The good news is that state officials in Texas have been debating how to provide one of the largest tax cuts in the state’s history and were even talking about eliminating school maintenance and operations (M&O) property taxes. But that good news withered away in the second special session of the 88th Texas Legislature, as the amount looks to be only about $12.7 billion in new relief (an additional $5.3 billion to maintain past relief was passed in HB 1 budget) of the at least $33 billion surplus. And given that the largest property tax cut was $14.2 billion for 2008-09, the state would need to provide $21 billion in new relief this time for it to be the largest tax cut in Texas history, so Texans could have the same purchasing power of relief as they had then.
While there has been a lot of debate on how the state should provide property tax relief of school district maintenance and operations (M&O) property taxes, which comprise more than 40% of total property taxes collected by local governments across the state, the best way to provide the most relief to everyone is through compression. This is simply using state dollars—mostly through sales taxes—to buy down school district M&O property tax rates that the state mostly controls with its school finance formulas.
Instead, the compromise between the House and Senate, which Governor Abbott looks poised to sign, is a watered-down approach that provides too little in relief—just $12.7 billion in new relief in SB 2 (88(2))—because they chose to spend too much. And there is too little in compression with just $7 billion for 10.7 cents per $100 valuation in reduction for school M&O property taxes. The rest is a combination of raising the homestead exemption for school districts by $60,000 to $100,000, limiting non-homestead appraisal growth to 20% for three years, and requiring three directors on appraisal district boards to be elected with counties that have a population of 75,000 or more. The next part of the package is SB 3 (88(2)), raising the franchise tax exemption for gross revenue to $2.45 million from $1 million. The final piece is HJR 2 (88(2)), which puts this package (except the compression) on the November 7, 2023, ballot for voters to consider approving.
While it is good that there is so much going to tax relief, this package will make the tax system more complicated, make it more difficult to eliminate school M&O property taxes, contribute to higher school M&O property tax rates, and shift the burden around as homesteads and small businesses are chosen as the winners while renters and other employers are losers. The government should not be in the business of socially engineering people’s lives through the tax code by picking winners and losers, and this is exactly what this package does.
Paths to Eliminating Property Taxes
I have long researched and published on eliminating property taxes in Texas. There are different ways to do it, but the one discussed most recently by Texans for Fiscal Responsibility and Governor Abbott was the buy-down of school M&O property taxes until they’re eliminated, something I supported in a paper I co-authored in 2018. The plan has been through multiple iterations. My July 2021 co-authored paper looked at this buy-down approach of using 90% of state surplus dollars above a stricter spending limit of population growth plus inflation to compress school M&O property tax rates until they are zero within about a decade; the other approach explored in this paper was of tax reform that would broaden the sales tax base to eliminate those taxes immediately, without raising the rate, based on a dynamic economic model. Both of these were built on a strong spending limit, given spending is the ultimate burden of government on taxpayers.
The latest was a December 2022 co-authored paper where we address the affordability crisis in Texas and how the buy-down plan would help with this while providing more economic growth. I also wrote a 2023 paper updating this based on how quickly this could be done if a frozen budget with zero growth was used to provide more surplus funding to eliminate these property taxes. I also wrote another 2023 paper noting how there is no need to be fearful about a recession or reduced revenue as there would be the need for spending restraint or cuts, plenty of money in the rainy day fund, or excess reserves held by school districts to address any shortfall to maintain the relief and fund public education.
Adding to this research were two professors at Rice University who, in 2018, also studied different reforms of the buy-down approach and the sales tax expansion approach to eliminate school M&O property taxes. They found that these approaches would provide substantial benefits to the state in terms of increased economic growth and job creation.
After reviewing different options for the buy-down approach, compression is best because everyone benefits, including from the dynamic effects of more growth, more jobs, and lower prices. It’s also the only way that’s being discussed today to get the school M&O property tax rate to 0%.
Another approach to provide property tax relief was pushed by the Senate this year and looks to be included in the bill passed in the second special session: raising the homestead exemption from $40,000 to $100,000. But this approach will never eliminate those taxes and will push the burden of funding spending to everyone else, making the system less equitable while quickly evaporating any relief from appraisal growth and making the path to elimination harder because rates will rise from it when school spending increases.
Given the different approaches discussed this year by the House and governor and then the Senate and lieutenant governor, I did an analysis of the median valued home in Texas of $350,000 in Austin, Houston, and Dallas. I used the tax rates for each of these locations and had the home increase in value by 10% per year, which is the maximum growth for a homestead under current law. I didn’t change anything else to provide an apples-to-apples comparison of a tax reform in 2023 to estimate what would happen over the next five years given a 1) $60,000 increase in the homestead exemption, 2) SB 1 (88(1)) with $60,000 increase in the homestead exemption and 10-cent compression (similar to tax relief package in second special session), 3) HB 1 (88(1)) with 16.2-cent compression, and 4) what would be largest tax cut in Texas history of $21 billion with a 25-cent compression. I should note that this modeling is just on a homestead, so it doesn’t account for the much more broad-based effects of the compression scenarios.
The following three charts are for Austin, including Austin ISD, to see what these four scenarios would look like given the assumptions above in each year.
The first chart shows what would happen for total property taxes (i.e. ISD, city, county, and special purpose district property taxes) under these scenarios compared with the total tax paid of $5,945 for a $350,000 home in Austin. The results show that SB 1 and the 25-cent compression are similar; however, both of them would have only one year of lower total property taxes until 2025, when the amount paid would exceed that of 2023.
The second chart shows similar results as SB 1 and the 25-cent compression have the greatest effects on the 2023 ISD M&O property taxes of $3,089. However, HB1 also provides relief until 2028, when the amount paid would exceed that of 2023.
But, more importantly, given these are only homesteads and don’t account for families who pay rent or own a business, the third chart’s example shows that HB 1 with 16.2-cent compression and the 25-cent compression cut the tax rate the most over time, as this compression in just 2024 continues to buy down the rate as values increase by 10%.
The following charts are for Houston, with similar results for each of the scenarios.
The following charts are for Dallas, with similar results.
In my conversations with CBS News Texas, ABC 13 Houston, and The Texan, I recently explained how compression is the gold standard to eliminate school M&O property taxes. I also recently wrote[VG1] how the Texas Legislature had the largest spending increase in Texas history this session, thereby not providing enough in property tax relief. I argued that Governor Abbott should veto the budget or at least $8 billion of budget items and use it for compression so that Texans get record relief. But that did not happen.
It should be noted that compression will help renters. The Texas comptroller’s report (see Table 33 below) finds that 26% of school property taxes is passed along to renters. Businesses submit 52% of those taxes, but people pay for them through higher prices, lower wages, fewer jobs, and higher rent. Simple supply and demand shows that the property taxes would rotate the private market supply of housing leftward, thereby raising rents and lowering the quantity supplied compared with the free market. In other words, the market does set the rents, but that market is distorted by property taxes, so removing those school taxes would help push down rents through competition. When the landlord has a vacancy and is paying lower property taxes, then she will lower the rent given lower cost to attract tenants. It may not happen overnight, but it will as that’s how competition works, and those businesses that don’t will be forced out of the market through losses. This wouldn’t just be a shift in supply of housing that would reduce rents; that would happen some when this tax is cut and certainly when it’s eventually eliminated, but that’s not the only way.
The following chart shows that there’s movement down the demand curve as the supply curve corrects to the private supply curve (S1) rather than the distorted supply curve (S2) with the ad-valorem property tax, which will lower prices and increase the quantity supplied. This is through competition that will happen as consumers will have more negotiating power and landlords will want to rent out every unit but won’t if they don’t lower their rents, as their competition will because their costs have been reduced.
From the fact that property taxes are going down, there’s a reduction in cost by the landlords, so they have the ability to get more renters at a lower rent. As renters know, if property taxes don’t go down, they will go to another location—hence more consumer power. The consumer has much power in every market if they choose to wield it, especially when government gets out of the way. Again, it wouldn’t change rents overnight, as many are in leases, but it would over time. One of the issues contributing to the affordability crisis in Texas, especially for lower-income folks, is skyrocketing property taxes. Any relief would be most appreciated by 100% of property holders through compression.
Lowering school M&O property tax rates through compression is the best path for everyone to benefit from lower taxes, more economic growth, and tax rates that would go to zero. Many groups shown in the page below have already stated their support for the buy-down plan, which was supported by the governor; the House passed much of it, though that was mostly thrown out in the final package. And they needed to add HB 16 (88(2)) by State Rep. Briscoe Cain, which would put in statute the buy-down plan to zero, along with his HB 17, which would impose spending limits on local governments.
At the end of the day, I’m glad Texans are talking about property tax relief. Other states have been cutting taxes, so Texas can’t sit back and be competitive with other states without spending less and cutting taxes, as corporate welfare makes the problems worse. The Legislature unfortunately passed a revamp of the expired Chapter 313 in HB 5 during the regular session. This new version, called Chapter 403, provides property tax abatements issued by school districts to mostly big businesses. Fortunately, when school district M&O property taxes are eliminated, this corporate welfare will be eliminated, too.
There are so many reasons to eliminate property taxes. Texas will be an economic juggernaut! And what’s maybe the most important is that Texans will have more of their right to own property preserved instead of renting from the government forever with this immoral wealth tax known as property taxes. Raising the homestead exemption might be a part of the final deal, but we should remember that it picks winners and losers, is not sound tax policy, and has been tried three times (1997, 2015, and 2021) without substantial reductions in those taxes paid.
I’m okay with broadening the sales tax base and eliminating school M&O property taxes immediately and using surplus dollars above a stricter spending limit to buy down sales taxes over time. This would also broaden the sales tax base for local governments, which should use those funds to buy down their own property taxes and limit their spending with a restrictive limit like the state’s based on population growth and inflation to use surplus dollars to buy down the rest until they are zero. But there isn’t the political will yet to take this approach, so the best way right now is the buy-down path for school property taxes by the state and local government buying down their own could happen over the next decade for the eventual elimination of all property taxes in Texas. The way to do this is by sufficiently reining in government spending, which the Legislature did not do this session—thereby wasting an unprecedented opportunity to do something big.
Eliminate school property taxes first, then find a way to eliminate the rest. My preference is to limit all local government spending to the state’s spending limit based on population growth and inflation, and use 90% of their surpluses to buy down their own property taxes until they are zero. This is a path to giving Texans their God-given right to own property. Get tax relief done for Texans! Stop renting, start owning!
Originally published by Texans for Fiscal Responsibility.
Vance Ginn, Ph.D.