 2: Study and consider possible methods of providing property tax relief, including potential sources of revenue that may be used to reduce or eliminate school district maintenance and operations property tax rates.
While the Legislature did an outstanding job in the 86th Session at capping future property tax increases, Texans still face high property tax bills. Policymakers could continue to explore an idea raised during that session but not enacted into law: raising more revenue through the state sales tax and using that additional revenue to “buy down” property taxes. If the Legislature pursues this idea, Increased sales tax revenue could be obtained by either increasing the state sales tax rate or by repealing certain exemptions from the state sales tax in current law.
Key legislation from the 86th Session included House Bill 3 and Senate Bill 2. Together, these bills overhauled the state’s school finance system and reformed Texas’ property tax system. Under the new law, local voters generally must approve any year-over-year increase of 3.5 percent or more in a taxing unit’s maintenance and operations (M&O) tax revenue (2.5 percent in the case of school districts). Under prior law, local taxing units could generally increase M&O revenue by up to 8 percent without requiring voter approval. As a result, voters are protected from unapproved significant property tax increases, irrespective of whether those increases result from an increase in the applicable property tax rate or an increase in the appraised value of property.
It is difficult to overstate the importance of House Bill 3 and Senate Bill 2. As the Texas economy has grown in recent decades and attracted businesses and people from other states, property values have risen significantly- particularly in large cities such as Austin. Many homeowners and businesses have faced crushing property tax increases as a result. House Bill 3 and Senate Bill 2 will constrain soaring property tax bills while still providing local voters the flexibility to approve tax increases if they are truly necessary.
House Bill 3 and Senate Bill 2 were tremendous conservative victories, but 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 is relatively modest; owners of $250,000 homes on average were projected to save an estimated $200 in 2019.[II]
In addition to the property tax burdens homeowners continue to face, business owners in Texas still must deal with the property taxes which are assessed on their personal property which is used in business or for the production of income. As TCCRI has noted before in other testimony, the business personal property tax is a poorly-designed tax that imposes significant burdens on small businesses, particularly in light of Texas’ exemption of $500 of property from the tax being miniscule compared to most other states’ exemptions.
II. Policy Reasons to Favor Sales Taxes over Property Taxes
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.”[iii]Sales taxes 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 property taxes themselves tend to be regressive. Moreover, the regressivity of sales taxes 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.
III. Property Tax Data
Property taxes in Texas are imposed only by local taxing units such as cities, counties, and school districts; the state does not impose property taxes. Table 1 below shows the breakdown of the $59.4 billion in property taxes levied by taxing units for calendar year 2017, the most recent year for which data is available.
The healthy 5.93 percent year-over-year increase in property tax levies from 2016 to 2017 was not an anomaly; From 1995 to 2015, annual property tax collections in Texas soared more than $36 billion—an increase of 227 percent.[IV]
Taxing units assess two primary types of property taxes: interest and sinking (I&S) taxes and maintenance and operations (M&O) taxes. I&S tax revenue pays down indebtedness incurred for the construction of facilities, and M&O tax revenue pays for the day-to-day operations of the taxing unit. M&O tax revenue for a taxing unit is usually much greater than I&S revenue in a given year. Crucially for purposes of this interim charge, taxing units may lack the legal power to modify their I&S tax rates due to the terms of their agreements with bondholders. Thus, M&O taxes will generally be the target of any significant property tax cuts.
IV. Possible Solutions
As is clear from Table 1 above, school district taxes comprise the majority of property taxes levied in Texas. As such, they (or at least the M&O portion) are a logical target for property tax deduction. If the revenue lost due to property tax cuts is to be offset, the state might consider at least two options to raise the offsetting revenue in a revenue-neutral manner: raising the state sales tax rate or eliminating select sales tax exemptions, or a combination of these two approaches.
In 2016, a TCCRI task force report found that school district M&O property taxes could be repealed and replaced with revenue from the state sales tax and the motor vehicle sales tax. The state sales and motor vehicle sales tax rates would need to be increased from the current 6.25 percent to 8.80 percent, but could be lowered to 8.25 percent three years later as a result of the dynamic fiscal effects of the tax swap. This projection would also require the elimination of many exemptions and exclusions from the state sales tax. Given the political challenges of entirely eliminating school district M&O taxes, the Legislature may wish to focus instead on measures which would ease the property tax burden on Texans.
A. Increasing the State Sales Tax Rate in the Context of Revenue Neutrality
The state sales tax rate is currently 6.25 percent. Local taxing units which levy taxes in a given area may (and often do), in the aggregate, impose an additional 2 percent sales tax charge. Thus, many Texans pay a combined sales tax rate of 8.25 percent on purchases of non-exempted goods and services. The sales tax is by far the largest single source of revenue for the state (ignoring federal income), bringing in an estimated $60.6 billion during the 2020-21 biennium per the Comptroller’s July 2020 projections.
House Bill 4621 (86R, 2019) provides a possible template for the Legislature in the 87th Session. House Bill 4621 (along with House Joint Resolution 3) would have increased the state sales tax rate to 7.25 percent. All revenue attributable to this one percentage point increase in the states sales tax rate would have been used to reduce school district M&O taxes by “buying down” the state compression percentage. The fiscal note for HJR 3 estimated that over the five year period from fiscal year 2020 to fiscal year 2024 (inclusive), the state would have taken in an additional $25 billion in sales tax revenue. With school district taxes in calendar year 2017 topping $32 billion, the state’s extra $5 billion a year in sales tax revenue from a 7.25 percent sales tax rate would afford Texans significant property tax relief. This relief could take the form of cuts to existing property tax bills or additional restraints on the growth of property taxes (beyond the restraint already provided by SB 2 and HB 3).
It should be noted that, under existing law, a similar mechanism is already in place with respect to sales taxes imposed by counties. Counties may impose sales tax (subject to the aggregate local cap of 2 percent), but revenue raised through such taxation is first directed to certain property tax relief.[V]
Of course, even in the overall context of revenue neutrality, policymakers should be mindful of the danger that too high a sales tax rate could adversely affect the state economy. Currently, Texas’ highest possible combined state and sales tax rate- 8.25 percent- places it 25th in the country.[VI] Raising the state sales tax rate from 6.25 percent to 7.25 percent would push the maximum possible combined state and local sales tax to 9.25 percent, which would place Texas in a tie for the 14th-highest.
However, many local jurisdictions in other states do not impose the maximum sales tax rate possible, whereas many cities in Texas do. If the average combined state and local sales tax in Texas is calculated based on the relatively high rates in place in populous areas, it is 8.19 percent, which places Texas 13th among states in average combined state and local sales tax rate. If Texas raised its state sales tax rate by one percentage point to 7.25, its average combined sales tax rate would climb to 9.19 percent, which would move it from the 13th-highest average combined sales tax rate to the 6th (just barely staying lower than those of Washington and Alabama).
Policymakers must be particularly aware of how Texas’ sales tax rate compares to its neighbors, because significantly lower rates in those states could encourage Texas consumers to travel to and make large purchases in those states. Currently, Oklahoma, Arkansas, and Louisiana all have average combined state and local sales tax rates greater than Texas’ 8.19 percent: 8.94, 9.47, and 9.52 percent, respectively. New Mexico’s average rate, however, is 7.82 percent. Thus, if Texas were to raise its average combined sales tax rate to 9.19 percent, such a rate would be in line with those of its neighbors, except that New Mexico’s combined rate would be a significant 1.37 percentage points less. However, this comparison is not “apples to apples”; as the Tax Foundation points out, New Mexico’s sales tax base is unusually broad in that it includes many business-to-business services. While policymakers should weigh the drawbacks of increasing the state sales tax rate in exchange for property tax relief, they should do so in light of the fact noted above: Texas’ property tax rates are already among the highest in the nation.
B. Eliminating Exemptions from the State Sales Tax in the Context of Revenue Neutrality
Alternatively, rather than pursue property tax relief through raising the sales tax rate, the Legislature could broaden the state sales tax base by repealing various exemptions and exclusions from the sales tax in current law. To provide the property tax relief which HB 4621 would have, eliminating or curtailing exemptions and exclusions equal to roughly $25 billion over five years would be necessary. While that number is obviously significant, it would be achievable given the number of exemptions and exclusions from the state sales tax. According to the November 2018 Tax Exemptions and Incidence report by the Comptroller, the total value of exemptions, exclusions, and discounts from the state sales tax in fiscal year 2020 will be $46 billion (although the COVID-related economic downturn may lower this estimate). Nearly $16 billion of this amount is attributable to items which are subject to a different tax under current law (e.g., motor fuels) and $10 billion is for materials used in manufacturing (in order to avoid double-taxation). Nevertheless, that leaves approximately $20 billion in annual exemptions for policymakers to scrutinize.
Although eliminating exemptions may be politically challenging, the sheer number of exemptions from sales tax under current law provide a variety of combinations which could raise substantial revenue for property tax relief. For example, according to the Comptroller’s report, the exclusions from state sales tax applicable to the following types of professional services are alone worth more than $2.2 billion in fiscal year 2020: legal, accounting, audit, architectural, engineering, management consulting, public relations, contract computer programming, and research and development services. Repealing the exemptions for sales of water, agricultural feed, items, and machinery, and over-the-counter drugs would raise another $1.3 billion.
Current law provides that items exempt from state sales tax are generally exempt from local sales taxes as well.[VII]If the Legislature chooses to curtail or eliminate certain exemptions from the state sales tax and dedicate the new revenue to property tax relief, it should ensure that the formerly exempted items which become subject to the state sales tax continue to be exempted from local sales taxes. Absent such a provision, raising the state sales tax to raise revenue with which to compress property tax rates could result in a net tax increase on Texans.
 The period is actually closer to 4.5 years, because the provisions of the bill apply to taxes imposed on or after January 1, 2020, which is four months after the start of the 2020 fiscal year.
[I] Legislative Budget Board, Fiscal Size-up 2018-2019 Biennium (September 2018). [II] See Section 323.505, Tax Code. [III] All data relating to state rankings on sales taxes comes from Janelle Cammenga of the Tax Foundation, State and Local Sales Tax Rates, 2020 (January 2020), available at https://files.taxfoundation.org/20200115132659/State-and-Local-Sales-Tax-Rates-2020.pdf [IV] Section 321.208, Tax Code. [V] 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/ [VI] Lt. Gov. Dan Patrick: Statement on Sine Die of the 86th Legislative Session, (May 27, 2019), available at https://www.ltgov.state.tx.us/2019/05/27/lt-gov-dan-patrick-statement-on-sine-die-of-the-86th-legislative-session/ [VII] Federal Reserve Board, Testimony of Chairman Alan Greenspan (dated March 3, 2005), available at https://www.federalreserve.gov/boarddocs/Testimony/2005/20050303/default.htm