Houston’s revenue cap, which went into effect in 2004, shows how property tax reform laws can impact the ability of cities and counties to fund services and infrastructure.
Photo by Jose Losado / Unsplash

The state’s property tax reform bill, which limits the amount cities and counties can raise property taxes to 3.5%, is expected to significantly affect one of the largest sources of revenue for local governments. Many will be looking for ways to circumvent the financial constraints of the measure. That’s something Houston has been dealing with since 2004.

For the past 16 years, the City of Houston has operated under a so-called “revenue cap” — a limit on the amount of property tax revenue it can collect each year, which, over time, has indirectly pushed the city’s property tax rate consistently downward.

Whether this is a good thing or a bad thing depends on your perspective about the city government’s need for revenue and its approach to spending money. But one thing is clear: Now that property tax reform has been passed at the state level, other cities are likely to be in the same boat before too long.

State’s property tax reform law is similar to Houston’s revenue cap

Property taxes are controversial in Texas, in large part because they are higher here than they are in most other states. According to WalletHub, Texas has the seventh-highest effective property tax rate of any state — higher than New York, Michigan, Ohio and California. In part, this undoubtedly is due to the fact that Texas has no state income tax, though other Southern states with no income tax have lower property taxes.

The state’s property tax reform takes the same approach as Houston’s revenue cap, which was passed in 2004. The revenue cap limits the annual growth of property tax revenue to the combined rates of inflation and population growth or 4.5%, whichever is lower. (Though voters later allowed the city to raise $90 million per year on top of that cap to pay for public safety). The state property tax reform law limits increases in property tax revenue to 3.5% without a vote, though new construction is exempt from this cap.

As a result of the revenue cap, Houston’s property tax rate has diverged from that of Dallas. According to a new Kinder Institute report on large-city finances in Texas, Dallas and Houston had approximately the same property tax rate 20 years ago — about 66 cents per $100 of assessed value. Today, however, Dallas’s property tax rate is 77 cents per $100, while Houston’s is approximately 57 cents per $100 — about 35% lower. (The Kinder Institute report used city budget documents to update analysis on this topic originally conducted by the University of Houston Hobby School for Public Policy.)

Now, however, Dallas, San Antonio and other cities and counties in Texas will be subject to a revenue cap similar to Houston’s unless they can persuade voters to raise the cap. Though the exemption for new construction will be of benefit to the local governments (for example, Dallas in FY 2019-2020 budgeted a 3.5% increase in revenue from the tax rate and another 2.7% increase from new construction), the property tax reform law will constrain the state’s cities and counties in a way that’s similar to how the revenue cap has constrained Houston.

The impact on local governments will be somewhat delayed because of a provision in the property tax reform law that lifts the restriction if a state of emergency is declared, which Gov. Greg Abbott did this spring because of the COVID-19 crisis. But once the crisis is over, cities and counties throughout Texas will have to face up to the state’s cap on property tax revenue.

Cities will be looking for loopholes

One thing cities are likely to do in response to the state cap is look for workarounds. And Houston’s experience suggests that one workaround does exist: tax increment reinvestment zones.

Under state law, TIRZs take a portion of increased property tax revenue from a particular geographical area and reinvest those funds in infrastructure and public improvements in that same district. TIRZs are widely used around the state and across the nation, but Houston diverts far more property tax revenue to TIRZs than other cities — perhaps as a result of the revenue cap. (Money diverted to TIRZs does not count against the city’s revenue cap.)

According to the Kinder Institute report, TIRZs account for about 14% of Houston’s land area, compared to 5% in San Antonio and 2% in Dallas. The amount of property tax money diverted to TIRZs is also much greater — about $140 million in Houston, compared to $70 million in Dallas and $20 million in San Antonio. In some cases, Houston TIRZs contract with the city to engage in infrastructure improvements that, under other circumstances, might have been paid for by the city itself.

Houston’s approach to TIRZs is unusual at this point. But as other cities in Texas bump up against the state property tax limit, the Houston experience could become the norm.