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Texas Tax Talk: Development Bill Needs Bilateral Buy-In

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Law360 recently published an article by Baker Botts Partners Matt Larsen and Renn Neilson, and Senior Associate Bucky Brannen highlighting the Texas Economic Development Act and the drivers behind potential changes to the program.

 

To read the article in Law360, please click here.

 

For the past 20 years, Texas Tax Code Chapter 313 — also known as the Texas Economic Development Act — has been the state's most important tool for attracting capital investment by lowering the property tax burden imposed by school districts on the state's largest manufacturing projects.
 

As we mentioned in a previous Law360 guest column, with Chapter 313 set to expire at the end of 2022, the Legislature is currently evaluating how to move forward. Several bills have been introduced that would simply extend the program, while another makes renewable energy companies ineligible to participate.
 

However, another recently filed bill would significantly overhaul the program, including its core economics, eligibility measures and application process. This edition of Texas Tax Talk takes a closer look at Chapter 313, the drivers behind potential changes to the program, and arguments both for and against a program overhaul.
 

Understanding and resolving concerns of both project developers and school districts will be critical, because Chapter 313 has been too successful not to preserve. Whether or not Chapter 313 is changed, it must emerge from the legislative session in a form that continues to both attract investment and incentivize school district participation.

 

Chapter 313 Background

Because Texas does not have a personal income tax, it is commonly thought of as a low-tax state, but that is not the case for capital-intensive industrial facilities.

In many Texas locales, the combined property tax rate exceeds 2.5% of a property's market value. The Texas Taxpayers and Research Association, or TTARA, estimates that the average $1 billion facility will pay over $500 million in property taxes over 25 years — the fourth highest such property tax burden in the country.1

School district property taxes generally account for about half of an industrial facility's property tax bill in Texas. A school district's tax rate includes two components: maintenance and operations taxes, and debt service and facilities taxes — with the M&O portion typically making up 75%-100% of school district taxes.

The current version of Chapter 313 allows school districts to place a 10-year value limitation on a qualifying project's appraised value for M&O property tax purposes.

Each district is assigned its own value limitation amount based on the property wealth of that district, with the value limitation amounts ranging from $10 million for the smallest districts to $100 million for the largest.

A $1 billion manufacturing facility with a $20 million value limitation can save more than $100 million in tax payments over the life of the agreement — simultaneously improving the project's viability and Texas' attractiveness as a location for the project.

Because Texas' school finance system redistributes M&O tax revenues from property-wealthy to property-poor districts, the tax savings from a Chapter 313 agreement does not result in significant revenue loss to the school district — except in limited cases discussed below — and districts have enjoyed the additional revenue from debt service and facilities tax collections, which are not subject to the value limit.

The Texas comptroller reports at least 509 current and executed agreements under Chapter 313, with at least 66 pending applications. As of June 1, 2020, the comptroller estimates that the program has created at least 56,000 new jobs and $217 billion in new investment.2

 

What's Next?

H.B. 1502, H.B. 778 and S.B. 144 would simply extend the current program.

H.B. 2084 would prevent renewable energy companies from participating in Chapter 313, which — given the success of the program in attracting renewable energy to Texas — would significantly hamper the program's overall benefit.

But the most sweeping changes to the program are proposed in H.B. 1556, introduced by Rep. Jim Murphy, R-Houston.

H.B. 1556 addresses a number of project developer concerns, so provided it is able to adequately address school district concerns and sufficiently incentivize school districts to participate, it could make Chapter 313 an even more useful economic development tool.

 

Economics

H.B. 1556 would overhaul the economics of Chapter 313. It replaces the M&O value limitation with an exemption for all but a small portion — up to 8 cents per $100 of value — of the district's M&O tax rate — for the same 10-year period as under current law.3 And it provides that this nonexempt portion of the M&O tax rate is the only amount a school district can receive under a Chapter 313 agreement.

Appreciating the significance of these changes requires a quick overview of current Chapter 313 economics. As mentioned above, because Texas's school finance system redistributes M&O tax revenues from property-wealthy to property-poor school districts, the addition of significant property value from a new project does not result in long-term additional M&O revenue for the district.

Likewise, a Chapter 313 value limitation does not cause a district to forgo revenue in most tax years. However, until a 2019 law change, a year-over-year property value increase created a one-time benefit for the district, and a decrease created a one-time loss.

So, in almost all Chapter 313 agreements, developers have agreed to pay the school district revenue protection payments, or RPPs, to compensate for these one-time benefits or losses.

Even after 2019 changes to school finance law largely eliminated these one-time revenue impacts, RPPs had become such a traditional component of Chapter 313 agreements because they provided the district with a financial incentive to attract the project that the 2019 law change required RPPs to continue being calculated as if the one-time benefits or losses still existed.4

RPPs have typically been payable in years following the addition of significant project value, i.e., the early years of the Chapter 313 agreement.

Chapter 313 agreements have also traditionally provided for annual payments in lieu of tax, which are most commonly calculated as the lesser of a percentage of the developer's tax savings or $100 per student.5

H.B. 1556 would eliminate these RPPs and payments in lieu of tax. Proponents of the bill argue that these payments absorb too much of the developer's tax benefits in many cases, and that RPPs, which are calculated based on school finance law, can be opaque and complicated.

Districts have argued that these payments are critical to incentivize districts to participate in economic development, because most M&O tax benefits from new projects are otherwise simply redistributed to other districts under school finance law.

Districts also contend that they must have some mechanism for addressing scenarios in which changes in school finance law or district circumstances result in unexpected adverse impacts to the district. The economic concerns of both sides will need to be addressed so that both developers and school districts will continue to be incentivized to use Chapter 313.

H.B. 1556 also changes the economics of Chapter 313's job creation requirements.

Currently, a project is required to create a minimum number of jobs, which number can be waived by the district, paying at least 110% of the county or regional wage for manufacturing jobs.6 Compliance is all or nothing: Failure to comply can result in termination of the agreement and there is no benefit to the developer for creating more than the minimum number of jobs.

Under H.B. 1556, developers would be formulaically incentivized to create jobs. In each year of the agreement, the state would be entitled to recoup 10% of the developer's annual tax savings from a Chapter 313 agreement if the developer fails to create any jobs. This amount is reduced by the developer's total payroll for that year.7

 

Eligibility

Only certain projects are eligible for Chapter 313. H.B. 1556 extends eligibility for the types of projects that have historically utilized the program: manufacturing facilities, renewable energy generation, research and development, and capital investments in excess of $1 billion dollars.8 And the bill adds a new type of facility that is becoming more common in Texas — battery storage projects.

One of the most significant — and positive — changes to eligibility under H.B. 1556 is the addition of existing-facility upgrades. Under current law, an investment is not eligible if it would replace or upgrade existing buildings.9 For example, the comptroller's office will not currently approve new Chapter 313 agreements for wind repowering projects.10

H.B. 1556 would make such projects eligible unless the comptroller determines the applicant would make the investment regardless of whether it receives the Chapter 313 agreement.11 Both applicants and school districts should welcome this proposed expansion of the program.

 

Application Process

Under current law, the Chapter 313 application process runs through the school district.

The developer initiates conversations with the school district; submits a lengthy Chapter 313 application to the school district for initial review; and pays the district an application fee, generally between $75,000 and $100,000, so that the school district can hire consultants to analyze the financial impact of the project on school district funding.

The school board then votes on whether to consider the application — all before involvement of the comptroller's office.

H.B. 1556 would put the comptroller at the forefront of the application process. Developers would submit a shorter application to the comptroller's office; pay the state a $50,000 application fee; and wait for the comptroller's review — all before involvement of the school district.

The comptroller would be tasked with analyzing the financial impact of the project on school district funding and could only approve Chapter 313 applications that it determines would not harm the district's finances.

Proponents of the bill tout this as a simpler, more centralized process.

Others have suggested that the comptroller's office would need to hire school finance experts to analyze this financial harm test, and wonder whether and to what extent school districts and developers would be given the opportunity to work with the comptroller or have flexibility in Chapter 313 agreements to address any concerns the comptroller raises about financial harm.

This is another component of the bill that will need to be carefully structured to address both sides' concerns.

 

Considerations for Developers

Murphy's introduction of H.B. 1556 is only the first step in the legislative process. If H.B. 1556 ends up being the vehicle for extending Chapter 313, it still must go through the committee process, floor action and governor approval, and would be subject to amendments before being finalized at some point this summer.

Nonetheless, developers considering Texas for new economic development should keep a careful eye on the bill's progress.

As drafted, the bill would take effect Sept. 1 — applying only to Chapter 313 applications that are filed after this date. Agreements based on applications filed before this date would be subject to current law throughout the agreement period.

Accordingly, if passage of the bill becomes likely, a developer considering whether to enter into a Chapter 313 agreement and choose Texas for its project site would need to consider its project timeline and weigh the benefit of finalizing the agreement earlier in the year against any advantages the new law might give the project.

Because Chapter 313 agreements are granted only to projects not already committed to Texas, waiting until later in the year to begin the application process may be a challenge for developers eager to undertake development steps.

 


 

Matt Larsen and Renn Neilson are partners and Bucky Brannen is a senior associate at Baker Botts LLP.

 

Disclosure: Baker Botts is a member of the Texas Taxpayers and Research Association, which has published materials in support of changes proposed by H.B. 1556. However, the views expressed in TTARA's publications should not be attributed to Baker Botts.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
1Understanding Chapter 313, School Property Tax Limitations and the Impact on State Finance, a research report published by TTARA, https://www.ttara.org/wp-content/uploads/2021/01/UnderstandingChapter313_1_27_21.pdf.
2Texas Economic Development Act Chapter 313 Summary Data 2021, Texas Comptroller of Public Accounts.
3Chapter 313 has never applied to school district interest and sinking fund rates (for district debt). This would continue under HB 1556.
4Tex. Edu. Code § 48.256(d).
5Tex. Tax Code § 313.027(i). In small districts, a $50,000 minimum PILOT often replaces the $100/student calculation.
6Tex. Tax Code §§ 313.021(3)(E); 313.021(5).
7The developer would receive full credit for direct payroll of employees and 50% credit for amounts spent on contract workers.
8HB 1556 would remove certain project types that have historically gone unused: clean coal projects, advanced clean energy projects, and electric power generation using integrated gasification combined cycle technology.
934 Tex. Admin. Code § 9.1051(16)(E).
10Wind farm repowering entails upgrading key components of existing wind turbines to improve power capacity.
11As part of its review of 313 applications, Tex. Tax Code § 313.026(c)(2) tasks the Comptroller's office with determining that the 313 agreement is a "determining factor" in the project locating in Texas. HB 1556 maintains this requirement.

 

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