In Texas, School Growth Clashes With a Shrinking Budget

AUSTIN, Texas — It's impossible to understand the fiscal challenge ahead of Texas until you realize how fast the state's population is growing. Texas grew feverishly throughout the past decade, not only in the boom years before the recession but right through the recession years, as well. In all, the state added 4.3 million new residents, a 21 percent surge that surpasses any of the other five largest states, including Florida, which has actually declined in population since 2008. 

It is not the extent of the growth that poses the biggest challenges for Texas. It is the nature of that growth. Texas is taking in massive numbers of school-age children, an increasingly large share of whom do not speak English as a native language. On average, the state's schools enroll more than 500 new students every school day.

The influx of the young and foreign-born would seem to demand heavy spending on education. Instead, a conservative Republican governor and legislature are slashing school expenditures and refusing to raise taxes.

That is why, a few years from now, Texas' fiscal future could be determined in a courtroom. On one side will be a group of school districts, suing for more money. On the other will be the lawyers for the state. If the court rules in favor of the schools, which seems likely based on past decisions, lawmakers will have to find a lot more education money — enough to force changes on the entire state fiscal system that will likely go farther than the ones being enacted this year. 

Not that this coming year's budget won't represent real change. Traditionally, Texas budgets have been very lean, and the next one will be leaner than most. The legislature is grappling with the effects of the recession and a structural budget deficit to erase a shortfall of as much as $27 billion over a two-year period. The state House and Senate remain about $12 billion apart, suggesting they may have to call a special session this summer to pass a budget.

No matter what the final agreement is, the new budget will include billions of dollars of cuts to K-12 education. The House has recommended cutting nearly $8 billion. Not long after the budget is adopted, the school districts are likely to sue, setting in motion a long-term legal process that may very well reverse those education cuts and force lawmakers to find some other way to put the state budget back into balance. 

Even further into Texas' future is the question of how the state will pay for the high costs of Medicaid should the federal health care overhaul remain intact. Texas dedicates a smaller portion of state funding to Medicaid than every state but Wyoming. The federal government is poised to pick up nearly all of the tab for increased Medicaid enrollments through 2019. But by 2020, Texas, like every other state, would have to pay 10 percent of the new costs, plus its existing Medicaid bill.  

Most legislators aren't looking that far down the road, of course. They are fixated on the budget problems in front of them. "They say we're concerned about the future, but the future has to take care of itself," says Bill Hamilton, the state's former deputy controller. "Right now we have to make this current budget work. That's kind of where they are." 

Declining revenue

Texas fared better during the recession than most states. Its unemployment rate topped out at 8.3 percent in January — lower than the national average — and has since started to decline. In March, the state added 37,200 new jobs, roughly 17 percent of all the new jobs created in the United States, according to the U.S. Census Bureau. Meanwhile, home prices in Texas never cratered, as they did in California or Florida. 

Yet Texas is in fiscal trouble. Quarterly revenue dropped 26 percent from its peak in 2007 to the trough of the recession in 2009 — and revenues still haven't recovered to what they once were. Because it doesn't have an income tax, Texas relies on the sales tax for about 60 percent of its tax revenue. Sales tax revenues came in below projections during the current biennium, forcing the state to have to close a $4.3 billion gap in the current fiscal year before addressing the much larger imbalance for the next biennium. 

But the recession is not the only cause of Texas' fiscal troubles. A 2006 change in school financing gave the state more of the burden of funding education, while providing homeowners with a significant break on their property taxes. 

The change resulted from a lawsuit brought by a coalition of school districts that contended the state's traditionally low level of funding forced them to boost the local property tax rate to the maximum level permitted. The funding structure, they argued, essentially created a statewide property tax, which is illegal under the Texas constitution. The court agreed and directed lawmakers to find a solution. The legislature decided to cut local property taxes by about one-third, while increasing the state cigarette tax and rewriting the state tax code for businesses — known as the franchise tax — to compensate. To sweeten the deal, lawmakers also boosted teacher pay by about $2,000 a year. 

But even in the rosier economic days of 2006, projections showed that the new taxes wouldn't come close to making up the revenue difference. Only about 60 percent of the roughly $7 billion lost every year from the lower property taxes was accounted for. In effect, lawmakers had enacted a sweeping tax cut. They promised the schools they would be kept whole but didn't come up with a long-term funding stream to make do on that promise. 

"Hot check"

That kind of bet might have seemed plausible in 2006, when the economy was booming. But even then, some officials saw trouble lurking. Carole Strayhorn, then the state's comptroller, wrote to Governor Rick Perry calling the plan "fiscally irresponsible" and accusing him of writing "the largest hot check in Texas history." Strayhorn said the change eventually would make it necessary for the state either to raise taxes or drastically cut public education.

As it happened, the situation now is even worse than anticipated then. The franchise tax brought in more than $2 billion less than had been expected every year, exacerbating the budget gap. During the 2009 session, lawmakers were able to patch up the budget with federal stimulus money, putting off the hard decisions until now. There aren't a lot of options, according to Dick Lavine, senior fiscal analyst for the Center for Public Policy Priorities, an Austin think tank. "You either need a new source of state revenue, or you have to allow the school districts to raise their local property tax rates back up, or you have to reduce the amount of funding for public education," he says. "That seems to be the range of options." 

Lawmakers so far have been trying to balance the budget almost exclusively with cuts. In March, the House approved a budget for the next biennium that is $23 billion — or 12.3 percent — smaller than the current two-year budget. It would spend $7.8 billion less on K-12 education. The Senate recently passed a plan that would cut $11 billion overall and $4 billion from schools but would also take $3 billion from the state's rainy day fund and use a variety of accounting maneuvers to balance the budget. Reconciling those plans and getting the governor to sign off won't be easy.

Litigation option

School districts are watching closely. David Thompson, a Houston lawyer who argued the 2005 case on behalf of the schools, says it's not guaranteed that schools will sue again, but it may have to come to that."If we wind up with requirements or mandates that simply can't be supported and fulfilled with the money available," Thompson says, "then obviously we have to look at the litigation option."

Like many states, Texas is constitutionally required to provide an adequate education to its students. School advocates around the country have used that adequacy requirement to bring court cases aimed at forcing
lawmakers to spend more on education. In the majority of those adequacy lawsuits, courts have sided with the schools, suggesting that Texas school officials could once again prevail in court. That would put intense pressure on lawmakers to find a way to boost school funding. "They've got to fix that issue," says Thompson. "Otherwise when we come back in 2013, this is a structural problem that is simply going to continue to get worse."

In the view of Lavine, the fiscal analyst, it is the school funding problem that could bring about a revolution in state finances, putting pressure on lawmakers to diversify and strengthen the state's revenue streams. "It could be that this is when they run out of alternatives and really have to restructure the revenue system," he says. 

Of course, there's always the possibility that the economy will improve enough for revenues to bounce back and put off the state's day of reckoning. Sales tax collections have been rebounding enough that Comptroller Susan Combs added $300 million to her projected revenues for the current fiscal year. She also foresees an 8 percent increase in sales tax receipts in 2012-13, an optimistic figure but one that several economists say is achievable.

Increasing oil prices also could help Texas in a big way. Since much of the state's oil and gas tax revenue goes to the rainy day fund, Texas could find itself with a balance of more than $12 billion, which would create new political pressures to spend a significant portion of it. 

A big wildcard, however, is whether all the budget-cutting going on in Texas will ripple through the state's economy in the form of layoffs. The state's Legislative Budget Board estimates that the severe cuts envisioned by the House budget could result in the loss of 330,000 jobs over baseline projections in 2013. Of those jobs, more than 40 percent would be private sector jobs that depend on state spending. 

Perry and some lawmakers have said that estimate is overblown. Still, about 1 million people currently are out of work in Texas, and losing anything close to 330,000 jobs would push the unemployment rate substantially higher and depress sales tax collections. Bill Hamilton, the former deputy comptroller, calls those lost jobs "an anti-stimulus." 

Hamilton says lawmakers are betting that this recession will look like the last one that state weathered, in 2002-03. Although the legislature made some painful cuts, Texas benefited from a strong rebound driven by the real estate market. 

"This one's going to be a little harder to come out of just because of the stagnant nature of the national economy," Hamilton says. "What this really looks more like to me is the 1980's." Back then, the collapse of the oil industry — which accounted for a larger share of the state's revenue at the time — brought down real estate and banking with it. "It took a matter of five or six years to get out of that problem," Hamilton says. "And I think that's what we're going to have here." 


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