In the face of growing credit pressure, downgrades and negative outlook revisions for Texas public schools outpaced upgrades and positive outlooks by a margin of 2.5 to 1.0 in 2024. The recent trend of negative rating actions reflects the confluence of inflation-driven pressures on operating expenditures, constrained local revenue growth, and limited increases in basic aid for public schools over the past two state biennial budgets. Taken together, these factors have weakened financial performance for many districts and have led some to materially thinning reserve positions. Legislative negotiations over education funding are ongoing, and as a result, Texas has not disbursed approximately $4.5 billion in contingent appropriations for basic aid funding that is in the current state biennial budget. In our view, negative credit pressures will continue absent implementation of state or locally derived funding solutions. S&P Global Ratings will continue to monitor potential solutions the state and school districts could implement for the 2026-2027 fiscal biennium, and if the proposals support greater financial predictability and credit stability for schools.

What's Happening

The Texas State Legislature convened its session on Jan. 14, 2025, with unresolved policy differences related to education reforms and state funding for public schools. Negotiations to increase per-pupil funding and establish a statewide ESA program stalled during the 2023 legislative session and subsequent special sessions. Since this time, some school districts have seen a material deterioration in credit quality as they grapple with revenue and expenditure mismatches amid historically high inflation, property tax compression, and insufficient state funding levels, which have remained essentially flat since 2019. We expect the legislature will likely resolve education funding differences in either the amended fiscal 2024-2025 biennium budget or the 2026-2027 biennial budget. If increases to per pupil funding are approved, this will likely provide some relief to school district operating budgets, although adjustments may not fully offset inflationary cost increases in recent years. In addition, we are monitoring how any additional local property tax relief measures affect local revenue-raising authority and how the statewide ESA program, if enacted, could affect public school enrollment (a key determinant of the basic aid funding formula) and the resilience of school district finances over time.

Why It Matters

Credit deterioration could become more widespread in fiscal years 2025 and 2026 if public schools don't take further action to address revenue shortfalls.

We expect budgetary pressure will continue if basic aid funding is not adjusted to accommodate inflationary growth in operating costs, or if the requirement to adopt essentially revenue-neutral local tax rates is not balanced by electorate-approved increases to local property tax rates above this neutral level. In addition, expiration of federal stimulus funding and moderating enrollment growth in the past year have exacerbated credit deterioration for some school districts, primarily tied to structural imbalance, eroding reserves, and expectations for continuing operating deficits.

Districts experiencing enrollment growth and/or those that significantly built reserves in recent years are better-positioned to maintain credit quality.

Any upgrades in the past year were for districts with expanding local taxing bases, stable enrollment levels, and proactive management of expenditures to maintain strong reserve positions. The availability of federal economic stimulus funding generally bolstered schools' reserve positions, which many districts have used to offset increasing operating costs without corresponding revenue growth in the past two fiscal years. Districts with stable or growing enrollment and effective cost controls have generally maintained balanced operations and large reserve positions, providing significant runway to weather the challenging state and local revenue environment. However, we expect that even strong, nominally large reserves could begin to erode in the next year, limiting districts' capacity to offset rapid growth in operating costs, barring adjustments to state basic aid funding.

What Comes Next

Approximately $4.5 billion in contingent appropriations could become available for public school funding and ESAs if passed.

In our view, disbursement of these contingent appropriations budgeted for the current biennium, and any additional increase to fund per-pupil aid and teacher salaries for the next biennium, will likely hinge on resolving policy differences over establishing a statewide ESA program. The magnitude of state funding increases will determine the level of possible financial relief to school districts. However, the creation of a school choice program also poses competitive challenges and potential enrollment losses for public schools--particularly those in urban and suburban settings where private schools have become increasingly prolific--and could lead to additional financial challenges for some districts. S&P Global Ratings will continue to monitor for potential enrollment losses and budgetary pressures for public schools, particularly if a statewide school choice program is approved and funded by lawmakers.

We expect districts will be held harmless if they receive additional property tax relief, but this funding might not keep pace with long-term inflation.

In the 2023 legislative session, lawmakers increased the homestead exemption significantly to $100,000 from $40,000, though losses in taxable value for schools were offset by the state. Districts have historically been held harmless by the state for losses in taxable value due to increased exemptions. Given Texas' strong budgetary performance and significant liquidity and reserves, we expect this support will continue. However, inflation could continue to outpace increases to basic aid, which might cause additional pressure on Texas school districts' financial performance and reserves.

Related Research

U.S. Local Governments Credit Brief: Texas School Districts Means And Medians, April 4, 2024