LEGISLATIVE BUDGET BOARD Austin, Texas FISCAL NOTE 75th Regular Session April 18, 1997 TO: Honorable Paul Sadler, Chair IN RE: House Bill No. 4, Committee Report 1st House, Substituted Committee on Revenue and Public Education Funding By: Craddick House Austin, Texas FROM: John Keel, Director In response to your request for a Fiscal Note on HB4 ( Relating to school property tax cuts, the distribution of replacement revenue, the imposition, administration, rates, collection, and enforcement of various taxes, and the allocation of revenue from those taxes and other sources for the funding of primary and secondary education; providing penalties.) this office has detemined the following: Biennial Net Impact to General Revenue Funds by HB4-Committee Report 1st House, Substituted Implementing the provisions of the bill would result in a net negative impact of $(993,761,293) to General Revenue Related Funds through the biennium ending August 31, 1999. It is anticipated that $1 billion of available revenue from the 1998-99 biennium will be appropriated by the Legislature for property tax relief. The bill would make no appropriation but could provide the legal basis for an appropriation of funds to implement the provisions of the bill. Fiscal Analysis SCHOOL FINANCE The bill would repeal recapture. The bill amends the Foundation School Program's two-tiered funding formulas with a single-tiered, guaranteed yield system for maintenance and operations with a maximum school district tax rate of 70 cents per $100 of valuation on residential property. The guaranteed yield would be set at $53.15 per penny per student. The M&O guaranteed yield would be based on residential property only. Additional state aid would be provided for districts unable to generate the level of revenue they would be projected to have available in 1998-99 under current law. In addition, a separate guaranteed yield would be created for either local enrichment or existing debt service. The combined tax rate would be limited to 10 cents. The bill would also create a guaranteed yield for debt authorized and issued after September 1, 1997. The yield would be $36.40 per student per penny. Districts qualifying for funds would be limited by appropriation. METHODOLOGY To estimate these effects a school finance model was run. The guaranteed yield for maintenance and operations would increase the cost to the state by $12.45 billion in the 1998-99 biennium. The hold harmless for current projected M&O revenues would add approximately $205 million to the cost of the FSP for the 1998-99 biennium. The existing debt service tier would cost the state an additional $300 million for the 1998-99 biennium. These costs are partially offset by the elimination of the current facilities grant program ($170 million). This note assumes that no districts would access the enrichment tier in the 1998-99 biennium. If districts increase their tax rates by the 2.5 cents authorized under the bill's rollback provisions, the cost of this tier is projected to be $3.5 million in the year 2000 growing to $10.5 million by the year 2002. The new debt tier would cost the state an additional $110 million in the 1998-99 biennium, based on assumed issuance of $2 billion of new debt. Because this tier is limited to debt issued after September 1, 1997, this note assumes that the cost would not begin until 1999. Assuming that district debt issuance maintains at $2 billion for 1999 and 2000, and then declines to $1 billion by 2002, the cost to the state is projected to be $220 million in 2000, growing to $395 million by 2002. The bill also would create an experienced teacher allotment that would provide additional funds to local districts with average teacher minimum salaries exceeding the state average by more than 3 percent. The additional cost to the state would be approximately $46 million for the 1998-99 biennium. The estimates in this note are based on projections of district property values provided by the Comptroller of Public Accounts and Legislative Budget Board projections of student enrollment growth of 2 percent per year statewide. STATE AD VALOREM TAX FISCAL ANALYSIS The bill would establish a state property tax of $1.05 per $100 of value on business property and set the school district tax rate on residential property at approximately $0.70 per $100. The provisions in this bill would create a gain to the General Revenue Fund, earmarked for public education, and a loss of local revenue to school districts, beginning in fiscal 1998. METHODOLOGY For the purposes of estimating the effect of this article, all property used for habitation, other than hotels and motels, was classified as "residential." All other property was classified as "business." The business and residential tax bases were estimated from information reported by schools and appraisal districts. The appropriate tax rates were applied to the business and residential tax bases, and the resulting levies were trended for growth over the projection period. The school district's reduced residential levy was subtracted from the estimate of the school district M&O levy under current law to derive a school district levy loss. The business levy would be a gain to the state. The bill would allow persons 65 years of age or older who move from one homestead to another to continue a tax freeze that they would otherwise lose under current law. A mobility factor was estimated by dividing the national number of 65 and over homesteads moving within their states by the total U.S. number of 65 and over homesteads. Each year's levy loss, net of 65 and over deaths, is cumulative. The school funding formula would reimburse school districts after a one year lag, resulting in a state cost and a corresponding reduction in the cost to school districts. An estimated loss also was included for the 65 and over taxpayers who would receive lower frozen levy amounts (or keep their existing tax freeze amounts if lower) under the proposed bill. The bill would require the Comptroller to pay a share of each appraisal district's budget based on the state ad valorem tax levy as a percentage of the total levy for all taxing units in each appraisal district. The school districts' share was reduced because of their reduced levy. The cities' and counties' shares were increased because the total property tax levy from all taxing units would be reduced while the city and county levies would remain unchanged. The Comptroller's collections expenses would be a cost to general revenue. The appraisal budget and collections costs were estimated from actual costs reported by appraisal districts, trended over the projection period. NOTE: All estimates are contingent on the passage of constitutional amendments establishing a state ad valorem tax, abolishing optional homestead exemptions for school district M&O purposes, permitting the school tax freeze for an elderly person to be transferred to a newly acquired homestead, and any other amendments required to implement the provisions of the bill. FRANCHISE TAX BASE EXPANSION FISCAL ANALYSIS The bill would amend Chapter 171 of the Tax Code to make a series of changes to the state's franchise tax. Non-corporate business entities other than sole proprietors would be included under the franchise tax. Business entities newly taxable would include general partnerships, limited partnerships, limited liability partnerships, business trusts, and professional associations. Passive income received by newly-taxable entities would be excluded from taxation. Passive income would include receipts of interest, dividends, capital gains, rents, royalties, and income from oil and gas working interests. The franchise tax floor would be raised from $100 to $500: any tax liability below $500 would not be assessed. For taxable entities other than partnerships, the statutory exemption from the officer compensation addition requirement (Section 171.110(b) of the Tax Code) available to 35-or-fewer-shareholder corporations would be revised. Compensation would have to be added to the tax base, to the extent deducted in computing federal taxable income, for officers, directors, and owners who own 0.1 percent or more of the firm but who are not officers. The first $100,000 of compensation paid to a "0.1 percent-or-more" business owner would be deductible. For partnerships, the earned surplus base would be the total income of the partnership taxable to the partners. A $100,000 deduction would be available for each partner in 35-or-fewer-partner firms to the extent of compensation (guaranteed payments) actually paid. The exemption from GAAP accounting requirements for taxable capital for taxpayers with 35 or fewer owners ( Section 171.113 of the Tax Code) would be amended: only taxpayers with gross receipts of less than $500,000 would qualify for the exemption. Certain exemptions for non-profit and for-profit corporations would be repealed. The unrelated business taxable income of non-profit corporations that retained their exempt status would become subject to tax. Six separate changes would affect the computation of the gross receipts apportionment factor. Finally, the deduction for solar energy devices and the temporary (FAS 96) credit would be repealed. METHODOLOGY Data on business entities were obtained from many sources, including: (1) the Comptroller's tax records, (2) the Internal Revenue Service, (3) the United States Federal Reserve System, and (4) other states' published tax information. Tax calculations specified by the bill were performed and the fiscal impact was computed. Raising the tax floor from $100 to $500 would be a revenue loss. Repealing the exemptions for certain for-profit corporations would have an insignificant revenue impact on the state. All other provisions would be a revenue gain. NOTE: Because of the uncertainty surrounding the issue of whether the earned surplus of non-corporate business entities proposed under this article would be considered an income tax and thereby subject to Article VIII, Section 24 of the Texas Constitution, the estimated revenue gains from enactment of this section are contingent upon voter approval of a constitutional amendment clarifying that issue. In addition, the proposed Committee Substitution for House Joint Resolution 4 would have to be amended to clarify that the franchise tax would apply to income earned after December 31, 1996. SALES TAX BASE EXPANSION FISCAL ANALYSIS The bill would expand the taxable base of the sales tax to include previously exempted items or services. Items that became taxable as a result of this article would be subject to local government sales taxes. Cities and counties would hold elections to select the manner in which the additional sales tax revenue would be spent. Transit authorities, however, would have their tax rates reduced to offset an increased tax base unless voters approved an exemption to the reduction. A temporary prior contract exemption would be provided, set to expire January 1, 2000. This section would take effect October 1, 1997. METHODOLOGY The fiscal impacts were based on the Comptroller's 1997 study, Sales and Franchise Tax Exemptions. An incremental increase to the state sales tax was estimated for each proposed item, projected through fiscal 2002 using appropriate economic variables, and adjusted for an effective date of October 1, 1997. It is not known how cities or counties would allocate their additional sales tax revenue. This analysis assumes that transit authorities would experience a permanent reduction in their sales tax rates. The fiscal impact on certain special purpose districts, such as crime control and prevention districts, hospital districts, or municipal management and improvement districts, cannot be determined. INCREASE AND EXPAND INSURANCE PREMIUM TAXES FISCAL ANALYSIS The bill would amend various articles in the Insurance Code to eliminate certain insurance premium tax credits and exemptions, to revise the insurance premium tax rate structure, and to eliminate the franchise tax credit available to title insurance holding companies. METHODOLOGY The potential fiscal impact of the provisions in this article was estimated based on Comptroller tax collection data and the 1998-99 Biennial Revenue Estimate. LOTTERY SURCHARGE FISCAL ANALYSIS The bill would amend the State Lottery Act to increase the state share of lottery proceeds through a reduction of the prize percentage. This article would take effect September 1, 1997. METHODOLOGY The estimate fiscal impact was based on the 1998-99 Biennial Revenue Estimate, as adjusted to reflect the change proposed by this article. OTHER AMENDMENTS TO THE TAX CODE The bill would also amend the Tax Code to increase excise taxes on Alcohol and Tobacco Products. It would repeal the motor fuels tax exemption on aviation fuel and the exemption for certain commercial vessels. It would increase various other taxes. ADMINISTRATIVE COST The bill would increase the tax base by an estimated 700,000 new taxpayers. All major activities of the Comptroller's Office would be affected by the increased workload. Assuming that voters would approve the amendment proposed by CSHJR 4 in 1997, the Comptroller's Office would require an emergency appropriation of $2 million in fiscal 1997 to begin educating and notifying the new taxpayers, training current staff, hiring contract programmers, and purchasing additional computer hardware. When all provisions of the tax bill are fully implemented the following activities would require additional personnel: The Audit Division would require 48 additional auditors and support staff to handle the increased workload. The Enforcement Division would require 100 additional taxpayer compliance officers and support staff for increased field assignments. The Revenue Processing Division would require 84 additional accounts examiners for file maintenance responsibilities. The Property Tax Division would require 65 additional appraisers and support staff to administer the state ad valorem tax. Finally, the Tax Policy Division would require 60 additional policy analysts to assist new taxpayers. This administrative cost estimate does not include funds for additional leased-space or facilities for 357 FTEs. Methodolgy GENERAL Some provisions of the bill, are contingent on the adoption of a constitutional amendment proposed by House Joint Resolution 4, Seventy-fifth Legislature, Regular Session, 1997. The proposed constitutional amendment will be submitted to the voters at an election to be held August 9, 1997. The probable fiscal implications of implementing the provisions of the bill during each of the first five years following passage is estimated as follows: Five Year Impact: Fiscal Year Probable Probable Revenue Probable Revenue Probable Net Savings/(Cost) Gain/(Loss) from Gain/(Loss) from Revenue from Foundation General Revenue General Revenue Gain/(Loss) from School Fund Fund - State Ad Fund - Expansion General Revenue Valorem Tax on of State Fund - Business Property Franchise Tax Base Expansion of Sales Tax Base 0193 0001 0001 0001 1998 ($6,248,200,000) $4,033,871,211 $387,709,000 $506,552,000 1998 (6,649,100,000) 4,094,379,279 375,117,000 677,068,000 2000 (6,961,000,000) 4,155,794,968 356,606,000 721,828,000 2001 (7,147,300,000) 4,218,131,893 377,075,000 759,538,000 2002 (7,441,900,000) 4,281,403,871 413,117,000 796,117,000 Fiscal Year Probable Revenue Probable Revenue Probable Revenue Probable Revenue Gain/(Loss) from Gain/(Loss) from Gain/(Loss) from Gain/(Loss) from General Revenue General Revenue General Revenue Foundation Fund - Insurance Fund - Lottery Fund - Other Tax School Fund Premium Tax Increases 0001 0001 0001 0193 1998 $169,904,000 $130,926,000 $505,334,000 $49,590,000 1999 230,770,000 168,986,000 702,991,000 85,243,000 2000 235,344,000 177,418,000 698,881,000 89,311,000 2001 240,027,000 184,278,000 729,247,000 92,161,000 2002 244,852,000 188,619,000 722,492,000 95,266,002 Fiscal Year Probable Revenue Probable Revenue Probable Probable Change in Number Gain/(Loss) to Gain/(Loss) to Savings/(Cost) Savings/(Cost) of State local School Counties/Cities Comptroller Office of Employees from Districts - Administrative Attorney General FY 1997 Cost - General Administrative Revenue Fund Cost - General Revenue Fund LCL-SCHOOL LCL-COUNTY 0001 0001 1998 ($6,262,000,000) ($72,123,000) ($107,839,180) ($1,264,028) 295.0 1999 (6,525,000,000) (111,210,000) (104,597,079) (1,201,496) 295.0 2000 (6,833,000,000) (117,898,000) (107,700,983) (1,201,496) 373.0 2001 (7,100,000,000) (123,470,000) (106,637,767) (1,201,496) 304.0 2002 (7,378,000,000) (128,804,000) (108,706,753) (1,201,496) 304.0 Net Impact on General Revenue Related Funds: The probable fiscal implication to General Revenue related funds during each of the first five years is estimated as follows: Fiscal Year Probable Net Postive/(Negative) General Revenue Related Funds Funds 1998 ($573,416,997) 1999 (420,344,296) 2000 (634,719,511) 2001 (654,681,370) 2002 (809,941,376) Similar annual fiscal implications would continue as long as the provisions of the bill are in effect. Source: Agencies: 302 Office of the Attorney General 304 Comptroller of Public Accounts LBB Staff: JK ,BR ,GC ,DD