IN THE TAX FIELD, FEW THINGS ARE AS LIP- smacking good to lawmakers as the prospect of a property tax cut. A former Texas House Ways and Means chairman once told me: “My argument was — and still is — that if you throw out the red meat of property tax cuts, you can pass any tax bill you care to put behind it. If the choice is between tax breaks on people’s houses or for business, houses win every time.” Since property taxes are mainly a local government revenue source, there’s also the special attraction for the state of cutting someone else’s taxes and still getting political credit for the effort.

Even though the economic times are less-than-ideal — or maybe because they are — property tax cuts remain very much on the minds of state lawmakers around the country. Just look at what’s happened in the last year or so. Although it is among the states whose state and local budgets have been hardest hit by the subprime mortgage crunch, Florida voters in January 2008 amended the state’s constitution to extend previous property tax limits. The state has long protected “homesteaders” — Floridians who live in their houses for more than six months of the year — by limiting the increase in the assessed value of their homes to 3 percent a year. In January, voters added to those limits. The new measure ensures that homesteaders who move to a new home can take along the tax benefits they built up in their old home.

Even that wasn’t enough, apparently. There was a measure on November’s ballot that would further roll back property taxes and increase the state sales tax to do so. However, in September, the state Supreme Court removed the multibillion tax swap plan from the ballot, saying it would have misled voters about its potential school finance implications. But not to worry; lawmakers say they’ll try again when the Legislature meets next spring.

In March 2008, Indiana Governor Mitch Daniels signed legislation to cut property taxes by an average of 30 percent and, starting in 2010, to cap the taxes at 1 percent of assessed value. The state will assume some program costs formerly borne by local governments and pay for them by boosting its sales tax from 6 to 7 percent.

And then in June, Governor David Paterson of New York proposed legislation to implement a cap on school property tax levies in the state. As recommended by the governor’s Commission on Property Tax Relief, the cap would limit the growth in school property tax levies to 4 percent or to 120 percent of the rate of inflation, whichever is less.

More recently still, North Dakota Governor John Hoeven has been pushing a $100 million income tax relief plan that would cut the top rate from 5.54 percent to 5.12 percent, and would reduce other rates similarly. The governor also wants to expand his earlier property tax cut plan from a $200 million proposal to $300 million. The governor wants to increase state spending on schools to give local governments a chance to reduce property taxes by a like amount. As should be plain from all this, the notion of swapping state funds for local property tax cuts is fast becoming something of a fad among the states.

The problem with state legislatures cutting the property tax, though, is that the property tax is a damnably hard tax to keep down. It has an annoying way of rebounding as soon as it’s pushed down, either because of rising property values or because the local governments that experience the cuts decide they need more revenue to meet their budget needs and therefore raise tax rates.

Texas represents a case study where both of these rebound factors have been at work on school property tax cuts originally approved by the Legislature back in 2006. Prior to the reduction, school taxes accounted for about 60 percent of all property taxes levied in the state and totaled about $20 billion a year. The other 40 percent funds cities, counties and a wide range of special districts. The property tax and state funding are the mainstays for financing Texas public schools. Rising values had, in fact, pushed the percentage paid for by the property tax higher and higher since the last effort to cut school taxes, back when George W. Bush was governor. Rising property values produced increasing amounts of local revenue, making it possible for the state to cover its share of public education with fewer dollars than might otherwise have been the case. Prior to the recent cuts, the school property tax accounted for about six of every ten dollars spent on Texas public education, compared with about 50 half a decade ago.

People were starting to notice — and not in a good way. So, in the spring of 2006, after a couple of unsuccessful attempts, Texas lawmakers passed a massive package of school finance reforms. School tax rates for maintenance and operations were to be rolled back by one-third over two years, providing an estimated $7 billion in annual property tax relief. Over five years, the tax cuts and approved funding increases adopted along with them were estimated to amount to a whopping $43 billion.

As in North Dakota, Indiana and the abortive Florida effort, this cut was really a swap, with the lost local school taxes made up for, at least in theory, by a restructuring and sizable increase in the state’s business franchise tax, an increase in the cigarette tax and a commitment of surplus state budget funds sufficient to pay for the balance of the local cuts. Two years have now passed. The tax cuts have been made, and a recent analysis by the research arm of the Texas Taxpayers and Research Association (TTARA), a group that represents business taxpayers, makes the case that the cuts have, in fact, worked pretty much as advertised. School taxes, which would have risen by an estimated $4.7 billion, actually declined by $2.3 billion — a net difference of the promised $7 billion. For what is probably the first time in state history, the property tax in 2007 fell from the previous year.

So, you might imagine, there’s dancing in the streets. The property tax demon, if not slain, is at least chopped down to size. Imagine that if you wish, but Texas property owners are not all that exuberant. They haven’t seen the visible reductions in their tax bills that they were led to expect. Homeowners were told their tax bills would be, on average, $2,000 a year lower when this plan took effect. That may be true, but their bills aren’t $2,000 lower than what they were in prior years. Many taxpayers have seen minimal changes in their tax bills from previous years — some a little more, some a little less.

Supporters say, correctly, that tax bills would have been much higher without the cuts — TTARA estimates about 20 percent. Unfortunately, the argument that things would have been worse is generally a losing one where tax issues are concerned. Taxpayers compare this year’s tax bill to last year’s bill, and they draw their own conclusions. It is, as the saying goes, difficult to prove a negative. Moreover, the tax, having been cut, is starting to creep upward again like some particularly devilish weed that won’t stay chopped down.

So, what led to this turn of events? The TTARA report offers an explanation in four parts. One major reason is that property values have continued to rise and carry property taxes up as they go. Texas has not yet experienced the major drop in values experienced in other states. Its housing market didn’t overheat to the extent that the markets did in California and Arizona, and it has remained largely unscathed by the subprime problem so far. Given rising values, local governments can simply raise more money by following values upward and without a rate increase. TTARA found that between 2005 and 2007, values on business properties rose by 13.3 percent annually, well above the growth in the state’s economy. Residential property values grew more slowly but still averaged 7.5 percent a year. Those increases translated into higher taxes with or without a rate increase.

Second, other units of local government — all those cities, counties and special districts —didn’t have their taxes pushed down. This is not an insignificant group of governments and now represents about half of all property taxes levied in the state. Texas is a big place (in case no one from the state has ever mentioned that fact). In addition to more than 1,000 school districts, there are 1,056 cities, 254 counties and more than 1,500 special districts. According to the TTARA report: “During the previous 10 years, city, county and special district taxes had risen with school taxes — with average annual increases of roughly 7 to 8 percent. Increases of that magnitude alone would have obscured school tax relief had they continued; but in fact, since 2005, average annual tax growth in these jurisdictions has accelerated to roughly 11 to 12 percent — well above the 3.6 percent inflation increase in the municipal cost index (American City and County Magazine) and the 2.2 percent average annual Texas population growth.”

That’s a valid point, but it’s interesting as much for what it doesn’t say as what it does. Unlike many states, Texas doesn’t offer much in the way of intergovernmental aid to its local governments. As a result, they reply almost exclusively on their own source revenues, mainly property and sales taxes, and on federal funds. Local sales tax rates are capped at a total of 2 percent by state law, and federal funding is fitful at best. Local governments in Texas and elsewhere are under significant pressure to meet new service requirements and to cover the effects of inflation on their budgets. With a large and growing urban population, the list of service demands is impressively large, and rising fuel prices have complicated the budget picture for everything from police patrols to garbage pickup. The local governments argue that they need the extra cash, and that they will, after all, have to answer to their own voters if they overstep.

A third point, says TTARA, is that local voters have approved additional debt service taxes for schools. Those taxes weren’t part of the property tax cut. “The 214 bond elections in 2007 were the most in over 10 years and the average bond package was also big — at $67 million it was almost twice the average of previous years. With lower tax rates taking effect, school districts submitted a record amount of bonds to voters who proved to be more willing to authorize them,” TTARA found. Better than $12.8 billion in new debt was approved in 2007, since 89 percent of the bond proposals were approved by voters. Those bond issues will be paid for by higher property taxes.

A final point of explanation is that the tax relief legislation gave school districts some flexibility to raise taxes for local enrichment purposes above the new compressed tax rate. At one level, this was a political concession to persuade dubious school officials to go along with the plan, but it has a more practical aspect as well. Had districts not been given some degree of local discretion, the courts would likely have viewed the result — with all districts at a uniform tax rate of $1 per $100 of value — as amounting to a statewide property tax, something the state constitution expressly forbids.1 The state would have been back in court, and that would be a disaster since solving ongoing school finance lawsuits at least partly prompted the current plan in the first place. The state would like to stay out of the courts over the issues of the adequacy and equity of its school finance system for a while, something it hasn’t really managed to do all that often since the Rodriguez court case that dates all the way back to 1971.2

Within the fine print of the plan adopted by lawmakers, a couple of escape hatches were installed for local districts. School districts were allowed to impose additional taxes, up to a rate of four cents above the compressed tax rate of $1 per $100 in value, by a simple majority vote of the school board and without consulting the voters. If local voters approved, districts could increase rates by an additional 13 cents, to a new tax rate of $1.17 per $100 of valuation. By 2007 1,006 of the state’s 1,026 school districts had opted to raise taxes above the base tax rate. “On average, school districts (and their voters) have exercised their discretion to raise tax rates $0.045 above the compressed rate,” according to the TTARA report. “That equates to additional taxes of about $675 million, thereby shaving planned tax relief by about 10 percent. For property owners in a district that levies the maximum tax rate of $1.17, relief was reduced by one-third.”

Now we come to 2008, and districts were still feeling pinched financially. One report estimates that 700 districts have already used the full four cents in voter-free flexibility. Last fall, 119 districts held tax rate referendums to seek authority to move above the four-cent rate increase level. At least 100 school districts are considering or have already announced plans to ask voters to approve higher tax rates this fall. “It’s about increasing funding to meet inflation, performance standards and community expectations,” according to Lynn Moak, a school finance expert who works for school districts. “Most districts are hurting,” said Clayton Downing, president of the Texas School Coalition, one of what seems like dozens of school finance groups working the issue in Austin. He said that the number of school districts that are seeking voter approval for rate increases this year is, if anything, lower than it probably would have been in more tranquil times. “While most people still support their local school district, many are in no frame of mind to run out there and vote for higher property taxes when they’re paying $3.50 a gallon for gasoline and seeing their grocery and medical bills go up and up.”

Moak, for one, doesn’t think this restraint will last. He told one reporter that there will be a flood of tax rate elections in 2009 if the Legislature doesn’t take significant action on school finance when it meets next January. Most districts, it appears, are simply out of wiggle room.

The situation as it now stands has also pushed local districts to the sort of shenanigans that are sure to become an issue in the Legislature this year. The districts are, for example, being cagey about how they approach the rate increase issue, more than aware of the voters’ general dissatisfaction with property taxes in general and the promised cuts in particular. Many of the 100 or so districts that were likely to ask for rate increases in 2008 found a way to avoid a tax rate election on the same day as the Nov. 4 general election. Most held their required elections in early October, when fewer voters were expected to go to the polls. They argued that they wanted the tax rate issue to be considered separately from the general election, when it could become lost in the hubbub over the presidential election and other major state and local races. Critics say, as you might expect, that the districts were taking advantage of a loophole to camouflage their actions from the vast majority of voters who resolutely ignore most elections not involving national offices any way.

It will be interesting to see what the Legislature chooses to do when it meets this year. Many lawmakers must be feeling like a slice of week-old ham lodged between two pieces of stale bread. State Sen. Kevin Eltife of Tyler recently told a reporter that the 2006 deal did little to fix school finance but has tied the hands of local districts to provide their own financing. It has been, he said, a “trifecta disaster,” having disappointed business owners, homeowners and school districts. In other words, it has made just about everyone who votes in Tyler unhappy.

A House interim panel that was considering what more needs to be done on the property tax got an earful from irate taxpayers as it held hearings around the state. The complaints weren’t limited to the seemingly shrinking tax break, but also to frustration with the property tax system as a whole, including the familiar complaint that rising appraisals will price people out of their homes, despite the $7 billion in school tax cuts.

In fact, it’s hard to see who, finally, won here. It is certainly true that taxpayers got a significant tax break, but unfortunately for all concerned, this boon turned out to be the tax equivalent of getting a nice sweater for Christmas when you wanted a pony. Some business taxpayers reportedly fared well in the tax swap, benefiting more from lower property taxes than they will pay in higher business taxes. However, many other businesses that paid little in the way of property or business taxes before the new plan took effect are angry and upset with the higher taxes on their businesses. It’s worse in an odd way for homeowners. For whatever reason, they were led to believe that their actual property tax bill would go down — not from a theoretical future level but from what it was before the cuts. It just didn’t work out that way, and it has left a bad taste in their collective mouths.

For lawmakers, the fact that really big tax cuts didn’t translate into lower tax bills probably frustrates them as much as it does taxpayers. In addition, from a longer term standpoint, the state used up an enormous amount of its available tax capacity to buy down the property tax and didn’t make much of an increase in the state’s investment in public education in the process. Worse still, much of the cut was financed by using surplus state funds. That option won’t last forever, and the state tax increase adopted to finance the plan is woefully short of raising the billions of dollars the property tax cuts will absorb out of the state budget over the next few years.

School districts certainly haven’t gained anything and may have lost much. To many districts, the new financing arrangement is a deal with the devil, since their local financing flexibility is now heavily constrained, and they are more reliant on the traditionally parsimonious state government to see that basic educational needs are met. The debate, of course, will be over the question of who defines those basic needs. “I’m a big advocate for maintaining schools with adequate resources, but I also understand that there are other needs in the state,” said Representative Dan Branch of Dallas, who chairs another House interim committee, this one on school finance. “We want to be prudent and not promise something we cannot deliver.”

Finally cities, counties and special districts may wind up the biggest losers. If you can cut school maintenance and operations taxes by a third and still not make voters happy, the other local governments that rely heavily on the property tax as their key source of income know full well that the next effort could be legislation to limit the level of property taxes generally, probably through further limits on appraisal growth or on local tax levies. These governments are, in a sense, innocent bystanders in this debate, since the state doesn’t provide them with much funding and is unlikely to start, and they have their own needs, their own elected officials and their own voters to keep happy. They are minding their own business and can only hope that lawmakers mind theirs this year.

I’m not naïve enough to imagine that lawmakers across the nation will cease to worry over and try to limit property taxes beyond the many limits already in most state statutes. The desire to cut property taxes is seemingly eternal and isn’t going away. It just sounds so politically appealing. It’s a case of what in the revenue estimating business we used to call the Disney Hypothesis — wishing makes it so. The trouble it, it doesn’t.

Still, Texas should at least provide some useful lessons on the problems and pitfalls of the effort. Property taxes are the key revenue source for funding local government in most states. Local governments have few real funding alternatives and certainly none that raise the same sorts of dollars as the property tax. There are few people who like the tax, but it actually works reasonably well, and there are mechanisms, like the property tax circuit breaker and various homestead and elderly exemptions, to prevent it from having a devastating effect on those least able to pay.

Still, there is frustration, if not downright anger, with the tax among taxpayers, and where there is taxpayer frustration, there will be a legislative desire to find a fix. As in Texas and other states, legislation will be proposed and adopted, headlines will trumpet the good news and hopes will be raised. But the tax, as the TTARA report demonstrates, is hard to keep down, and taxpayers just do not fully appreciate being saved from hypothetical tax increases. Moreover, the property tax in most states is so large that it can’t reasonably be eliminated completely with other known revenue sources. In an effort to make reductions that someone will actually notice, the states will use up valuable tax capacity trying to fill the massive hole in funding that any significant tax cut necessarily creates. Other states may follow Texas’ path, and in so doing, they, too, may look up a couple years down the road and find that no one’s particularly happy and that the whole cycle of frustration has started again. ✯

This article was previously published in State Tax Notes, which can be found online at www.tax.org, under the title “That Not-So-Obscure Object of Desire.”