The testimony below was submitted to the Texas House Committee on Ways & Means on September 8, 2022, by the Texas Conservative Coalition Research Institute (TCCRI).
Texas Conservative Coalition Research Institute
House Committee on Ways & Means
September 8, 2022
Regarding the Committee’s Charge: Conduct a comprehensive review of the impact of not renewing Chapter 313, Tax Code. Evaluate tax incentives offered by other states and make recommendations for incentivizing manufacturers and other capital-intensive businesses to locate to Texas.
Background
Commercial property taxes in Texas are burdensome relative to other states due to a combination of high tax rates and a broad tax base. Businesses in Texas are of course taxed on their real property just as homeowners are, but in addition they must pay tax on the tangible personal property used in their businesses (tangible business personal property, or “BPP”[1]), which includes equipment, furniture, and inventory. As a result, businesses that use a lot of physical equipment in the course of business (e.g., manufacturers) are hit particularly hard by property taxes. This illustrates one of the conceptual flaws of property taxes; they effectively discriminate in favor of certain businesses whose property is wrapped up in intangible assets and/or whose focus is providing personal services.
Concerned that Texas’ property tax system was hurting its economic competitiveness, the Legislature in 2001 enacted the Texas Economic Development Act, codified in Chapter 313 of the Tax Code (the program is often informally referred to as “Chapter 313”). Chapter 313 offers significant property tax abatements to companies re-locating to, or expanding in, Texas. Specifically, Chapter 313 permits school districts in the state to enter into agreements with companies under which the companies’ new properties in the school district are limited to a fraction of their actual value for the purpose of calculating school district maintenance & operations (M&O) property taxes. (M&O taxes are distinct from interest and sinking (I&S) property taxes, which are used to pay down capital investments and the bonds issued in connection with them.)
These value limitation agreements stay in place for a 10-year period, after which the property is taxed at its then-fair value. The company is required to make a minimum capital investment in the area and create a minimum number of jobs (although as discussed below, waivers of the job creation requirement are frequently granted). In addition, the Comptroller must determine that the tax break was a “determining factor” in the company’s decision to invest in Texas.[i] A particular point of interest about the program is that a company often agrees to make side payments, sometimes called “payments in lieu of taxes”, or “PILTs” to the school district during the agreement term. A 2017 study found that the average PILT amounted to 31 percent of the value of the tax benefits granted to the applicable company.[ii] The Comptroller made a more modest estimate of 13-18 percent in its 2021 biennial report on the program.[iii] In any case, these supplemental payments from beneficiary companies to school districts are significant.
In 2021, the Legislature declined to extend Chapter 313, which is scheduled to expire on December 31, 2022. As discussed below in detail, Chapter 313 had many failings that emerged over the years. These failings, along with a strong sentiment against these types of economic development policies, led to a disagreement over its reform and extension.
The Legislature’s decision to not extend the program beyond the end of 2022 does not prevent companies and school districts from entering into agreements before December 31, 2022.[iv] Any such agreement will generate 10 years’ worth of property tax abatements. Thus, once the Legislature failed chose not to extend the program, it could be anticipated that companies will eagerly seek these “grandfathering” provisions by entering into Chapter 313 agreements before December 31, 2022. Sure enough, hundreds of companies have rushed to submit applications this year in an effort to beat the expiration deadline. The Dallas Morning News reported in August 2022 that companies had already filed 389 applications so far this year.[v] For context, as of June 2020 there were 509 active Chapter 313 agreements in the state.[vi]
Problems with Chapter 313
Even if the analysis is restricted only to the agreements in place as of June 2020, approximately $10.8 billion in tax breaks have been, or will be, granted to companies over the life of the agreements.[vii] An aggregate tax break of this size—granted to a relatively small number of Texas companies—raises serious questions and calls for a searching examination. That examination highlights a number of flaws in Chapter 313.
First, a key flaw in Chapter 313 is its failure to provide broad property tax relief to all business owners. Indeed, its benefits flow primarily to large companies with the pre-existing ability to hire a large number of workers or make significant capital investments. The average small business owner in Texas, in contrast, simply sees his or her property tax bill climb year after year. Given the contributions that small and mid-sized businesses make to the state economy, Chapter 313 almost exclusively favoring larger companies raises fundamental questions of fairness in both the existence and application of such programs. Indeed, some industries are automatically excluded from Chapter 313; for example, restaurants and retail stores generally cannot qualify. To many, the program seems perilously close to government picking winners and losers.
Second, the idea that companies receiving Chapter 313 tax breaks would not have expanded in Texas unless they were provided tax breaks has come into serious question. Although the Comptroller is tasked with verifying that a company applying for Chapter 313 tax breaks would not move to Texas without the breaks, there is no practical way for the Comptroller to determine this beyond taking the company at its word, and most companies give that word eagerly. In recent years, there have been news reports of companies breaking ground on projects in Texas and then subsequently claiming in their Chapter 313 tax application that they would not be relocating to Texas if it were not for the tax break.[viii] Nate Jensen, a professor at the University of Texas at Austin, estimates that 85 percent of the companies receiving Chapter 313 tax breaks would have expanded in Texas even without the tax break.[ix] This suggests that the program is both unnecessary and, for the most part, wasteful.
Third, the idea that Chapter 313 is not necessary to entice many of its beneficiaries to move to Texas is bolstered by the practice of companies making side payments to school districts as part of the negotiated agreements. This kickback-like arrangement makes clear that Chapter 313 subsidies are more generous than necessary to attract businesses; if companies are wiling to pay school districts X percent of the value of their tax benefits, they evidently did not need the full subsidy to be persuaded to relocate to Texas.
Fourth, throughout its history, Chapter 313 has had a poor track record of job creation. Notably, creating high-paying jobs was one of the original goals of the applicable statute. Eventually, even modest job creation demands on the part of the state (10-25 jobs created per Chapter 313 project) were apparently too much to ask. Many Chapter 313 projects, especially those in the renewable energy industry, routinely request and are granted waivers of the job creation requirement. Proponents of Chapter 313 will argue that these tax breaks generate all kinds of economic activity indirectly, but even if those claims could be verified, the same is true of any economic subsidy. The real question is whether the state’s taxpayers as a whole are getting value for the Chapter 313 subsidy.
Fifth, while there is no question that some school districts get a good deal from Chapter 313, they may do so at the expense of the state. Under the state’s funding formula for public schools, school districts can receive state aid if their taxable property values are low compared to their number of students. As the Comptroller noted in 2016, “Most of the local tax revenue the school district forgoes under Chapter 313 is replaced with state funding. Thus, the act uses state revenue to promote local economic development.”[x] Compounding the “localization” of benefits, the side payments school districts receive from companies—unlike property tax revenue—are excluded from the state funding formula and thus are never at risk of being distributed by the state to other school districts.
Sixth, for those districts which do have a Chapter 313 agreement, an overlooked flaw of Chapter 313 is that, by the time a given valuation limitation agreement expires and a company’s property is placed on the tax rolls at its fair value, the property may have already depreciated considerably. For example, manufacturing equipment valued at $250 million at the time the agreement is signed may be exempted from school district M&O taxes for 10 years, but at the end of that 10 years the property may be worth only $80 million.
While the above flaws raise serious concerns about the wisdom of the Chapter 313 program, it is important to note that the program has arguably had some positive effects too. For example, the agreements in place as of June 2020 are estimated to have increased the I&S tax base throughout the state by more than $92 billion.[xi] And while some companies may exaggerate the importance of Chapter 313 in being a “determining factor” in their decision to set up shop in Texas, there is no question that Texas’s property tax system is unfriendly toward capital-intensive businesses. Given the fierce competition among states to attract business development—witness the nationwide bidding war for Amazon’s HQ2 project in 2018—Texas must re-think its property tax system.
An improved property tax system would recognize that the state’s current system is not welcoming to capital-intensive businesses, just as Chapter 313’s implementing statute so recognized. But unlike Chapter 313, a reformed property tax system would make sure that property tax relief is extended to all businesses, not just a handful of favored ones. And if the Legislature does opt to offer tax incentives only to certain companies, the state has the right to demand specific, non-waivable job creation and capital investment commitment from the companies. Finally, a guiding principle of commercial property tax reform should be ensuring that interested parties are not playing with house money; the state should never be on the hook for agreements that local taxing units negotiate with businesses.
Possible Approaches to Offering Commercial Property Tax Relief
The Comptroller recently estimated that the state will conclude the current biennium with a record $27 billion surplus.[xii] Tax relief should always be a priority for a policymakers, and especially so when the state has such a large surplus. The 88th Legislature will have the ability to make significant property tax reforms. In replacing Chapter 313, it should focus on alleviating the property tax burdens faced by capital-intensive businesses. Several possible approaches for delivering this tax relief are discussed below and could be pursued separately or concurrently:
A Gradual Buy-Down and Elimination of Maintenance & Operation Property Taxes
The ideal policy would be to buy down M&O property taxes using surplus state revenue. Over recent biennia, the state’s general revenue has tended to grow faster than population plus inflation. In 2019, the Legislature passed a critically important bill into law—Senate Bill 1336—which generally limits increases in state appropriations of general revenue for a given biennium to no more than the rate of population growth plus inflation. Given the state’s strong economic track record and the fiscal discipline required by SB 1336, it is likely that the state will continue to grow its surpluses over time. The proposed buydown of M&O property taxes would require the state to effectively lower M&O property tax rates throughout the state and offset the decline in property tax revenue with the state’s surplus general revenue.
Because of the enormous sum of property tax revenues that local taxing units levy annually—over $67 billion in 2019—this policy of buying down M&O property taxes would have to be accomplished over a considerable period of time. The state could dedicate a percentage of its biennial surplus revenue, or revenue in excess of a certain figure, to property tax relief. The reform could be implemented by first targeting a subset of M&O taxes, such as school district M&O taxes. House Bill 3 (86R) put in place an ongoing mechanism through which the state buys down school district M&O tax rates over time. Using a large portion of the surplus to accelerate this process would be ideal. Buying down M&O taxes offers the advantage of offering straightforward property tax relief to all Texans (not just businesses) without creating additional administrative costs or procedures and without the government favoring certain constituencies over others.
Phase-in Elimination of the Business Personal Property Tax, or Provide for a Partial Exemption
Revenue from the BPPT comprises perhaps 10 percent of all property tax revenues in Texas. With property tax revenue reaching an estimated $73.2 billion in 2021,[xiii] eliminating the BPPT entirely would carry an annual “cost” of between $7 billion and $8 billion. While such an elimination would be ideal policy, it may be more feasible to phase-in a dramatic reduction (rather than an elimination) of the BPPT over a period of time. This approach would offer the benefit not only of giving the state time to adjust to the fiscal impact, but also of avoiding the need for a constitutional amendment, which outright elimination of the BPPT would require. Importantly, entities that incur BPPT liability likely overlap substantially with those who can benefit under current law from Chapter 313 agreements. Replacing Chapter 313 agreements with significant BPPT reductions would therefore offer broad-based tax relief to companies that currently may enter into Ch. 313 agreements but without placing government in the role of picking winners and losers.
Opinions by the Texas Supreme Court indicate that the Legislature may adopt appraisal methods for items in a given class of property which yield a figure less than the item’s fair market value.[xiv] House Bill 2589 (85R; Button, et al.) would have taken advantage of this power of the Legislature and phased-in a drastic reduction of BPPT on inventory by reducing the appraised value of inventory by 10 percent each year (but not to zero). Notably, no constitutional amendment was required for HB 2589, although it ultimately failed to receive a committee hearing.
A similar approach could be used to reduced property taxes on BPP in general, not just inventory.
Extend the Appraisal Cap to Commercial Properties
Current law provides that the appraisals of homesteads for property tax purposes cannot increase more than 10 percent year over year, excluding the value added by new improvements. The Legislature should weigh expanding this provision to cover commercial property as well. Doing so would mitigate one of the flaws of property taxation; namely, how it can impose an increasing burden on taxpayers even if the taxpayer’s behavior and financial circumstances have not changed in any way. This approach would benefit all businesses with real property, including (but not limited to) capital-intensive businesses such as manufacturing.
Increase the BPPT Exemption to Accord with a Key Franchise Tax Exemption
Current law provides a $2,500 exemption from the BPPT. With such a small exemption, small business owners must spend significant time every year valuing their property and making the required reports. The Legislature could borrow a concept from its franchise tax system and apply it to its commercial property tax system. Businesses in Texas are exempt from the franchise tax if their gross receipts for the relevant tax year are below $1.23 million.[xv]This number is adjusted for inflation over time. The exemption recognizes that small businesses would be especially harmed by having to navigate the administrative burdens of the franchise tax. A similar recognition should apply to commercial property taxation. The Legislature could provide tax relief by simply providing that any small business that has gross receipts under the franchise tax threshold is automatically exempted from paying property taxes on BPP.
ENDNOTES
[1] This testimony refers to the property tax imposed on BPP as “the BPPT.”
[i] Tax Code, Section 313.026(c)(2). [ii] https://www.natemjensen.com/wp-content/uploads/2017/02/Jensen-Chapter-313-Policy-Brief-1.pdf (p. 5). [iii] See Comptroller, Texas Economic Development Act Chapter 313 Summary Data, 2021. [iv] Tax Code, Section 313.171. [v] https://www.dallasnews.com/business/2022/08/08/companies-lining-up-for-future-tax-breaks-as-texas-incentive-program-nears-end/ [vi] Note iii, supra. [vii] Id. [ix] https://www.natemjensen.com/wp-content/uploads/2017/02/Jensen-Chapter-313-Policy-Brief-1.pdf [x] https://comptroller.texas.gov/economy/fiscal-notes/2016/april/chap313.php#:~:text=Most%20of%20the%20local%20tax,to%20promote%20local%20economic%20development.&text=In%202001%2C%20Texas%20legislators%20argued,without%20competitive%20property%20tax%20incentives. [xi] Note ii, supra. [xii] https://comptroller.texas.gov/transparency/reports/certification-revenue-estimate/2022-23-update/ [xiii] https://www.texastribune.org/2022/04/22/texas-property-taxes-explained/ [xiv] See, e.g., https://caselaw.findlaw.com/tx-supreme-court/1890928.html [xv] https://comptroller.texas.gov/taxes/franchise/