A REVIEW OF THE TEXAS ECONOMY FROM THE OFFICE OF GLENN .

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SP EC I AL ED IT IO NJA N UA RY 2 01 9FISCAL NOTESAN EXAMINATION OF THE TEXASPUBLIC EDUCATION FINANCE SYSTEM —AND THE CHALLENGES IT FACES.A REVIEW OF THE TEX AS ECONOMY FROM THE OFFICE OF G LE N N H E GA R, TEX AS COMPTROLLER OF PUBLIC ACCOUNTSTEXAS SCHOOL FINANCEDOING THE MATH ON THE STATE’S BIGGEST EXPENDITUREEXECUTIVE SUMMARYEducation is essential to the growth of any moderneconomy. As knowledge-based industries assumeever-greater importance to the state and the nation,educated workers are vital.For decades, the state has sought to provide anequitable public school system funded by shared stateand local revenues. In 2016, the Texas Supreme Courtruled the system “meets minimum constitutionalrequirements” but needs “transformational, top-tobottom reforms.”1This report analyzes the history and intricaciesof Texas’ school finance system, to provide theperspective needed to understand the fundamentallegal, financial and policy challenges facing the system.Demands on the state’s education budget havenever been higher. Texas’ public schools serve morethan 5 million students, and enrollment is growing ata rapid pace. The number of economically disadvantaged students, who are costlier to educate, is risingrapidly, outpacing the growth of the overall studentpopulation. Demographers project this trend tocontinue, raising significant concerns about the system.School finance is undoubtedly one of the mostdifficult issues Texas state policymakers have toaddress, and attracts more opinions and criticism thanany other. This report does not address many issuesfalling under the general heading of education reform,focusing solely on funding.These are some key points about the currentschool finance system:Property tax bills are rising sharply, placinga growing burden on Texas businesses andhomeowners.G LE N N H E GA R, TEX AS COMPTROLLER OF PUBLIC ACCOUNTSMost public school funding in Texas comes froma combination of state and local revenue. Schooldistricts levy property taxes to fund the local share.Texas property tax rates, which are set by localentities including school districts, have changedrelatively little in recent years. Property tax revenue,however, has increased due to skyrocketing propertyvalues.As a consequence of strong economic growth andcurrent funding formulas, both the local share offunding and recapture payments continue to rise.While the state and school districts both areresponsible for a share of school funding, theFoundation School Program (FSP) formulas countthe district’s local property tax revenues first, withthe state providing the remaining portion of eachdistrict’s “entitlement” — its total amount of fundingas dictated by the formulas.CONTINUED ON PAGE 3

A Message from the ComptrollerThe 2019 legislative session, like all sessions, will grapple withdozens of challenges facing our state, some old and some new.But one issue that undoubtedly will be discussed and debated isa perennial one for Texas: public education, and the way in whichwe pay for it.Over the years, both the Legislature and our courtshave wrangled over our public school finance system, trying to find ways to guaranteea decent education for all of our kids while relying heavily on local property taxes forfunding. School districts throughout the state have radically different property values, andsimilar tax rates simply will raise much more money in some districts than in others. It’s afundamental inequality that lawmakers have spent decades trying to address.In 2016, the Texas Supreme Court ruled that our public education finance system wasdeeply flawed but constitutional, ending a 30-year legal battle. But the system’s problemshaven’t gone away. In particular, the rapid rise in Texas’ property values has forced local taxcollections sharply upward, putting a financial strain on many homeowners and bringingcalls for tax relief. Yet any limitation on property tax collections inevitably will create aneed for more state funding to compensate — and the state’s finances are always tight.It’s important, however, to realize that these problems are built into the fundingformulas of the current system. Right now, due to those formulas, rising property taxcollections are actually reducing the state’s share of the total bill, forcing schools to relyincreasingly on their own taxes despite widespread taxpayer dissatisfaction. It’s a situationthat could have serious implications for our state’s remarkable economic success.In this special issue of Fiscal Notes, we take a detailed look at Texas school financeand the problems and pitfalls it faces. It’s my hope that this report will give lawmakers andall interested Texans a clearer view of what has proved to be one of the thorniest and mostpersistent public policy challenges facing our state. G LENN HEGARTexas Comptroller of Public AccountsNote: This report contains estimates and projections that are based on available information, assumptions and estimates as of the date of theforecasts upon which they are based. Assumptions involve judgments about future economic and market conditions and events that are difficult topredict. Actual results could differ from those predicted, and the difference could be material.If you would like to receive paper copies of Fiscal Notes, contact us at fiscal.notes@cpa.texas.gov2 G LE N N H E GA R, TEX AS COMPTROLLER OF PUBLIC ACCOUNTS

TEXAS SCHOOL FINANCE: DOING THE MATH ON THE STATE’S BIGGEST EXPENDITUREA reasonable balance between state and localfunding is crucial to the system’s viability and helps tominimize its reliance on local property tax revenues.Yet the formulas ensure that any increase in local taxrevenue reduces state funding. The state’s share of FSPrevenues was 46.2 percent as recently as 2008; sincethen it has declined steadily, to 36.0 percent in 2018.2In essence, it’s a math problem:X Y ZIf left unchecked,the school finance formulaswill cause more districtsto lose funding to recapture.Any significant change in current Texas schoolfunding patterns will require changes to theFSP formulas.As with any equation, the two sides need tobalance. If X is local revenue, Y is state revenue andZ is the total amount needed to fund our schools,as fixed by the formulas, any increase in X requires adecrease in Y.The Legislature’s ability to provide an efficientsystem of public education — and to constrain thesystem’s increasing reliance on local property taxrevenues — depends largely on its willingness tomake changes to the school finance formulas.Texas’ school finance formulas do not respond toinflationary effects.Growing enrollment, especially among low-incomeand other disadvantaged students, will continueto exert upward pressure on funding needs.The goods and services used to provide publiceducation are subject to inflation, just as any otherelement in our economy. While both state and localper-student funding rose greatly between fiscal 2000and 2018, for instance, after adjustment for inflationstate funding actually fell. The FSP formulas thatdetermine the funding school districts receive have nomechanism that adjusts automatically for inflation.“Recapture,” the state’s primary vehicle forensuring equity, accounts for a growing portion ofoverall school district funding.To compensate for varying amounts of propertywealth among Texas school districts, the systemuses “recapture” to transfer some local revenue fromproperty-wealthy districts to those with low propertywealth. Essentially, recapture is used to bring moreequity to the system.Due mainly to the FSP formulas, recaptureamounts rise over time with taxable property values.If left unchecked, the school finance formulaswill cause more districts to lose funding to recapture;the Houston and Dallas independent school districts(ISDs) have joined Austin ISD as recapture districts inrecent years. The addition of large urban districts torecapture status will significantly increase the numberof students attending school in districts that lose localfunds to the state.About 59 percent of Texas’ public school studentsare classified as economically disadvantaged, and theirshare of total enrollment continues to rise — as will thedemand for special programming and compensatoryeducational funding.Any consideration of school funding sources shouldtake into account their inherent volatility and theirlong-term ability to grow with funding needs.The demand for education funding is rising steadily,but tax collections can and do fluctuate with theeconomy on which they are based. While property taxesare remarkably reliable as a funding source, the salestax that supplies well over half of all state tax revenueis vulnerable to the effects of economic downturns.Severance taxes are even more volatile, often varyingby 50 percent or more annually. Any consideration ofpublic education finance should recognize the higherinherent volatility of state revenue.Any standard for the relative state and local sharesof public school funding should consider thecharacteristics of all funding sources.The historical average of 40 percent state fundingand 60 percent local funding seems reasonablyattainable and may provide a useful starting point forthese discussions.FISCAL NOTES 3

TEXAS SCHOOL FINANCE: DOING THE MATH ON THE STATE’S BIGGEST EXPENDITUREA NOTE ON METHODOLOGYThis report uses data from a variety of state andfederal sources to highlight and assess the mostsignificant historical and future trends in Texas publiceducation finance.The Texas Education Agency (TEA) was theprimary source of statewide public education datafor this report because it houses the Public EducationInformation Management System (PEIMS). ThroughPEIMS, individual school districts are required toregularly report certain data regarding studentand educator demographics, district finances andacademic performance.The Legislative Budget Board (LBB) supplementedthe TEA data presented in this report with state andlocal revenue data from the FSP, which provides abroader perspective on the funding relationshipbetween school districts and the state. In addition,some data gathered by the Comptroller’s Property TaxAssistance Division were used. The report also relieson Comptroller revenue data from other taxes.Some data in this report are provided both in“current” dollars (2017 or 2018) and “constant” dollars,adjusted for inflation using 2017 or 2018 as a base.The report assumes current trends will continue, suchas inflation, population growth and increases in thenumber of economically disadvantaged students.4 to state government and therefore categorizes themas “state” revenue.For the purposes of this report, as well as formore general discussions of school finance, theComptroller’s office suggests a different approachto examining the state and local shares of publiceducation spending. We believe an accurate depictionof the revenues that support the FSP requires theinclusion of all local tax collections, regardlessof whether or not they affect the state budget.Furthermore, recaptured property taxes are raisedfrom a local tax and accordingly are best characterizedas a local contribution.The Comptroller’s calculation of state and localshares over time is as follows:SHARES OF TEXAS PUBLICEDUCATION FUNDINGFISCAL 2000-2018FISCAL YEARSTATE SHARELOCAL 563.5200435.464.6200533.466.6200630.569.5FSP State and Local Revenue Shares200737.063.0The LBB and TEA provide much of the primary data forpublic education finance in Texas, yet their analysesof data concerning the FSP have different goals andinvolve important differences in methodology.LBB’s approach, as published in its biennialFiscal Size-up report, focuses primarily on capturingpotential impacts to the state budget. One majorimplication of this approach is that it does not reportall local interest and sinking (I&S) tax collections,including only those affecting the state’s obligationsunder the Instructional Facilities Allotment andExisting Debt Allotment, two programs providing stateaid for school facilities. In addition, LBB categorizesrecaptured local property taxes as “local” revenue.TEA’s reports, by contrast, usually include all localI&S tax collections. Moreover, TEA views recapturedlocal property taxes as a method of finance available200846.253.8G LE N N H E GA R, TEX AS COMPTROLLER OF PUBLIC : Texas Education Agency and Texas Comptroller of Public AccountsAppendix 2 compares this analysis with those of theLBB and TEA.

INTRODUCTIONPublic education is one of the most importantfunctions of Texas state government and currentlyrepresents the biggest share — 38.9 percent — ofTexas’ general revenue spending. 3 The state andmore than a thousand local school districts share theresponsibility for providing all Texas schoolchildrenwith the opportunity to acquire the knowledge theyneed to thrive in a modern society.The Texas Constitution requires the state to makesuitable provisions for the support and maintenanceof public education. For decades, the school financesystem has faced repeated constitutional challengeson the basis of equity and efficiency, but despitemisgivings, the Texas Supreme Court has ruledthat the current system remains constitutional inthese respects.Our challenge today is different.The need for education funding has never beenhigher. Texas’ school-aged population and the numberof higher-need students are growing dramatically.Upkeep and expansion of facilities are expensive;maintenance and operations costs are rising.The funding we provide, however, increasinglycomes from local property tax revenue, requiringless from the state but burdening local taxpayersmore and more each year. Texas property owners aredemanding tax relief, but any substantial reductionin local property taxes would require significantincreases in state funding.In essence, it’s a simple math problem: X Y Z, where Z represents the total amount of schoolfunding called for by the state’s educational fundingformulas. X and Y are the state and local components;since the equation must balance, any increase in Xreduces Y. And vice versa.This balancing act is a natural consequence of ourpublic education funding system — and one that isproving increasingly difficult to sustain.This report examines the Texas school financesystem from a number of angles, including itshistorical context as well as current trends inschool funding.I. T HE LITIGATION THAT SHAPEDTEXAS PUBLIC EDUCATIONA general diffusion of knowledge being essentialto the preservation of the liberties and rights ofthe people, it shall be the duty of the legislatureof the State to establish and make suitable provision for the support and maintenance of anefficient system of free public schools. 4With these words, the Texas Constitution ordersstate government to provide a free public educationto the state’s schoolchildren — a single sentencerepresenting perhaps the most difficult continuingchallenge faced by generations of Texas lawmakers.Through the years, the Legislature and our schooldistricts have grappled to produce a system offeringefficient, equitable public education funded in partby taxes assessed on property values that vary greatlythroughout the state. After a long series of lawsuits,in 2016 the Texas Supreme Court finally held that ourschool finance system is constitutional but called for“top-to-bottom reforms.”5 The ruling ended a lengthychapter in Texas jurisprudence, but not the array ofchallenges still facing the system.In many ways, the story of Texas public educationfunding is the story of the litigation that shaped it.THE EDGEWOOD CASESSan Antonio’s Edgewood ISD is a school district withlow property wealth that happens to adjoin AlamoHeights ISD, a district with much higher propertywealth. In 1984, Edgewood and 67 other Texas schooldistricts filed a lawsuit highlighting this stark contrastas an example of the unacceptable disparity inresources among Texas’ public schools.The Texas Supreme Court agreed, finding theschool finance system unconstitutional and insistingthat “districts must have substantially equal accessto similar revenues per pupil at similar levels of taxeffort.” 6 It was the first in a series of clashes betweenthe Texas Supreme Court and the Legislature —collectively called the Edgewood cases. Lawmakersattempted to remedy these disparities with 1989’sSenate Bill (SB) 1, using state funds to equalize wealthamong 95 percent of Texas school districts. But ina ruling subsequently known as Edgewood II, thenew law was struck down for still failing to providesufficient equity across the state.7FISCAL NOTES 5

TEXAS SCHOOL FINANCE: DOING THE MATH ON THE STATE’S BIGGEST EXPENDITUREIn 1991, the Legislature passed SB 351, whichestablished 188 county education districts (CEDs) toapportion and level out tax revenue among schooldistricts. Wealthier school districts promptly sued,claiming the CEDs created an unconstitutional, defacto statewide property tax. In Edgewood III the courtagreed, since the CEDs’ boundaries, tax rates andrevenue distribution all were prescribed by state law.8Forced back to the drawing board, the Legislaturenext introduced the complex “recapture” systemwith 1993’s SB 7. The court approved this systemin its Edgewood IV ruling, satisfied that the law’saccountability and accreditation systems ensuredthe minimal standard of adequacy required for the“general diffusion of knowledge.”The ruling dismissed a claim that the state wasfailing to make “suitable provision” for schools byproviding only 43 percent of funding while thedistricts provided 57 percent. But it also offered awarning: if enough districts were eventually forced totax at the maximum rate of 1.50 merely to maintainadequacy, they would no longer have meaningfuldiscretion to set their own tax rates, resulting yet againin an unconstitutional statewide property tax.9 It was apreview of the cases to follow.THE WEST ORANGE-COVE CASESThe next cases challenging the public school financesystem were called West Orange-Cove I and II. In 2001,a group of wealthy school districts sued the state,alleging that the 1.50 cap on the maintenance andoperations (M&O) property tax rate equated to astatewide property tax because it left them with nomeaningful discretion in setting tax rates.10 In a 2005ruling, the court sided with the plaintiffs and orderedchanges, reiterating that:The State’s control of this local revenue is asignificant factor in considering whether localtaxes have become a state property tax. [We caution] that a cap to which districts areinexorably forced by educational requirementsand economic necessities will in short orderviolate the prohibition of a state property tax.11The Legislature responded in 2006 with HouseBill (HB) 1, which tweaked the tax system, loweringlocal rates by about a third and adding additional6 G LE N N H E GA R, TEX AS COMPTROLLER OF PUBLIC ACCOUNTSstate money.12 The parties to the case and the courtwere satisfied with this response and the case wasdissolved.TEXAS TAXPAYERS AND STUDENTFAIRNESS COALITION CASEIn 2014 still another suit, Texas Taxpayers and StudentFairness Coalition v. Williams, challenged Texas’ schoolfinance system on many of the same grounds coveredin Edgewood and West Orange-Cove: adequacy, equity,efficiency and “meaningful discretion” in taxation.13This time, the diversity of the plaintiffs wasnoteworthy, as the case was a consolidation of severallawsuits with different perspectives and legal claims.The array of plaintiffs eventually involved in thelawsuit — more than 600 districts, equity advocates,school choice groups and business groups — was aclear sign of the wide divergence of opinionsregarding school finance, as well as increasedfrustration with stricter testing and accountabilitymeasures; the decreasing share of state funding in theface of

a review of the texas economy from the office of glenn hegar, texas comptroller of public accounts n texas school finance an examination of the texas public education finance system — and the challenges it faces. doing the math on the state’s biggest expenditure january 2019.

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