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Voters Pass a Cap on Property Tax Revenues
In 2004, voters in the city of Houston passed a limit on the amount of property taxes the city can collect. To raise property tax revenues above the limit requires voter approval. Without voter approval, the limit in the growth in property tax revenue is the lower of 1) an increase of 4.5% over the revenue in the previous year or 2) fiscal year 2005 revenues adjusted for population growth and inflation in each year.
The city finance office reports that the limit has reduced the total property tax revenues collected by $2.23 billion since fiscal year 2015.[1] This calculation assumes the property tax rate is constant at the 2015 value. However, experience indicates that city leaders will likely reduce the tax rate to win political points as property values increase rapidly. In addition, a state limit on property taxes took effect in January 2020, which preempts that city provision after that date if it is the binding limit. Therefore, an accurate estimate of the reduction in the city’s property tax collections should account for the state revenue limit. Nonetheless, the voter-approved proposition in 2004 has likely slowed the rise in property taxes collected from taxpayers in the city of Houston, as the voters intended.
Even with the limit, property taxes have grown faster than population growth and inflation. There are several reasons for this. One of the most notable is the passage of Proposition H in 2007, which added a $90 million public safety exception to the limit on property taxes. However, property taxes would have grown faster than population growth plus inflation without Proposition H. To this day, the city collects an additional $90 million yearly for public safety.
This brief discusses the growth in property tax revenues over the last two decades. In addition, it discusses whether limits on property tax collections have reduced revenues relative to annual increases in population plus inflation, a standard measure of the resources needed to maintain a constant level of real public services. It also discusses the ability of taxpayers to shoulder the financial burden of rising costs of public services and concludes with some broad suggestions for creating a sustainable city budget.
Growth in Property Tax Revenues
A good starting point is to examine the growth in property tax revenues in the city of Houston over the last two decades, specifically the limit’s impact on property taxes. The limitation on property taxes is intended to protect taxpayers from unreasonable and unsustainable increases. It does this by limiting increases in property tax revenues to the lower of 1) the sum of inflation plus population growth or 2) 4.5%. However, not all sources of property tax revenue are constrained by the cap. Thus, it is essential to examine the total increase in property tax revenues that impact taxpayers as opposed to only those revenues included in the city’s budget.
Table 1 shows the average annual growth rate in the population of the city of Houston, inflation (as measured by changes in the consumer price index), the combined growth in population plus inflation, property taxes as reported in the recent proposed budget, and total property tax collections. It is important to note that total property tax collections include the revenues transferred to tax increment reinvestment zones (TIRZs), which are zones created by Houston City Council to attract new investment. The tax collections transferred to the TIRZs are not included in calculating the limit on property taxes. Figure 1 shows a graph of property taxes in the budget and total property tax collections.
Figure 1 — Property Taxes in Budget Proposal and Total Property Tax Collections ($ in Thousands)
In Table 1, each variable’s average annual growth rate is shown for fiscal years 2005–14, 2015–24, and 2005–24. The break in the 2005–24 timeframe captures the fact that the property tax limit was not binding until fiscal year 2015. If the limit on property taxes is effective, there should be a reduction in the growth of property tax revenues from 2015 to 2024, relative to 2005 to 2014. Table 1 reveals several interesting trends about the growth rate of property taxes over the last two decades.
Table 1 — Compound Annual Growth Rates
The first row of Table 1 shows the annual growth rate of the population in the city of Houston for the three time periods. Row 2 shows average inflation over the last two decades and a breakdown before the property tax cap was binding (2005–14) and after the property tax cap was binding (2015–24). Average annual population growth has been falling over the last two decades, growing by 0.9% from 2005–14 and 0.5% from 2015–24. The city’s population growth was negative in 2020–22, partly due to population movements related to the pandemic. However, Houston’s population has been trending down for the past two decades and has been roughly flat since 2017. A lack of population growth will significantly impact the city’s financial health, making it harder to close the existing structural budget deficit.
Inflation has followed a very different path than the city’s population growth. Inflation was low from 2004–20. However, inflation has spiked to a near-record high of 8.2% in the last several years. While inflation has fallen considerably since June 2022, the current level is still moderately high relative to the Federal Reserve’s target inflation rate of 2%.
There is considerable uncertainty regarding how much longer inflation will remain elevated. Higher inflation impacts the city’s financial position in several ways, with two significant impacts in offsetting directions. Inflation raises the cost of providing city services and the revenue from sales taxes, property taxes, and other sources. In addition, inflation will reduce the real value of existing debts, especially if the interest payments on the debts are fixed. It will also affect the financial health of the city’s pension funds to the extent that the level of inflation is different from the level assumed by the pension in its actuarial projections. In the case of pensions, it also has offsetting impacts, and the net effect is hard to predict. Finally, high inflation will shrink the difference between the city’s property tax limit and that of the state.
Row three of Table 1 shows the sum of population growth plus inflation, an essential economic concept that reflects how quickly the cost of city services should grow to maintain the same level of real benefits for each city resident. If the population and prices are constant, no additional expenditures are required to provide the same level of city services. Table 1 shows that the city of Houston’s population growth plus inflation was 3.2% over the last two decades, 3.3% from 2005–14, and 3.0% from 2015–24.
Table 1 also shows that the average annual property tax growth rate, calculated from data presented in the mayor’s proposed budget for 2025 (excluding the $90 million in additional revenues under proposition H), was 3.5% over the last two decades, 3.9% from 2005–14, and 3.1% from 2015–24. Thus, during the previous two decades, property taxes have grown faster on average than population growth plus inflation by roughly 0.3%. Before the property tax cap was binding (2005–14), the difference was more significant at 0.6%. After 2015, when the property tax cap was binding, property taxes grew 0.1% faster than population growth plus inflation.
Hence, the property tax cap did restrain growth in property taxes. The increase in property tax revenues has been faster than necessary to provide a constant level of real benefits to the residents of Houston. To the extent that the provision of many city services such as water, sewage, garbage, and public safety benefit from economies of scale, this conclusion is more robust. But this is only part of the story. As presented in the mayor’s proposed budget, the property tax data leaves out a significant fraction of total property taxes collected from city residents and businesses.
According to the city’s annual comprehensive financial report (ACFR) and as shown in row 5 of Table 1, total property tax collections grew at an average annual growth rate of 4.6% from 2005 to 2024, 1.4% faster than population growth plus inflation.[6] From 2005 to 2014, before the property tax cap was binding, total property tax collections grew at an average annual growth rate of 4.7%, 1.4% faster than population growth plus inflation. From 2015 to 2024, after the property tax cap was binding, total property tax collections grew at an average annual growth rate of 4.4%, 1.4% faster than population growth plus inflation. Total collections grew at an annual growth rate roughly 1.4% larger than population growth plus inflation before and after the property tax cap was binding. Taxpayers in the city of Houston have yet to see much relief in the total burden of city property taxes from 2005–24, contrary to much of the data provided in various city documents.
Given the Revenue Limit, How Have Total Property Tax Revenues Grown So Fast?
As shown above, total property tax collections grew at an annual rate of 4.4%, 1.4% faster than population growth plus inflation, while the property tax limit was in effect from 2015 to 2024. Why was the limit relatively ineffective at slowing total property tax collections? Before the limit was binding, total property taxes grew at 4.7%, also 1.4% faster than population growth plus inflation. And why are total collections growing 1.3% faster than property taxes reported in the city’s budget documents in the period that the revenue limit was binding (2015–24)?
The primary difference between the property taxes in the mayor’s proposed budget and total property tax collections are property tax revenues collected for use by TIRZs.[7] The 2023 ACFR states that the taxes shifted to the zones equaled $245.6 million. This is consistent with the 2022 ACFR that shows that the city budgeted for “$296.4 million of tax increments to be transferred to special funds for the zones, as required by State law, of which approximately $48.3 million will be transferred back to the City for affordable housing projects, an administrative fee and a fee for municipal service costs.” This implies that revenues transferred to TIRZs are roughly 15.8% of total collections (13.3% net of the fees for affordable housing, administration, and municipal services) and 19% of property taxes included in budgeted resources ($1.38 billion).
The city’s property tax limit calculation does not include revenues transferred to the zones. This implies that as the city creates new zones or expands and extends the life of existing zones, it effectively transfers future property tax revenue from the city’s general budget into the zones. The revenues fund various projects in the zones under the control of a small number of unelected officials. It is not a coincidence that TIRZs rarely dissolve after completing their initial objectives. If a TIRZ ends, the tax increment would return to the city’s budget, and future increases in the value of those properties would impact the calculation of the property tax limit. This change would tighten the property tax cap, leaving less revenue for city leaders to spend and more money in the pockets of taxpayers.
Thus, excluding the increment from the property tax cap creates a dangerous incentive for city leaders to allow some of the most valuable parts of the city, especially those whose taxable value is expected to grow relatively fast, to be transferred to TIRZs (e.g., Memorial City, Uptown, Downtown, Medical Center, and others that are not blighted areas). By doing so, the city can accomplish two goals: 1) shift some of the costs of providing public infrastructure to the newly created zones, easing its budget issues, and 2) reduce the effectiveness of the property tax limit by shifting faster-growing areas to TIRZs. Suppose that the city includes relatively high-growth areas in the zones. In that case, the tax rate necessary to comply with the property tax limit will ignore the rapidly increasing value of the tax increment in the high-growth areas. Table 1 shows that the difference in the growth of property taxes included in budgeted resources and total collections is growing over time. The difference in budgeted taxes and total collections from 2005–14 was 0.8%. After the revenue limit was binding (2015–24), it was 1.3%. This trend is likely to negatively impact the city, especially areas outside of the TIRZs.
An article in the Houston Chronicle indicates that this strategy may be in play. The article states that “this cap doesn’t apply to TIRZ revenue. So Turner’s transition team advised him to ‘shift the funding responsibility’ for projects from the city to TIRZs and free up dollars in the city budget.” The article also states that former mayors Annise Parker and Sylvester Turner expanded and extended the life of many zones, including several in high-growth areas. The process shifts revenues from the city’s general budget to specific zones in the city and gives control of the funds to unelected and unaccountable TIRZ boards. It is hard to argue that the Uptown area or the Memorial Park area is in any way “blighted,” and these areas were almost certainly predicted to grow relatively fast in terms of taxable value both 20 years ago and today.
In the Houston Chronicle article mentioned above, former Mayor Parker, who opposed the property tax limit, argued, “The reason we create TIRZs is because there’s not some infrastructure fairy that comes and puts money under your pillow.” But aren’t property taxes and other city revenues collected to do that — fund infrastructure and other city services? The analysis above shows that property taxes have grown 1.4% faster than population growth plus inflation for the last 20 years. Yet, a structural budget deficit has persisted and gotten worse. A lack of revenue has not created the city’s current problems, and raising revenues to solve the problem could make the situation worse rather than better. The cost of government cannot continually grow faster than the income of the residents who fund the government. That is the bedrock of an unsustainable government finance system.
This raises an interesting question: What would the total burden of city property taxes be if the property tax cap had not been in place? The last row of Table 1 shows that the annual growth rate of property taxes would have been 7.5% from 2015 to 2024 if there was no property tax cap and the tax rate remained constant at its 2015 value. That is 4.5% greater than population growth plus inflation during the same period! This would be a significant burden on the taxpayers of the city of Houston. However, as discussed above, the 2020 state property tax cap (and the potential for token reductions in the property tax rate as property values skyrocket) would have mitigated some of these increases.
The state-imposed limit on property tax revenue was enacted in Senate Bill 2, the Texas Property Tax Reform and Transparency Act of 2019. The state limit on property tax revenue increases is 3.5% but can be averaged over the last three years. When the Legislature enacted the state property tax cap, it appeared as though the city of Houston property tax cap would be the lower of the two limits (and thus it would be the effective limit). This was the likely outcome because population growth plus inflation was consistently around or below 3.5%, which implied that the city property tax cap would increase more slowly than the state cap. However, the recent spike in inflation and continued moderate rates of inflation above 3% have increased the likelihood that the state limit on property tax revenues could become the binding limit, though it may not stay that way permanently. For example, the 2023 state limit equals 0.523479, which is the voter-approval tax rate adjusted for unused increment (the unadjusted rate is 0.494955) per $100 of taxable value. The city property tax cap implies the fiscal year 2024 tax rate of 0.51919 per $100 of taxable value. The city and state limits on property taxes are similar. The comparison of population growth plus inflation and the state rollback rate of 3.5% will continue to impact which of these limits is binding.
One note about how the city calculates the limit on property tax revenues is interesting. The city does not use population growth plus inflation if the population growth rate is negative. Instead, in years when the population growth rate is negative, it appears the city uses inflation only to adjust the limit. For example, see the calculation of fiscal year 2021 and 2022 limits in the fiscal year 2025 proposed budget. Given the lack of growth in the city’s population over the last decade — and the recent data highlighted by Bill King on population growth by city size — if inflation returns to the Federal Reserve’s target of 2%, the city’s limit on increases in property tax revenues may continue to be the binding limit. However, if the current moderate- to high-inflation environment continues to hold, the state limit will eventually take over as the binding limit.
Are Taxpayers Pockets Deep Enough to Solve This Problem?
Consider some economic factors facing the city of Houston and its residents. Figure 2 shows sales tax revenues from 2015 to 2024, where fiscal year 2024 is estimated based on nine months of actual data. Sales tax revenue grew 3.1% from 2015–24 and 4.6% from 2018–24. Population growth plus inflation rose at an annual rate of 3% over 2015–24. After the decline in oil prices at the end of 2014, average yearly sales tax revenue grew by about 1% from 2015–21. Real sales tax revenues declined slightly over this period. From 2021–24, average annual sales tax revenue grew by 7.6%. Sales tax revenue is a volatile source of revenue as it ebbs and flows with economic cycles.
However, with such a rapid increase in sales taxes in the last several years, the city’s budget position should be much better than it is now. As discussed in my previous research on the state of Houston’s finances, this is a source of risk facing the city’s current fiscal position. Unfortunately, the latest data presented by the Greater Houston Partnership shows that sales taxes in the city of Houston are down 2% in the first quarter of 2024 relative to the first quarter of 2023. By comparison, sales tax collections in the Houston metropolitan area were up 0.2% over the same period.
Figure 2 — Sales Tax (Fiscal Year, $ in Thousands)
Water and sewer rates have also increased rapidly since 2014. While it is difficult to calculate precisely, the average increase in the water rate has been 6.5%, and the average increase in the sewer rate has been 8.1%.[8] King states that from 2021–26, water rates will increase by 50%–78% depending on usage. These rate adjustments have significantly impacted the financial health of the Combined Utility System’s (CUS) net position. As King noted, the increase in CUS’s net position from slightly negative to $3.1 billion will allow the city to make necessary investments in its water and sewage infrastructure. This is a bright spot in the city’s financial picture. However, these fees will continue to be a burden on the pocketbooks of city residents.
City of Houston residents and businesses have faced significant increases in property taxes, sales taxes, and water and sewage fees over the last several years. Other local governments, such as school districts and counties, may also raise taxes and fees. For example, Harris County’s finances have deteriorated recently, requiring additional revenues and less spending to reach a sustainable budget. By contrast, per capita personal income of city of Houston residents grew at an annual rate of 2.3% from 2014–21.[9] Data on average hourly earnings of private employees in the Houston metropolitan area show that wages have increased by 2.7% per year from 2015 to 2024.[10] The personal incomes of the city’s residents are not keeping pace with the increases in taxes and fees, even with the limit on property tax increases in effect. If the property tax cap had not been in effect, Houston residents would have faced an additional increase in property taxes. However, as noted above, it would be less than the city’s finance department estimate of $2.3 billion, as reported in the FY2025 Budget Overview and General Fund Five-Year Forecast.
An article in Bloomberg News states that “almost two-thirds of Americans considered middle class said they are facing economic hardship and don’t anticipate a change for the rest of their lives.” In addition, roughly 25% of those making over $150,000 struggle to make ends meet. While the major economic indicators of the economy are strong — including gross domestic product (GDP), employment, and the stock market — households are facing significant financial headwinds. According to the article, these headwinds include housing affordability and rising debt payments driven by substantial increases in mortgage and interest rates, increasing insurance costs, rising childcare costs, and high home prices as homeowners with historically low mortgage rates are reluctant to sell. Additionally, households are tasked with saving for emergency expenses and retirement while managing the costs of utilities, food, transportation, and recreational activities. The last thing Houston residents can afford is property tax increases, especially increases as large as those that would have occurred in the absence of city and state property tax caps.
It’s a Spending Problem, Not a Revenue Problem
Contrary to the political narrative that the city has a revenue problem, the property tax cap did not cause the current financial issues facing the city of Houston. Excessive spending (on things other than infrastructure) has been, and continues to be, the city’s major problem. Some of that spending is unavoidable, such as the massive expenses related to public employee pensions, which resulted from overly generous benefits changes (over two decades ago) and led to skyrocketing pension contributions that the city often failed to make. Nonetheless, the city must identify ways to reduce spending significantly.
However, the city cannot decrease spending across the board, as noted in my previous research. Additional expenditures on infrastructure such as water, roads, and drainage are critical. The problems facing the city are related to the allocation and level of spending. The city must target its reductions carefully and find cost savings through sharing costs with other local governments. It should also consider whether it can afford to continue allocating half of the city’s sales taxes to its public transportation system, METRO, especially given the track record of spending hundreds of millions or billions of dollars on projects based on ridership numbers that are massive overestimates. While METRO should continue on a smaller and more efficient scale, it is necessary to significantly reduce expenditures and reallocate funds to infrastructure improvements.
The city cannot afford to continue transferring significant revenues to the TIRZs. Continuing on a path where more and more of the city’s property tax revenues must be spent within these zones will create problems, especially in areas outside the zones. In addition, the lack of transparency of the TIRZs and the inefficient allocation of expenditures make it difficult to determine if the city’s best interest is a top priority. It is dangerous to allow 15% of the city’s property tax revenues to be controlled by unelected boards that are not accountable to its residents.
The immediate goal should be to restrain growth in the city budget to be less than population growth plus inflation. Over time, spending discipline and revenue growth can start to reduce the city’s structural deficits. In addition, making immediate changes to the structure of TIRZs and taking a fraction of the funds dedicated to METRO (and reigning in nonessential project expenditures) can provide some immediate budget relief. The city’s primary focus should be to find ways to reduce public spending and increase efficiency in delivering public services. Since taxes and fees have grown faster than the incomes of city residents in recent years, raising revenues and fees should be a last resort and only considered when accompanied by significant spending reductions and reallocation.
Notes
[1] This document is available online. See Melissa Dubowski, “FY2025 Budget Overview and General Fund Five Year Forecast,” City of Houston, https://www.houstontx.gov/finance/Five_Year_Plan_FY2025.pdf.
[2] John Whitmire, City of Houston: Proposed Operating Budget For the Period July1, 2024 to June 30, 2025, https://www.houstontx.gov/budget/25budprop/25proposed.pdf.
[3] Chris B. Brown, “City of Houston, Texas Annual Comprehensive Financial Report for the Fiscal Year Ended June 30, 2023,” City of Houston, 2023, https://www.houstontx.gov/controller/acfr/acfr2023.pdf.
[4] Whitmire.
[5] Brown.
[6] This shows total property tax collections in the statistical section of the report in a table titled “Ad Valorem Tax Levies and Collections.”
[7] A detailed analysis of tax increment reinvestment zones (TIRZs) is beyond the scope of this brief. However, such an analysis is needed.
[8] The increases are calculated as a simple average of the water and sewage rate adjustments presented in the 2023 ACFR (Brown).
[9] This data is published in the 2023 ACFR in a table of demographic and economic statistics (Brown, 267).
[10] This data is available at Federal Reserve Economic Data (FRED), https://fred.stlouisfed.org. The data series is SMU48264200500000003: Average Hourly Earnings of All Employees: Total Private in Houston-The Woodlands-Sugar Land, TX (MSA), Dollars per Hour, Quarterly, Not Seasonally Adjusted.
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