United States: Texas District Court Rules School Finance System Is Unconstitutional

On August 28, Judge John Dietz1 of the 250th District Court ruled that the method the state of Texas currently uses to finance public schools is unconstitutional in several respects.2 The decision discussed state constitutional deficiencies in the equity of the distribution of educational funding, the adequacy of the amount of funding, and effectively constituting a prohibited state property tax. However, the court found that the school finance system does not violate taxpayer equity under the state constitution. The court has given the Texas legislature the opportunity to correct the constitutional deficiencies by July 1, 2015 before the state is enjoined from distributing educational funds under the current school finance system. The state is expected to appeal the decision to a higher court.

Background

The Texas public grade schools and high schools are funded by a combination of local school district property taxes and state funding. Under the current system, some property tax revenues from the wealthier districts (as considered by total property tax revenues) are shared with the poorer districts. This "share-the-wealth" or "Robin Hood" system has resulted in numerous controversies between the state of Texas and its school districts with respect to the constitutionality of the school finance system. The following summary of litigation and legislation represents only the more noteworthy developments.

Beginning in 1984 when the Edgewood Independent School District (ISD) filed a lawsuit claiming the system was inequitable through the current court challenges, there have been several successful legal challenges by both property-value-poor districts and property-value-wealthy districts. Financial transfers from wealthier to poorer school districts began in 19933 when the Texas legislature finally responded to the Texas Supreme Court's 1989 ruling that concluded there were glaring and unconstitutional funding disparities between poor and wealthy districts.4 The Texas Supreme Court upheld the Robin Hood system and the overall new school funding system in 1995.5

In 2003, property-value-wealthy districts legally challenged the Robin Hood system as inefficient and effectively constituting an unconstitutional state property tax that pushed many districts to raise tax rates to the maximum legal rate. By being forced to impose the maximum tax rate, the districts argued that they had effectively lost the discretion to set their own tax rates. Numerous other districts joined the case arguing that the system was inequitable and insufficiently funded public education. In a trial involving over 300 districts in 2004, District Judge Dietz ruled the system unconstitutional and inefficient and set a deadline of October 2005 for the legislature to fix the problem.6 The Texas Supreme Court ruled in 2005 that the system was effectively an unconstitutional state property tax.7

Under pressure from the courts, the legislature in 2006 sought to allocate more state funding to districts while cutting local school Maintenance and Operations (M&O) property tax rates by almost one-third.8 One funding mechanism created in that session was the Revised Texas Franchise Tax, which was intended to increase franchise tax revenues. Minimum school funding requirements based on the amount spent per student that year were set in place to make sure no district lost money by freezing these thresholds.

While districts were given some discretion over their tax rates, the maximum M&O tax rate that could be imposed by the districts was set at $1.17 per $100 of valuation. Prior to 2006, the school M&O tax rate was capped at $1.50 per $100 (except for seven districts in Harris County). Also prior to 2006, the school Interest and Sinking Fund (I&S) tax rate was capped at $0.50 per $100 valuation; a limit few districts had reached. The $0.50 I&S rate cap remains in effect. Currently, total property tax rates within Texas, including school district, city, county, and special district rates, vary from under 2 percent of property value to well over 3 percent of value.

In 2011, the legislature cut more than $4 billion in state spending on public schools in its effort to balance the state budget without raising taxes or draining the state's rainy day fund.9 Consequently, many school district tax rates were raised to the maximum limit. As a result, numerous plaintiffs filed lawsuits in 2011 and 2012 claiming the school finance system was again unconstitutional on a variety of grounds. More than 360 districts claimed the system was inequitable and inadequate, and more than 120 other districts claimed the tax rate cap constituted an unconstitutional state property tax.

In the initial school finance trial of the combined plaintiffs from the 2011 and 2012 lawsuits, Judge Dietz informally ruled the school finance system to be unconstitutional because of inadequacies of funding and inequitable distributions of those funds.10 The judge deferred action pending a second trial after the legislature had an opportunity to meet in 2013 and pass legislation and a budget that might mitigate the defects in the system.

In its 2013 session, the legislature restored much of the prior funding cut, and reduced the number of standardized tests required for high school graduation, but did not make fundamental changes to the school finance system.11 The reduction in standardized testing was thought by the legislature to reduce the amount of funding required to be "adequate." After considering the 2013 legislation in the most recent trial, Judge Dietz has formally ruled the Texas school finance system is unconstitutional on grounds that included inadequacy.

Texas School Finance System Court Ruling

Judge Dietz ruled the school finance system in Texas is unconstitutional because of defects in equity and adequacy and because the system is effectively a state property tax. From an equity perspective, the court found that the system violates Article VII, Section 112 of the Texas Constitution since the system fails to provide equal access to revenues necessary for the education of students by arbitrarily funding districts at different levels. From an adequacy perspective, the court decided that the system violates Article VII, Section 1 of the Texas Constitution since funding is inadequate for support and maintenance of public schools and providing education to students of poor families. Finally, the court concluded that the system can be construed as imposing a state property tax violating Article VIII, Section 1-e13 of the Texas Constitution, since poor districts are forced to tax at or near the $1.17 cap and no longer have meaningful discretion in setting their tax rates.

The ruling enjoins the state of Texas from distributing funds under the current school finance system after July 1, 2015 if the Texas legislature does not remedy the constitutional violations. If the state of Texas appeals the decision (to the Third Court of Appeals14 or to the Texas Supreme Court), the injunction is automatically stayed. The court also awarded "reasonable and necessary" attorney fees to the public school district plaintiffs, but not to other interveners including charter school plaintiffs.

Commentary

The issues litigated in this case are similar in nature to those previously litigated and discussed above. The lengthy decision, which relied on numerous findings of facts and conclusions of law, surprised few and places heavy reliance on those prior decisions and rationale.

In the process of adopting the Texas Constitution of 1876, the concept of "(a) general diffusion of knowledge being essential to the preservation of the liberties and rights of the people" was the most controversial and debated issue in the Constitutional Convention of 1875.15 From a tax perspective, the "inadequacy of funding" may have the greatest impact, as that same finding has had in the past. Expert witnesses testified that state spending would have to increase by over $6 billion per year to be considered adequate. That is a significant sum of money even for a Texas-sized economy.

The Texas Attorney General is expected to appeal the district court's ruling directly to the Texas Supreme Court. The appeals process could take about a year without a decision from the Supreme Court until after the legislature meets again in 2015. Alternatively, the Texas Attorney General could appeal the district court's ruling to the Third Court of Appeals. If so, the entire appeals process through the Texas Supreme Court could take over two years.

In any event, the legislature should have an opportunity to address the legal challenges with school finance system changes in the next legislative session scheduled for 2015. Historically, the legislature has been reluctant to increase funding or make significant modifications in anticipation of a court mandate because such funding or actions may be inconsistent with any eventual mandate. Texas public schools are funded significantly by local property taxes and those taxes and educational issues are always high on legislative agendas and priorities. School taxes comprise the majority of Texas property taxes and the Texas property taxes are already high by national comparison. However, the recent decision by the Texas district court means that some form of change to the funding and possibly the structure of the school finance system could at least be considered by the legislature. As potential changes to the school finance system may have a significant impact on taxpayers in Texas, developments relating to the constitutionality of the school finance system should be monitored until the legislature and the courts resolve the issue.

Footnotes

1 Texas tax practitioners may recognize Judge Dietz from his decision in Southwest Royalties, Inc. v. Combs, 353rd District Court, Travis County, Texas, Cause No. D-1-GN-09-004284, April 30, 2012; aff'd, Texas Court of Appeals, Third District, No. 03-12-00511-CV, Aug. 13, 2014 (refunds of Texas sales and use tax denied for oil and gas above-ground and below-ground production equipment). In the instant school finance system case, Judge Dietz survived the Texas Attorney General's Motion to Recuse.

2 The Texas Taxpayer & Student Fairness Coalition v. Williams, 250th District Court, Travis County, Texas, Cause No. D-1-GN-11-003130, Aug. 28, 2014.

3 S.B. 7, Laws 1993.

4 Edgewood Independent School District v. Kirby, 777 S.W.2d 391 (Tex. 1989).

5 Edgewood Independent School District v. Meno, 917 S.W.2d 717 (Tex. 1995).

6 West Orange-Cove Consolidated Independent School District v. Neeley, 250th District Court, Travis County, Texas, Cause No. GV-100528, Nov. 30, 2004. This was decided by the same judge as the instant case.

7 Neeley v. West Orange-Cove Consolidated Independent School District, 176 S.W.3d 746 (Tex. 2005).

8 H.B. 1, Laws 2006.

9 H.B. 1, Laws 2011.

10 The Texas Taxpayer & Student Fairness Coalition v. Williams, 250th District Court, Travis County, Texas, Cause No. D-1-GN-11-003130, Feb. 4, 2013.

11 S.B. 1, Laws 2013.

12 This section of the Texas Constitution provides for the support and maintenance of a system of public free schools. Specifically, this section provides that "[a] general diffusion of knowledge being essential to the preservation of the liberties and rights of the people, it shall be the duty of the Legislature of the State to establish and make suitable provision for the support and maintenance of an efficient system of public free schools." TEX. CONST. art. VII, § 1.

13 This section of the Texas Constitution provides that "[n]o State ad valorem taxes shall be levied upon any property within this State." TEX. CONST. art. VIII, § 1-e.

14 This is an intermediate appellate court that is located in Austin, Texas.

15 Neeley v. West Orange-Cove Consolidated Independent School District, 176 S.W.3d 746 (Tex. 2005), quoting TEX. CONST. art. VII, § 1.

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