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Legislative Testimony: The Role of the Local Option Sales and Use Tax

Texas Conservative Coalition Research Institute

Comments to the House Committee on Ways & Means

September 14, 2020

Regarding the Committee’s Charge:

Interim Charge 3: Study the role of the local option sales and use tax, including: an analysis of the available uses for those taxes, specifically economic development agreements; the statewide distribution of local tax rates; the proportion of the local government budget supported by sales and use taxes; the application of consistent sales sourcing rules; and the impact of shifting from origin to destination sourcing.


The state sales tax[1] rate in Texas is 6.25 percent. However, voters in local taxing units which levy taxes in a given area may choose (and often do) to impose an additional, aggregated sales tax charge of up to 2 percent. Thus, many Texans pay 8.25 percent sales tax on purchases of non-exempted goods and services. To further economic development at the local level, policymakers could consider increasing the 2 percent aggregate cap and dedicating the additional revenue to lowering property taxes.

I. Local Sales Tax Uses

There are several types of local sales taxes in Texas. Approval of the tax by voters is generally required and taxes are generally imposed in increments of one-eighth of one percent, provided that in the aggregate they do not exceed the cap of 2 percent. Table 1 below illustrates the primary types of local sales taxes.

Economic development corporations (EDCs) are of particular interest under this interim charge. EDCs are legal entities created by cities which utilize sales tax revenue for economic development purposes. EDCs are authorized under Chapters 501-504 of the Local Government Code and are classified either as Type A or Type B. Type A corporations may not be used if a city exceeds certain population limits. They may use their revenue for job creation and training as well as the development of infrastructure such as aviation facilities, manufacturing and industrial facilities, research and development facilities, commuter rail, port facilities, and corporate headquarters. The revenue may be used not only for construction of these facilities but also the acquisition of necessary land and equipment.

Type B corporations are subject to fewer restrictions than Type A corporations. They may be used by a greater number of cities, including any city which may utilize a Type A corporation. They may expend revenue for any purpose a Type A corporation may, but in addition they can spend funds on other projects, including affordable housing, sport facilities, tourism facilities, public safety facilities, and recycling facilities.

The Comptroller must submit a report to the Legislature by November 1st of each even-numbered year.[I] The Comptroller’s 2018 report, covering the years 2016 and 2017, indicates that there were approximately 730 EDCs in Texas during those two years- approximately 219 Type A corporations and 510 Type B corporations. The overwhelming majority of EDCs- approximately 95 percent- are created by cities with a population of less than 75,000. As the Comptroller notes, growth in EDCs has largely stalled as a result of more and more cities in Texas reaching the 2 percent cap on aggregate local sales taxes.

In each of 2016 and 2017, EDCs had revenue of more than $1 billion, with more than 70 percent of it coming from sales tax revenue (other sources include federal funds, lease income, and bond proceeds). The bulk of spending by EDCs in 2016 and 2017 were on capital costs, debt service, and particularly in the case of Type A corporations, direct business incentives (DBIs). DBIs include benefits conveyed to third parties, such as grants, sales tax rebates, loan guarantees, and rent subsidies.

II. Statewide Distribution of Tax Rates

According to a 2016 report by the Comptroller,[II] more than 1,500 local taxing units levy sales tax, including 1,150 cities. Most large cities in Texas (including Austin, San Antonio, Dallas, Fort Worth, and Houston) have reached the 2 percent cap on aggregate local sales taxes. Roughly half the counties in Texas- 123 of 254- levy sales taxes. As of 2016, only ten transit authorities in the state levy sales taxes.

III. Proportion of Local Government Budgets Supported by Local Sales Taxes

Sales taxes are a key source of revenue for local taxing units, although they are of lesser importance than property taxes. For fiscal year 2017, the Legislative Budget Board (LBB) reported that local sales tax remittances from the state to local governments were $8.43 billion, with cities accounting for $5.48 billion.[III] In comparison, city property tax revenue in the almost-contemporaneous period of calendar year 2017 was $9.73 billion. Thus, the statewide ratio of city property tax revenue to city sales tax revenue for FY 2017 was approximately 1.78.

Table 2 below illustrates the extent to which some of the largest cities in Texas depend upon local sales tax revenue versus property tax revenue. As the table illustrates, large cities depend more heavily on property tax revenue than sales tax revenue, although in one case (San Antonio) the difference is relatively minor. In general, large cities’ dependence on property tax revenue relative to sales tax revenue is slightly more pronounced than all of the state’s cities viewed as a whole.

IV. Shifting from Origin to Destination Sales Tax Sourcing

A key development regarding the local sales tax is currently unfolding. In a February 2020 editorial,[X] Comptroller Hegar described a practice in which some companies source internet orders to customer service centers in Texas for purposes of sales tax remittances. In some cases, the facility receiving the internet order is not even a fulfilment center. The seller collects sales tax and remits it to the city in which the customer service center is located. The seller and city often enter into a Chapter 380 agreement (named after that section of the Texas Tax Code) in which the city rebates a portion of the sales tax revenue to the seller. Thus, both the city and the seller benefit; the city benefits from jobs the seller creates in the city, and the seller benefits from the rebate.

After discovering this practice, the Comptroller adopted an amendment to the Texas Administrative Code which provides that online orders are, for purposes of sourcing sales tax, not received at the location of the seller.[XI] The intended effect of this change is to steer more revenue to the cities of online buyers, who are spread throughout the state, rather than concentrating the revenue in a few metro areas with fulfillment centers and service centers. Due to several concerns voiced about this change, the Comptroller has delayed implementation of the regulatory change until October 1, 2021, which will provide the Legislature with an opportunity to take action.

V. Recommendations

TCCRI’s testimony on Interim Charge #2 (submitted contemporaneously with this testimony) discusses Texas’ current high property taxes and the several reasons sales taxes are preferable to property taxes. The Legislature may wish to pursue an idea considered but not enacted during the 86th Session: increasing the state and/or local sales tax rate and dedicating the additional revenue to property tax relief. An additional argument for increasing the local sales tax rate and dedicating the additional revenue to property tax relief is diversification of cities’ tax base. As noted above, cities across Texas currently rely on property taxes to a much greater extent than sales taxes. Furthermore, sales taxes raise revenue from out-of-state visitors who make use of local services funded by taxes, whereas property taxes generally fail to capture such revenue.

The Legislature may wish to consider legislation similar to House Bill 705 (86R, 2019). This bill would have permitted cities and counties to impose a supplemental sales tax of up to 2 percent in a revenue neutral manner in lieu of the local city or county (as applicable) imposing property taxes. If each of an overlapping city and county imposed such a supplemental sales tax, the maximum combined state and local sales tax rate in Texas would be 12.25 percent.

While House Bill 705 offers an intriguing idea worthy of further consideration, policymakers should be cautious about raising combined state and local sales taxes to a rate that is significantly greater than that of other states. This is particularly so with respect to surrounding states, since high sales tax rates in Texas could encourage Texas residents to make large purchases in surrounding states. The table below shows how Texas compares to neighboring states in terms of its average tax rate (calculated by weighting local taxing jurisdictions by population) and its maximum combined state and local sales tax rate.

As the table shows, Texas compared to its neighbors has a lower cap on combined state and local sales tax rates, and it trails only New Mexico with respect to the average combined state and local sales tax rate. The Tax Foundation notes, however, that New Mexico has an unusually broad sales tax base in that it taxes certain business-to-business services. Thus, its listed average rate of 7.82 percent understates its effective sales tax rate.

Given the importance of maintaining low tax rates, if policymakers pursue legislation similar to HB 705 during the 87th Session, they may wish to cap the aggregate supplemental sales tax rate at 2 percent. While the state should be vigilant about maintaining its competitive sales tax rates, it should also take steps to lower its property tax rates, which are among the highest in the country.


[I] Chapter 502.153, Local Government Code.


[X] Comptroller Hegar, “How Some Texas Cities and Retailers Are Using a Tax Loophole to Snatch Sales Tax Revenue from Other Communities,” Dallas Morning News (February 4, 2020), available at

[XI] Title 34, Part 1, Chapter 3, Subchapter O, Rule §3.334 (subsection (b)(5) in particular).

[XII] Janelle Cammenga, “State and Local Sales Tax Rates, 2020,” Tax Foundation (January 15, 2020), available at

[1] For ease of reference, this testimony uses the term “sales tax” in lieu of the technical term “sales and use tax.”

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