REVERSE INTERGOVERNMENTAL AID: HOW FINANCIAL ASSISTANCE IS PRACTICED IN TEXAS

The State of Texas, unlike almost all other states, provides virtually no financial assistance to its cities. State aid, defined as a grant made by the state to cities from revenue generated by the state, is practically non-existent in Texas. Research conducted by numerous entities over many years has shown this to be true. The most recent study, released in 2008 by the National League of Cities, found that only in West Virginia is state aid to cities lower than it is in Texas.

State aid flows readily in other states, particularly in populous states. For instance, it is not at all uncommon for states to share state gasoline tax revenue with cities or to split other sources of state general revenue with municipal governments.

While city officials in Texas have seldom asked for state financial aid, they are increasingly aware of the numerous ways in which they are compelled to share city-generated revenue with the state in what can be described as a system of reverse intergovernmental aid.

Of the numerous ways in which cities transfer revenue to the state, four stand out:

  1. The state’s charge for administering the municipal sales tax.
  2. Fees levied on cities by the Texas Commission on Environmental Quality (TCEQ).
  3. “Local participation” in the cost of building and improving the state highway system.
  4. State fees imposed on municipal court convictions.

These forms of reverse intergovernmental aid are discussed in the following sections.

The State’s Charge for Administering the Municipal Sales Tax

When a Texan purchases a product that is subject to the state and local sales tax, the merchant collects the entire tax due and remits it to the state comptroller. The comptroller, in turn, remits the local share back to the appropriate local government (city, metropolitan transit authority, county, and/or special district). For providing this service and for performing other administrative, enforcement, and reporting duties, the comptroller deducts two percent of the local share of the sales tax and deposits that amount in the state’s general revenue fund.

The two-percent fee is high compared to the same fee in other states. The Texas Municipal League recently conducted a survey of the 24 states in which all cities may adopt a local-option sales tax; 16 states participated in the survey. Only one state charges more than two percent. Another state charges actual cost, not to exceed two percent. All the other states charge one percent or less; five states impose no charge at all.

In Texas, the two-percent fee generates $112.3 million annually. How much is paid by cities?

Cities
$76.4 million
Transit Authorities
$25.7 million
Counties
$6.7 million
Special Districts
$3.5 million

In mid-2008, TML undertook an effort to determine how much the comptroller’s office spends annually to provide sales tax services to local governments. The comptroller’s office informed TML that “(t)here can be no separate accounting of what costs are ultimately attribudiv to local tax administration that would not be arbitrary and potentially misleading,” and went on to note that the “Office of the Attorney General, the Legislature itself and other state entities are all involved in the process” of local sales tax administration.

Although the comptroller can’t calculate the total cost of providing local sales tax administration, it is instructive to calculate the extent to which the revenue generated by the two-percent local government fee covers the comptroller’s total annual expenditures for all activities.

For the current fiscal year, the comptroller’s baseline budget is $220.3 million. Thus, the total local government fee of $112.3 million is enough to cover nearly 51 percent of the entire agency’s total expenses, and the city share alone covers nearly 35 percent.

Texas Commission on Environmental Quality (TCEQ) Fees

According to its Web site, the mission of the Texas Commission on Environmental Quality is “to protect our state’s human and natural resources consistent with sustainable economic development,” and the agency’s goal is “clean air, clean water, and the safe management of waste.”

One would think that this mission and set of goals would merit substantial funding from the state’s general revenue fund. That’s not the case. The TCEQ Web site reveals that the agency’s revenue comes from the following sources:

State General Revenue
1.94%
Federal Funds
7.61%
Program Fees
88.41%
Other Sources
2.03%

Just who pays the “program fees” that constitute the lion’s share of TCEQ revenue? To a great extent, cities do.

The agency imposes more than 40 different fees on cities; roughly 20 are related to water quality. The revenue from these fees is used to pay for the costs of regulating cities under either federal or state law or both. In other words, cities pay TCEQ to regulate them.

Of all the fees, the two that have most impact on cities are the consolidated water quality fee (CWQF), which is imposed on wastewater treatment facilities, and the public health service fee (PHSF), which is paid by suppliers of public drinking water. For those two fees alone, cities paid the following amounts in the most recent state fiscal year:

CWQF
$7.9 million
PHSF
$4.2 million

Other fees paid by cities (the water quality permit application fee, stormwater permit fees, the solid waste disposal fee, and others) add considerable amounts to state coffers. In fact, cities (through the payment of fees) generate more revenue for TCEQ than does the state's general fund.

It has recently come to light that TCEQ’s water program fees will be insufficient for fiscal years 2010 and 2011. To address this shortfall there are three options:

  1. The legislature could inject more state general fund revenue into the TCEQ water programs. That’s not likely to happen. In fact, state general revenue support of TCEQ has fallen from nearly $30 million in fiscal year 2003 to $11 million in the current fiscal year. The state’s general fund provided 7.5 percent of TCEQ’s revenue in 2003; today it provides less than two percent.
  2. TCEQ could reduce its regulatory activities. Again, that’s not likely to happen at least in part because doing so would run afoul of federal requirements.
  3. The legislature and TCEQ could raise fees, including fees imposed on cities. This will probably be the preferred alternative for state policymakers.

Some might say that the fee-dependent financing structure used by TCEQ is fair since cities receive a service for each fee they pay. However, when cities impose fees-for-service on other levels of government, the legislature often acts to prohibit or limit those fees.

For example, when the legislature prohibited the imposition of stormwater fees on public institutions of higher education, some lawmaker argued that it’s unfair for one level of government to impose a fee on another level.

And when the legislature prohibited the imposition of municipal impact fees on school districts (unless a district agrees to pay the fee), the legislature's bill analysis stated that…

…impact fees place an undue burden on districts…payment of impact fees by school districts to cities amounts to a needless transfer of money among public entities and constitutes a de facto tax on school districts.

This statement is particularly ironic given that cities pay TCEQ fees and are not exempt from the state's 20-cent-per-gallon gasoline tax. "Public entities" (cities) are paying a state tax each time a police car or fire truck refuels.

Local Participation in State Highway Projects

The best way to describe “local participation” is to quote from a state document entitled “Background and Need for Partnering.” That document makes the case that the Texas Department of Transportation (TxDOT) faces a funding shortfall because growth in population, vehicle-miles per capita, and total vehicle miles have grown at faster rates than growth in the highway system and growth in revenue available for highway projects. Those trends, according to the report, will continue.

To help address this dilemma…

TxDOT continues to seek additional ways to fund the state transportation program. For years, TxDOT has partnered with local public agencies to make transportation improvements on state highways. This local participation has come in many forms, including provision of right-of-way, financial contributions, maintenance agreements and other forms… Cooperative partnering between state and local agencies will be needed to meet future transportation needs. TxDOT will depend on local and regional leaders to provide both leadership and commitment to help carry projects forward…TxDOT is currently suggesting to local agencies that they consider increasing their participation in TxDOT projects in order to expedite scheduling of locally desired projects. (Emphasis added.)

In short, “local participation” may become a “pay-to-play” system imposed by TxDOT on local governments who wish to see highway projects in their area move forward.

How much do cities annually contribute in local participation? In recent years, cities have pitched in more than $90 million per year in cash and much more in right-of-way donations and in-kind services. In addition, the state gasoline tax paid by cities accounts for many more millions of dollars paid by cities for the state transportation system.

Here’s the bottom line. In most states, the state government makes grants to cities to help those cities build and maintain city streets. In Texas, city governments transfer municipal revenue to the state to help pay for the state highway system.

State Fees on Municipal Court Fines

Municipal courts in Texas collect funds on behalf of the state for a wide variety of state programs. These state programs range from the Criminal Justice Planning Fund to the Crime Victims’ Compensation Fund. In most cases, the fees are imposed on persons convicted of any criminal offense. For these collection efforts, cities are generally allowed to keep some small amount of revenue as reimbursement for the costs incurred to collect the fees and remit them to the state.

Many city officials contend that state court costs adversely impact municipal courts in two ways. First, the state’s court costs are complicated to administer. While cities can keep a small percentage of the costs as an administrative fee, that amount is not sufficient to reimburse the cities for the bookkeeping and administrative problems connected with this function. Second, when setting an appropriate fine for an offense, a judge must consider the fact that the defendant will also be paying state court costs. As a result, municipal fine revenue is often lower than it would otherwise be because the judge has considered the state court costs when setting a defendant’s total fine.

Municipal court clerks also point out that the state requires that in the event of a partial payment, the state court costs must be paid first before the city can keep any of the fine. This means that cities must do all the work collecting fines but are not allowed to keep any money until the state court costs have been fully satisfied.

In recent years, the number and amount of the state fees collected by municipal courts have grown rapidly. For example, on a typical traffic offense conviction, a municipal court defendant must currently pay $82 in state-imposed fees before any city fine is collected. The following chart is a comparison of the present situation with fees imposed just seven years ago.

 
January 2002
January 2009
Crime Victim Compensation
$15.00
$15.00
Judicial/Court
Personnel Training
$ 2.00
$ 2.00
Fugitive Apprehension Fund
$ 5.00
$ 5.00
Consolidated Court Costs
$17.00
$17.00
Juvenile Crime/Delinquency
(Prairie View A&M)
$ 0.50
$ 0.50
Correction Management
Institute (Sam Houston State)
$ 0.50
$ 0.50
State Traffic Fine
--
$30.00
Jury Pay
--
$ 4.00
State Judges’ Salaries
--
$ 6.00
Indigent Defense
--
$ 2.00
Total
$40.00
$82.00

In many ways, municipal court collection of state fees is similar to the state’s collection of municipal sales tax. In each case, one level of government is processing a tax/fee levied by another level of government, is remitting it, and is keeping a fee for providing those services.

While there are similarities, however, there are also substantial differences.

For example, the state doesn’t really “collect” the municipal sales tax; it’s collected by the merchant. With regard to state fees on municipal court fines, however, a municipal court employee actually collects the fees and bears the brunt of any resulting fee-payer anger.

Second, the state controls the level of the municipal sales tax, but cities certainly don’t control the level of state fees on municipal fines. So while cities can’t unilaterally raise the city sales tax without permission from the state, the state can (and frequently does) increase the amount of state fees that cities must collect and remit.

How much state fee/fine revenue do municipal courts collect annually? For fiscal year 2007, the most recent year for which complete information is available, the amount was just over $215 million.

Summary

What’s the grand total amount of reverse intergovernmental aid in Texas?

  1. Texas cities pay the state $76.4 million annually to process municipal sales tax returns. Most states charge much less. TML has found the average charge to be 0.875 percent. Thus, Texas cities are transferring to the state roughly $43 million more than the norm.
  2. Texas cities pay $12.1 million annually to the Texas Commission on Environmental Quality just for the two most significant of that agency’s 40 separate fees on cities.
  3. Cities pay at least $90 million annually (probably much more) to support the state highway system.
  4. It is not unreasonable to believe that at least 25 percent of the $215 million in state fees annually collected by municipal courts would be retained by cities if it weren’t for the imposition of those fees. Thus, cities are probably foregoing another $53.75 million.

The annual total is at least $198,000,000, just from these four sources of reverse intergovernmental aid.

Conclusion

Why does this transfer of revenue from cities to the state matter? It matters because these transfers of resources result in either reductions in municipal services or increased local fees or taxes—most often the local property tax, which is the only general purpose municipal tax that a city council can raise or lower.

Texas taxpayers are increasingly concerned about property taxes. It is clear that some of the pressure on the property tax results from reverse intergovernmental aid, a system under which governments that must depend on the property tax (cities) transfer revenue to a level of government (the State of Texas) that has many revenue sources.

It's not hard to understand why some state legislators are tempted to turn to cities and ask them to generate revenue for the state. It's much harder to understand why some of those same legislators have been trying for several years to limit the revenue-generating capacity of cities by placing caps on the municipal property tax.

TML member cities may use the material herein for any purpose.
No other person or entity may reproduce, duplicate, or distribute any part of this document without the written authorization of the
Texas Municipal League.

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