Our last column covered potential tax legislative topics that the Texas Senate and House of Representatives were directed to consider in the run-up to the 88th Session of the Texas Legislature. Legislators began prefiling bills on Nov. 14, so although the session does not officially begin until Jan. 10, 2023, we are beginning to see the actual tax legislation that's being proposed.
As expected, most of the tax bills filed relate to property taxes, but there are also a few surprises.
Texas has the fifth-highest property tax rates in the country. Real estate valuations have risen dramatically since the legislature last convened in early 2021, providing many taxing jurisdictions with significant revenue increases.
Meanwhile, inflation and strong economic growth, particularly in the energy sector, have increased sales, severance and fuels tax collections to all-time highs, resulting in a record $27 billion budget surplus. In addition to the current surplus, Texas has $13.6 billion in the Economic Stabilization Fund, its rainy day fund.
As a result, there is significant legislative pressure to reduce taxes, and property taxes have been the most popular target.
The most common property tax bills relate to expanding the residential homestead exemption. The measures with the narrowest impact would lower the homestead appraisal cap on a temporary basis or apply only to select groups of people.
H.B. 610 and H.J.R. 44, for example, would raise the homestead exemption from $40,000 to $360,000 through 2024 only, after which the exemption would return to $40,000. It would be funded by the surplus in the state's general revenue fund.
H.B. 582 would provide an additional exemption for the parent or guardian of a child who is disabled. Several others lower the homestead cap for those who are themselves disabled or elderly.
Other bills would permanently and more broadly lower the homestead appraisal cap or limit the amount of tax a taxing jurisdiction can impose on a homestead. H.B. 745, for example, would permanently lower the appraisal cap from 10% to 5%, and H.B. 868 would take it down to 3.5%.
Under H.B. 117, once a residence has been a person's homestead for 15 years, the school district could not assess more tax in any subsequent year.
Other proposals would extend the homestead exemption to other types of property. H.B. 32 would include all single-family residential property, H.B. 665 all commercial real property and H.B. 746 all real property.
The broadest property tax bills would reduce or eliminate school district maintenance and operations taxes. H.B. 90 proposes to use the state's budget surplus to reduce these taxes, while H.B. 91 would eliminate them entirely as of the beginning of 2024. H.B. 38 would eliminate them as well but would offset the lost revenue by increasing other state tax rates.
Conditions are ideal for a broad-based reduction as opposed to a narrow fix, and while focusing a reduction on homeowners might be viewed as providing the largest return politically, the best policy outcome would need to benefit business as well, particularly given the sunset of the Texas Tax Code Chapter 313, or the Texas Economic Development Act, at the end of this year.
Chapter 313 is the state's largest property tax incentive program and the only incentive program applicable to school districts. A reduction to school district maintenance and operations taxes would both ease the otherwise high tax burden for new and expanding capital intensive businesses and provide broad relief to all categories of taxpayers.
Notably absent so far from the prefiled bills are any proposals for new tax incentive programs. Chapter 313 is expiring at the end of the year after attempts to renegotiate its terms in the last legislative session failed.
Chapter 313 significantly reduced school district property taxes for new qualifying industrial projects. For two decades, the program provided incentive for the development of capital-intensive projects, and helped attract many large projects and jobs to Texas.
Efforts have been underway to develop a school district property tax incentive program to replace Chapter 313, but as yet, no bill has been filed. Given the historic importance of school district tax incentives to the state's economic growth, it is critical that legislation be filed and gain traction soon, so that Texas does not disarm itself from competing for the large-scale projects it wants most to attract — and which it recently has been so successfully attracting.
Barring an extensive overhaul of the state's tax structure — discussed below — local tax sourcing will likely be the most important issue in sales tax addressed this legislative session.
Which city or county — the customer's location or some other jurisdiction from which the order is received or fulfilled — receives sales tax for internet sales has been a topic of controversy over the last two years, ever since the comptroller amended Rule 3.334 to provide that such sales would be sourced to the location where the order was delivered.
As our April 2021 column explained, these amendments threatened to disrupt many economic development agreements businesses had entered with cities and counties to source local sales taxes to those jurisdictions.
Some jurisdictions sued the comptroller, resulting in a repromulgation of the rule with a new notice and comment period — the repromulgated rule is still pending. In the meantime, legislators are under pressure to resolve the issue.
H.B. 432 is the first bill on the topic this session and would secure sourcing at the place where the item was most recently stored. The Legislature needs to act on this issue — failure to do so would likely result in continuing litigation and uncertainty.
Bills have also been filed concerning sales tax on firearms. H.B. 88 would impose an additional 1% sales tax on ammunition, firearms and firearm accessories. H.B. 447 would impose an additional 1,000% — yes, one-thousand percent — tax on assault weapons. For both bills, the additional tax would go to specific groups affected by gun violence.
Other sales tax bills seek to exempt certain products from tax: academic transcripts (H.B. 105), college textbooks (H.B. 164), certain computers (H.B. 688), diapers (H.B. 199 and H.B. 48), maternity clothing (H.B. 24), teacher-purchased school supplies (H.B. 346), and menstrual care products (H.B. 70, H.B. 510 and S.B. 128).
Replacing It All
In the most extreme proposals, H.B. 268, H.B. 43 and H.B. 577 would repeal almost all taxes, including maintenance and operations taxes, local sales taxes, state sales taxes, franchise taxes, and most other state taxes, and replace them all with a value added tax which — as opposed to a sales tax applying only to final sales — would apply to all sellers at each stage of the supply chain.
Input VAT, or VAT paid on the business's own purchases, would be subtracted from output VAT, or the VAT collected.
Supporters of a VAT system claim it is a more stable source of income for the government and would increase government revenue. Critics say it can lead to excessive government spending and set off inflationary tendencies.
Given that inflation is high already and Texas is already bringing in much more tax money than it needs to operate, these potential problems would seem to far outweigh the advantages.
A similar bill was also brought in the last legislative session but failed to advance.
Some form of property tax reduction is likely in the upcoming legislative session, given the number of related bills that have been prefiled and the state's favorable financial position. It is less clear whether a school district property tax incentive program will be implemented to replace the current expiring program, or whether there will be anything more than limited changes to sales tax or other state taxes.
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