School funding is back in the news as states struggle to reverse trends suggesting that students are performing at lower levels than before. Specifically, the country’s 13-year-olds showed the most significant declines ever recorded on the National Assessment of Educational Progress trend assessment in mathematics. The average math score for 13-year-olds declined 9 points between the 2019‒20 and 2022‒23 school years, and the average reading score declined 4 points over the same period. Compared to a decade ago, the average scores declined 7 points in reading and 14 points in math.
How to fund schools—and keep taxpayers happy—can be a challenge. As summer rolls on, many states are trying new approaches.
Texas
Texas is one step closer to providing taxpayers with a $18 billion tax relief package, with the House and Senate approving the measure. One result for taxpayers will be lower property tax rates—something almost everyone in the state can get behind. But some worry about what that means for local public schools.
According to the Lincoln Institute of Land Policy, public schools are typically supported by state and local funding. About half of public school funding comes from local revenue sources, with property taxes constituting the largest source of revenue for schools. It follows that higher tax rates tend to mean higher property tax revenues and lower property tax rates often result in less property tax revenue per student.
Lowering tax rates without significantly expanding the base—meaning affecting more taxpayers—will result in less revenue for Texas schools. The state intends to fill the gap with a method called rate compression. In simple terms, the state will give money to the school districts so they can lower their tax rates.
Texas has earmarked $12.3 billion to make that happen, with Gov. Greg Abbott (R-TX) saying that the amount would eventually help eliminate property taxes in the Lone Star State. The governor expects that funding for compression will come from other sources, like sales and franchise taxes, which are increasing due to recent growth in the state.
It works on paper—for now. But some worry what will happen once the $12.3 billion is gone. The state has traditionally reduced its contributions to public school funding—not the other way around. And while the state is experiencing rapid growth now, there are real questions about whether that will continue, especially with recent challenges to the state’s infrastructure.
Government Abbott has signaled that he intends to sign the bill. Voters must approve the plan in November for it to take effect.
Colorado
Colorado is also proposing a reduction in property taxes and redirecting taxpayer dollars.
Under the property tax proposal—referred to as Prop HH—homeowners could see up to $1 billion per year in relief.
Of course, as previously discussed, when you lower property tax rates, schools typically have less revenue. As in Texas, Colorado intends to use state money to make up some of the difference. However, how Colorado plans to make that happen is a bit different.
Since 1992, Colorado has followed a Taxpayer’s Bill of Rights—called TABOR—meant to control government spending. Under TABOR, the amount that the general fund can expand is limited. But Prop HH would allow the general fund to grow at an extra 1% per year.
How does that happen without raising taxes? Traditionally, the overage in the general funds is paid out to taxpayers as refunds, meaning the amounts change from year to year. But boosting the amount of money the state can keep on hand in any given year allows the state to hang on to dollars and pay out smaller refunds to taxpayers. The result, under Prop HH, is that instead of paying out refunds, the money would replace revenue for schools lost to property tax cuts.
As in Texas, Colorado voters will have to approve the measure in November.
Pennsylvania
In the Keystone State, tax authorities are taking a different tack to fund schools—they’re fighting for funding through the court system. And lately, they’ve been winning.
As noted earlier, school districts rely on property taxes for funding. Those taxes are paid by individuals and businesses.
An organization recognized under section 501(c)(3) of the tax code is considered tax-exempt for federal income tax purposes. That status is federal and not automatically transferrable to state and local taxes. In all 50 states, the exemption is not a sure thing—depending on state law, charities may need to apply for specific exemptions from sales and real estate taxes.
Pennsylvania is one of those states. To qualify for an exemption for real estate tax purposes in Pennsylvania, an entity must meet certain criteria, including the requirements outlined in Hospital Utilization Project v. Commonwealth, 487 A.2d 1306 (Pa. 1985). The so-called “HUP Test” is crucial. An entity must show that it:
- advances a charitable purpose;
- donates or renders gratuitously a substantial portion of its services;
- benefits a substantial and indefinite class of persons;
- relieves the government of some of its burden; and
- operates entirely free from private profit motive.
If an entity meets the HUP test, it must also prove that it satisfies the statutory requirements of Act 55 (they are similar but not identical).
And there’s one more hurdle—additional requirements under the Consolidated County Assessment Law.
Despite all those hoops, many tax-exempt entities have enjoyed continuous property tax exemptions even as their missions have evolved and their ownership and compensation structures have changed. That means they have not paid into the local tax system even though they have enjoyed some of the benefits of property taxes.
Those exemptions can make quite a dent in local revenues. As a result, many municipalities have asked tax-exempt entities for PILOTs—payments in lieu of taxes. These are voluntary contributions typically representing a percentage of the entity’s tax-exempt bill.
(Interestingly, PILOTs didn’t start as a local program. The idea started in 1976 under President Gerald Ford and was intended to help local governments fill revenue holes related to federal land in their jurisdictions—federal land is not taxable by local governments.)
Not all charities want to participate in PILOT programs—and not all local governments offer the option. But those local governments may still struggle with the loss of revenue due to exemptions—including Pottstown, located in Chester County.
In 2017, Reading Health System—now called Tower Health, LLC—bought several for-profit hospital facilities and properties in Montgomery and Chester Counties. While those two counties are two of the wealthiest in Pennsylvania, since school districts are funded by property taxes, the disparities between real estate values in certain communities are reflected in school budgets. That explains why a school like Lower Merion High School (where Kobe Bryant attended) has facilities that far outshine those at Pottstown High School—even though both are in the same county.
Among the properties that Tower Health bought were Brandywine Hospital, Jennersville Hospital, Phoenixville Hospital, and Pottstown Hospital. Stephen Rodriguez, superintendent of the Pottstown School District, estimated that the tax exemption for Pottstown Hospital resulted in a loss of roughly $900,000 annually.
The solution? The school district sued—and they weren’t alone. Similar suits were filed in Chester County.
In 2021, Chester County Court of Common Pleas Judge Jeffrey R. Sommer ruled that three local hospitals owned by Tower were not entitled to tax-exempt status—the decision was upheld on appeal in 2023. The initial decision in the Pottstown case favored Pottstown Hospital, but it was overturned by the Pennsylvania Commonwealth Court in 2023, finding that Pottstown Hospital was not entitled to an exemption—putting it back on the property tax rolls.
Among other things, the courts focused on management fees (the management fees increased from $4.4 million in 2018 to $23.16 million in 2020 for Pottstown Hospital) and executive compensation (notably, Tower Health executive compensation, which had previously been described as “eye popping,” was tied to the financial performance of the entity, suggesting a profit motive) to find that the hospitals did not satisfy the HUP test.
These cases could be a game-changer for the Commonwealth. More counties and local governments may look to the Tower cases as a template for evaluating whether hospitals and other tax-exempt entities qualify for a property tax exemption—those exempted taxes can add up.
Bottom Line
Services cost money. And even when taxpayers agree that there is value in those services—as with public education—there can be a fundamental disagreement about how best to pay for them. As governments look for ways to reduce taxes, the competing pressures to fund services will undoubtedly figure into future discussions.
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