Texas famously does not have an income tax, but it does have a tax on businesses’ gross receipts — not profits, but cash flow. This is the “franchise tax.” The tale of how that came to be might be filed under: How to take a race-baiting class-warfare lawsuit and turn it into a pretty good tax cut that basically everybody hates. Texas politics gets a little weird sometimes. (Warning: Wonkiness Ahead.)
Back in the dark ages of 1984, the Mexican American Legal Defense and Education Fund (MALDEF) filed a lawsuit against the state of Texas on behalf of the Edgewood Independent School District of San Antonio, alleging that Texas’s system of public-school finance, which relied almost exclusively on local property taxes, was unconstitutional. Because some districts are property-rich and some are property-poor, the same tax rate produced wildly different revenues from community to community. MALDEF argued that, under the state constitution, funding public schools was a state responsibility, not a mainly local one. The Texas Supreme Court, in a unanimous ruling, upheld MALDEF’s complaint, and there followed a decades-long saga that found the Lone Star State trying to construct a new system of school financing that would pass constitutional muster, and failing twice before it settled on a plan.
The new funding plan, adopted in 1993, had two salient features: a hard cap of $1.50 in school taxes per $100 in property value to fund “maintenance and operations” — your basic day-to-day school stuff, not including bond issues for capital improvements — and a condition that any revenues in excess of a statewide per-student ceiling be “recaptured” by the state and transferred from wealthier school districts to poorer ones. The latter feature gave the program its nickname, the “Robin Hood system.” Wealthy school districts were given a choice: They could either have their “excess” funds expropriated by the state and redistributed, or else enter into an agreement with a poorer cousin and transfer the money themselves.
But Texas’s constitution is a complicated document. In addition to prohibiting a state income tax, it also prohibits a statewide property tax. Pretty soon, practically every district in the state had run up against that $1.50 per $100 cap in order to meet statewide educational mandates, meaning that the state in effect had a uniform rate of property taxation to support schools. Another plaintiff argued that this, was equivalent to an unconstitutional statewide property tax, and the Supreme Court agreed in a 2005 ruling.
That left the Texas legislature with a three-pronged problem: First, it had to give local school districts enough discretion that the state would no longer have what amounted to a statewide property tax for schools. Second, it had to make sure that school districts were still able to raise sufficient revenues to get the job done. Third, it wanted to do both of those things without opening the door to endless, uncontrolled property-tax increases.
In 2006 the Texas legislature enacted a new plan to try to get all of that done. But Texas does things a little differently: Rather than raise the property-tax cap, the legislature cut it by a third, from $1.50 per $100 to $1.00 per $100, but allowed local school districts to raise taxes beyond that cap — on the condition that voters approved the tax hike in a referendum. Voters are not much inclined to do that, and the legislature didn’t want public-school revenues cut by a third overnight, so it rejiggered its statewide business tax, changing the formula for calculating tax liabilities and applying it to more kinds of businesses, i.e. broadening the tax base. The idea was that the new revenues generated by the revised franchise tax would offset the one-third reduction in the property-tax ceiling.