Multiple Lawsuits, Oil Prices Could Spell Budget Doomsday for State

Last week, lawyers for the state of Texas got the latest in a string of bad legal news.

A lawsuit challenging the state’s foster care system as inhumane appeared to gain steam when an appeals court rejected the state’s request to stop the appointment of two “special masters” to recommend reforms.

The overhauls that have been discussed so far would be pricey to implement — as much as $100 million per year, according to rough estimates from the state comptroller’s office. But they actually are on the lower end of all the extraordinary legal expenses the state is facing at a time when stubbornly low oil prices are simultaneously threatening to blunt its coffers.

Three other lawsuits against the state — two of them pending before the Texas Supreme Court, with rulings expected soon — could cost the state billions if it ends up on the losing side. Experts say the state may have the cash to cover one of them in a single budget cycle, but probably not any more than that — especially if low oil prices persist, dampening the state's stream of tax revenue. That could mean budget cuts when lawmakers meet for the 2017 session, at least if the Republican-dominated Legislature remains steadfast in its refusal to tap the state’s nearly $10 billion Rainy Day Fund.

Two of those three lawsuits, both tax cases, could cost the state a combined $10.4 billion in tax refunds and up to $2 billion in collections per year beyond that, according to the comptroller’s office, which is closely monitoring them.

Potential cost estimates do not exist for the last case — a high-profile challenge to the state’s public education funding system — but past school finance rulings have cost the state billions.

Such sums would handily eclipse the state’s $4.2 billion projected surplus, which could itself dwindle if oil prices remain low and further blunt tax collections. (Comptroller Glenn Hegar has already lowered projections once.)

“Any of those by themselves are a huge hit,” said Dale Craymer, president of the business-backed Texas Taxpayers and Research Association. “But if you start losing two or three of those issues then, yeah, it’s much more questionable that the state’s general revenue reserves are sufficient to cover that.”

Craymer, a former state revenue estimator, said the outlook would be much worse if lawmakers hadn’t intentionally left several billion dollars on the table last year following a spectacular plunge in oil prices — a choice Republicans trumpeted as principled and Democrats bemoaned in the face of several unmet needs.

That decision is “one reason we’re not in fiscal calamity,” Craymer said. “Today, a prolonged drop in oil prices may only threaten the size of our surplus.”

While low oil prices may not harm state coffers as much as feared, Hegar and other state officials are warning lawmakers that adverse rulings in any of the ongoing lawsuits could quickly change the state’s financial outlook.

Major tax cases

The ruling they have expressed the most concern about would come from a 2009 case pending before the state Supreme Court in which Midland-based Southwest Royalties — a subsidiary of Clayton Williams Energy — is arguing that metal pipes and other equipment used in oil and gas extraction should be exempt from sales tax.

A ruling in favor of the company could spur up to $4.4 billion in refund filings for 2017 alone, and $500 million per year after that, according to the comptroller’s office — projections Hegar stands by as “good numbers.”

“This one’s as big as they come,” he said shortly before the state Supreme Court heard oral arguments in the case this month.

A ruling against the state in the case “could very much change the landscape” for the state budget, Legislative Budget Board Director Ursula Park warned the House Committee on Business and Industry last week, calling the cost projections “quite a significant amount of money.”

Committee Chairman René Oliveira, a Democrat from Brownsville, said he asked Parks to testify because he thought it was important for members to know about the looming uncertainties so they could tell local officials back home “that it may be pretty tight on getting projects accomplished.”

“The state isn’t going to have much to give” next year, he said. That’s when lawmakers will convene for their next regular session.

The other pending tax lawsuit — between the state and the parent company of AMC movie theaters — is farther behind in the courts, meaning it may not be decided in time to impact the two-year budget lawmakers will write next year. However, the comptroller’s office estimates it would have an even bigger cost to the state if it eventually loses — $6 billion in initial refunds and $1.5 billion per year after that in lost collections.

In that case, AMC has argued that more of its expenses should fall under the franchise tax's definition of "tangible personal property," a move that would lower the theater chain's tax burden. Last April, Texas' 3rd Court of Appeals sided with AMC.

If the state ultimately loses the AMC cases, Craymer said it would be “certainly reasonable” to tap the Rainy Day Fund to cover the cost of refunds since they are a one-time expense, although he acknowledged that as “politically difficult.” In 2011, the Republican-dominated Legislature opted to balance a post-recession budget shortfall without tapping the emergency savings account even though it meant a $5.4 billion cut to public schools.

Foster care and school finance suits

Timing also is a big unknown in the foster care lawsuit, where two appointed “special masters” could take a year to recommend reforms, which the state would then likely challenge.

The exact cost of those reforms is unclear, but any ruling would undoubtedly call for more caseworkers and improved outreach services for former foster youth. The comptroller’s office estimates it would cost about $30 million to hire a sufficient number of caseworkers, although that assumes current salary levels. A spokeswoman said the courts could very well order the state to pay caseworkers higher salaries to combat high turnover.

The office also is contemplating $42 million in spending to cover a 10-percent increase to foster care payments as a possible way to boost oversight of the system, which was one of the overarching recommendations the judge made. And as much as $1 million more might go to pay the special masters.

It could easily rack up to “$100 million a year for each year of the biennium,” said Hegar in an interview this week where he discussed the long list of budgetary concerns while contending it was too soon for undue concern, mainly because no court rulings have come down.

The state Supreme Court is expected to rule any day on the school finance case, although Hegar said the potential price of that is “almost really kind of impossible to figure out.”

That’s because not all the legal questions in the case necessarily carry a price tag, he said.

For example, one of the claims by the more than 600 plaintiff school districts is that the state’s school finance system perpetuates inequities among school districts. If the court agrees, Hegar said it wouldn’t necessarily involve injecting more money into the system overall.

On the other hand, the court may find that the total amount of funding the state is investing in public education is inadequate and that it will be up to the Legislature to figure out how much more to put in. 

It is the seventh time since 1984 that a case challenging the state’s school finance system has reached the state’s high court. The state has never won.

Eva DeLuna Castro, a budget analyst at the left-leaning Center for Public Policy Priorities, said if the ruling does come with a cost, lawmakers may be able to delay paying up as they did a decade ago when the last school finance ruling came down.

“On the bright side: There should be $10+ billion in the Rainy Day Fund by the end of fiscal 2017!” she wrote in an email. “The Legislature just needs to remember what it’s for.”

Jim Malewitz and Edgar Walters contributed to this report.

Disclosure: The Center for Public Policy Priorities is a corporate sponsor of The Texas Tribune. A complete list of Tribune donors and sponsors can be viewed here.