Much of the action in Texas politics takes place at the intersection of government and economics - sometimes subtly, other times boldly. This shouldn't be too surprising, since state and local government is enmeshed in the economy at all levels and across all sectors. Government activities in the economy range from the most basic like employing people to run its operations, to the arcane like regulating telecommunications companies, to the ambitious like planning and building our system of state roads or fostering the high technology industry. When we examine the interactions that connect political decision making with economic outcomes, and economic decisions that involve politics and government, we are studying the political economy.
With government so involved in the economy, private economic actors, in turn, have every incentive to get involved in politics - in essence, to become political actors. From the earliest settlement promoted by land grants to the oil production bonanza fostered by supportive state laws, to the government backed technology booms of the past two decades, the state government has been instrumental in promoting and protecting economic interests. And it has done so with the active political participation of the representatives of those interests. This enduring marriage of business and politics has always been blessed in the councils of Texas government.
The stability of this union rests on a clear-eyed pragmatism that has been both the cause and result of the state's boom-and-bust economic history. In a state, the culture of which has made heroes of politically savvy entrepreneurs as well as entrepreneurial politicians, the government has nurtured and protected established businesses and industries with incentives, subsidies, exemptions, and state contracts - during both good economic times and bad.
But the resulting inefficiencies and distortions in the structure of the economy and the relative neglect of the public interest have slowed the development of a diversified and modern economy. The absence of an income tax, the reluctance to raise funds for the broad delivery of social services and education, and the failure to free up funds that by statute or constitutional provision are dedicated to narrow uses benefiting small constituencies, have distorted the state's development - robust in some areas, undernourished in others - and undermined its ability to promote the long-run interests of the people.
While the consensus that the business of government is to support business has been consistent throughout the state's history, the delivery of public services like education and public health has been uneven despite legal and constitutional mandates. If it is no surprise that the linkage between government and the economy is political and dominated by the influence of well-organized, well-financed private interests, it is equally unsurprising that state government perpetually struggles to deliver public goods such as quality education and a level of social services that might raise the relative position of Texas among the states.
These patterns of interaction between economic interests and policy making are expressed in the "low taxes, low services" approach to government that dominates both the halls of government and the broader body politic. Political leaders, business leaders, and many voters view a state income tax as beyond the realm of the reasonable. As a result, the services provided by the state remain minimal because the pool of money to fund them is limited. If thousands of interactions between politics and economics make up the fabric of Texas politics, the broad pattern that emerges from these interactions is the low taxes, low services consensus that dominates business, political, and policy making circles in the state. While there have always been dissenters from this consensus, their opportunities to effect policy in sustained ways have been few and far between.
It can be easy to lose sight of the ways in which interactions between politics and the economy impact people's lives. Our discussion of the political economy inevitably involves discussion of highly placed decision makers, of economic statistics and high-level characterizations of the settings in which policies are made. At the outset, take a moment to click through the interactive pie charts in the feature How Other People Spend Money. These charts enable you to make your own comparisions about how taxes as well as other costs inpact different social groups. As we consider the Texas political economy from an aggreagate, statewide perspective, it can be helpful to keep in mind how the "big picutre" of the political economcy provides the economic context for households across the state. As the pie charts suggest, the view can differ considerably depending on your economic situation.
1.1 Looking Ahead
We begin this chapter with a quick look at a recent public policy debate in Texas over the creation of the Texas Enterprise Fund, which was designed to attract new businesses to the state and promote the expansion of existing businesses. This fund is particularly interesting because it was approved at a time when budgets for state programs were being cut drastically in responses to a rather sharp economic recession. How the push and pull over this fund unfolded provides a unique glimpse of the forces at work in the state's political economy.
This short case study is followed by an overview of the evolution of the modern Texas economy. The economy of the state is much more diverse, urban, industrial, technological and international than it was even just a decade ago. Becoming familiar with the nature, shape, and overall dimensions of our modern state economy gives us a broad perspective of the issues and actors involved in our political economy.
We then examine how state government in Texas is financed. Government finance on all levels involves revenues and expenditures, also known as fiscal policy. Revenues come from a variety of sources, including taxes, federal grants and other transfers, user fees, interest income, and other sources. For most governments - certainly most governments whose jurisdiction is comparable to Texas - the primary source of revenues is taxes. We will review different tax schemes (sales taxes, income taxes, excise taxes, other payroll taxes, and more) to understand who wins and who loses. Additionally, we will compare Texas to other states to put into context the tax burden borne by Texans.
Finally, we briefly examine a set of prominent public policy issues to survey some of the economic and social policies that have emerged from the evolving structure of the state's political economy.
2. The Politics of Political Economy
Two related questions dominate debates about the relationship between the government and the economy: how much should the government be involved in the functioning of the economy (and in business in particular), and how much should the economy (especially business) be involved in the functioning of government?
The first question has been pondered since at least to the middle ages when private merchant interests became economically powerful enough to compete with the hereditary wealth and authority of royal rulers in Europe. As markets (and business) carved out their own independent space in society, they prompted considerable reflection on the proper balance between public authority and private interest. Indeed, the struggle for national independence for what became the United States in the 1770s was in part rooted in a struggle over the authority of King George III of England to impose various taxes and other restrictions on trade and commerce. Similar issues shaped the struggle for Mexican independence from Spain in the early decades of the 1800s.
Contemporary examples of the intervention of government in the economy include the regulation of prices and service levels for electric utilities, rules for sharing local communications trunk lines by telephone companies and cable operators, the promotion of professional sports franchises through tax breaks, and use of eminent domain to acquire privately owned real estate, just to name a few.
The second question - to what degree business and other powerful private interests should be involved in government and the shaping of public policy - is a central concern for liberal democracy. The tendency for market economies inevitably to produce an unequal distribution of economic resources directly undermines the ability of citizens to compete equally in the political arena. Is this a uniformly bad thing, or is it part of a necessary trade-off between democratic participation and personal freedom that societies must make?
The question also has deep roots in our national history and beyond. The famous ideological struggle between the Hamiltonians (after Alexander Hamilton, the first U.S. Secretary of the Treasury) and the Jeffersonians centered on whether the United States should be a nation of powerful commercial interests or of small landholders and merchants. The Hamiltonians wanted powerful commercial interests in part as a way to make the country an international power in both politics and economics. The Jeffersonians preferred a nation of small entrepreneurs out of concern to minimize differences in political power among competing interests.
President Andrew Jackson (1829-1837), a Tennessean from what was then the country's western frontier, took up the Jeffersonian cause when among other things he eliminated the Second Bank of the United States, the national bank at the time. Many of his fellow Tennesseans emigrated to Texas bringing their own particular brand of frontier populism that has evolved into a general distrust of government (the low taxes, low services consensus) and a preference for promoting business regardless of size - a unique mix of both Jeffersonian and Hamiltonian views, perhaps.
The politics of the political economy in Texas, as elsewhere, have been hotly debated, but there has been a longstanding baseline view that can only be described as conservative. Despite the growth of government in recent decades, the "low taxes, low services" consensus in Texas has held firm even as the state, and state government, have grown. For more information on the size of Texas government, see the discussion in the Financing Government section in this chapter. The Bureaucracy chapter also provides extensive coverage of the size and reach of government administration in Texas.
In practice, the twin questions of how government intervenes in the economy and how economic interests are incorporated into democratic institutions are frequently intertwined. Texas has a long tradition of providing business interests, large and small, with wide latitude in both economic and political ventures.
Economically, the state subsidizes or otherwise permits public expenditure on a variety of industries and activities ranging from road building to professional sports, manufacturing, and real estate development. Additionally, the state has encouraged oil extraction in environmentally sensitive areas, outsourced customer service functions for health and human services, and begun to consider selling subsoil water rights on state owned land in west Texas to private interests.
In terms of latitude granted to business to shape public policy, the state permits extensive lobbying of elected officials while requiring only light reporting of such activities. It only minimally regulates and enforces the timing, sources and amounts of electoral campaign contributions, and it imposes only loose restrictions on contacts and exchanges between private interests and executives in the bureaucracy.
In summary, Texas has developed a decidedly pro-business political culture that eschews public expenditure on social programs, while permitting huge contracts, subsidies, and sales to business interests. The flip-side of this political-economy coin is that the state tolerates wide disparities in political access between ordinary people and powerful economic interests.
2.1 Texas Enterprise Fund: Winners and Losers in Economic Policy
One of the most prominent economic development initiatives to emerge from the political process in recent years has been the Texas Enterprise Fund, whose creation illustrates the interplay of business and politics in the state. The fund also illustrates how the extensive integration of state government in the economy often takes place amidst rhetorical nods to the preeminence of markets and competition.
The Texas Enterprise Fund was created during the 2003 legislative session in response to Governor Rick Perry's request in his 2003 State of the State address for a special development fund of $390 million. Bills were introduced in each house of the legislature that would finance this fund by taking money from the emergency Economic Stabilization Fund (a.k.a. the "rainy day fund").
The rainy day fund was created in 1988 for special emergencies. During the 2003 legislative session, the legislature had earmarked nearly all of the $1.1 billion that had accumulated in the fund to pay for some unexpected needs (true "rainy day" emergencies like the clean up and reconstruction of buildings at the University of Houston damaged by Hurricane Alice) and as well as to cover budgetary shortfalls in state Medicaid and the Children's Health Insurance Program (CHIP) caused by slow growth in the economy.
Because of the general budget crisis in 2003, the Governor's proposed Texas Enterprise Fund ended up competing for the same money as health care and health insurance for low income Texans. This prompted debate over the proper use of scarce state funds both from a moral perspective (helping the poor or big business) and from an efficiency point of view (which use would have the biggest positive impact on the economy). For instance, a study jointly commissioned by the Texas Hospital Association (THA) and the Texas Medical Association (TMA) found that for every one dollar in cuts to Medicaid and CHIP, the state loses $2.81 in federal funds. This same study also found that impact from the losses in output for the state economy as a whole, the increased insurance and healthcare costs, and the lost tax revenue totaled several times more than the original cuts in funding. 
Critics might say that cost to the general economy of giving special business interests direct government subsidies was huge. Furthermore, some groups - namely low income households, doctors and hospitals - paid the most for this transfer of wealth to specific interests. On the other hand, supporters of the Texas Enterprise Fund argued that the state needed to stay competitive with other states who were offering grants and subsidies to attract new businesses.
In the final bill, the governor got $295 million, most of what he requested. The majority of the funds were to be dedicated to "deal closing," as the governor's website referred to it, which frequently means sweetening existing offers of tax breaks and infrastructure to attract new business investment.
Shortly after the fund was established, $40 million was used to convince the technology consortium Sematech to build a new chip wafer facility in Texas instead of Albany, New York. Another $55 million was targeted to attracting new IT and biotechnology firms to the state. Though it was mostly dedicated to funding incentive packages for corporations - what critics sometimes refer to as "corporate welfare" - the new discretionary fund also earmarked $60 million for disaster relief from things like tropical storms.
The reduction in funds for Medicaid and CHIP were especially painful given that Texas already lagged every other state in its percent of the population covered by some sort of health insurance. According to the US Census Bureau, the state had the highest percentage of people without health insurance for the three year period from 2000 to 2001, averaging 24.1 percent annually. This compares to the national average for the three year period of 14.7 percent.  Texas lost more ground from 2000-2001 to 2001-2002, during which time another 1.4 percent of the population was added to those already without insurance. Against this backdrop, the choice to pay for the governor's "deal closing" fund with money that could have reduced cuts in Medicaid and CHIP provides a vivid illustration of the tradeoffs that inevitably occur when budgeting decisions are made.
Funding for CHIP and some of the other cuts in spending were restored during the 2005 legislative session, when the legislature reduced funding for the Enterprise Fund to $185 million. But the legislature also created a $200 million Emerging Technology Fund, designed to encourage the development of high tech public-private partnerships. Though universities were flagged as potential partners and fund recipients, the governor and his staff signaled their preference for funding private enterprise initiatives by signing the bill creating the fund in a ceremony at a Samsung plant in Austin.
The Texas Enterprise Fund illustrates a number of themes that recur throughout our discussion of the political economy in this chapter:
Social services funding is frequently vulnerable to being used for short-term political ends.
Government "economic development" inevitably creates political winners and losers, both horizontally among competing companies and industries seeking to use government support for their own private goals, and vertically along class lines.
The influence of politics and economics are mutually reinforcing. Political developments shape state intervention in the economy. Subsequent economic developments subsequently feed back into politics.
Even seemingly narrow state economic intervention has political, economic, and social consequences.
Even if the legislature and governor had not worked to create the new gubernatorial discretionary fund and agreed to dedicate that money to Medicaid and CHIP, they would still have been affecting the economy. There would still have been winners and losers among economic interests as well as among social class interests. This point was evident in the THA/TMA study on the economic impact of state budget cuts to these programs. If Medicaid and CHIP funds were not redirected, then the healthcare industry and insurance industries would have faired much better, as would the general population, from lower healthcare costs and greater flow of federal dollars into the state.
In this chapter we look at the complex dynamics of the interplay between politics and economics, as well as the key economic activities of state government. The Texas Enterprise fund provides ample illustration of these dynamics and of the structure of state intervention in fostering business; yet it is only one of thousands of instances that constitute the Texas political economy.
3. The Modern Texas Economy
The popular image of the Texas economy has been symbolically defined by the primary goods - agriculture products and mineral resources - that dominated the state through most of its history. From the Civil War through the 1920s, cotton was the undisputed king, and cotton production came to symbolize the commercial agriculture business that dominated the early Texas economy. Agriculture, of course, never disappeared from Texas, but its preeminence was challenged and ultimately eclipsed by the petroleum industry as the oil age dawned. The state's oil reserves propelled the creation of a whole new industrial complex, and with it, new wealth.
The energy sector remains prominent among Texas industries, as do ranching, agriculture, and agriculture-related industries like cotton ginning. But other industries such as travel and technology (including computers, aerospace, and telecommunications) have grown dramatically, challenging the supremacy of traditional economic activities.
Part of the success of these industries derives from the fact that have enjoyed considerable encouragement and dollars from the federal government - particularly the aerospace industry. National and even international politics played important roles here. The arms and space races with Cold War foe the Soviet Union led to creation of the NASA facility near Houston. In turn, the aerospace industry has spawned growth in related industries such as telecommunications, information technology, and the airline industry and travel reservations industries.
The state's position in both the national and international economy has evolved in ways that have contributed to the transformation of its internal politics as well as its position in national and even international politics and economics. The Texas of the nineteenth and early twentieth century fit the profile of much of the South and Southwestern regions that is straddles. Texas was a moderately populated producer of primary goods and commodities situated in a largely dependent relationship to the more developed and industrialized northeast. The global embrace of oil helped propel Texas into a more prominent national and international role, though not without costs the state still feels. If Texas now ranks among the largest economies in the world, the legacy of its years of dependence on the production of commodities endure and is still in evidence. The oil crash of the mid-1980s sent the state into a prolonged economic downturn that caused multiple business failures, high unemployment, and regional real estate crashes. The severe repercussions of the downturn in the oil industry illustrated how Texas still bore similarities to late-developing nations. Such nations often depend on a single extractive or commodity industry, which leaves them highly vulnerable to economic booms and busts as the pricing for that commodity fluctuates. As the excerpt from our interview with former Governor Mark White illustrates, the downturn severely affected the state budget and state politics. This chapter's Thinking Comparatively chart Boom and Bust or Steady Growth? compares growth in the Texas Economy with other states, and also plots the decline of the importance of oil and gas in the Texas economy.
Despite this legacy, the state's economy has undergone a profound transformation and diversification that began - if slowly at first - in the 1950s. By the turn of the new century, the Texas economy has matured into a more dynamic, diverse and complex structure, much better equipped to withstand the buffeting of the increasingly globalized nature of economic transactions.
3.1 Sectoral Profile of the Texas Economy
A common way of thinking about the profile of an economy is in terms of economic sectors, parts of the economy devoted to particular kinds of activities or products, cattle ranching, cotton growing, travel and tourism, information technology, etc. Looking at the relative size of economic sectors is a useful way to think about where economic activity is taking place - where money is being invested, profits are being generated, and people are working. The Texas economy has become much more diverse in the relatively short period since the oil downturn of the mid-1980s, the culmination of several decades of population growth and economic development trends that resulted in the emergence of a much more modern economy as the 2000s began. Energy continues, however, to play a major role in the state's economy, as illustrated in a talk by Railroad Commission Chairman Michael Williams recorded at UT - Austin in 2006.
The general structure of the modern Texas economy can be glimpsed in the list of the 100 largest publicly traded employers in the state measured by their average number of workers - the so-called Texas 100. The Texas 100 list published in January 2003 by the state's Comptroller of Public Accounts (based on the number of employees in the last two quarters of 2001 and the first two quarters of 2002) shows the continued importance of the energy sector. But it also shows growth in areas that either didn't exist or were shaded backwaters of the economy only a few decades ago.
Many Texas-based companies outside of the petroleum industry are leading businesses in their industries. The high-technology sector includes such household names as Dell Computer Corporation, the personal computer maker based in Round Rock Texas, Southwestern Bell Communications (San Antonio), and Texas Instruments (Dallas). All three companies are among the top 100 employers in Texas. Several of the top employers in the retail sector are headquartered in Texas. These include: 7-Eleven, Inc. based in Dallas, J.C. Penney Company (which also owns Eckerd Drug) based in Plano, Radio Shack in Fort Worth, and Winn Dixie also based in Fort Worth.
In the services and finance sectors two Texas based companies enjoy a presence among the top 100 Texas employers. Administaff, Inc. is based in Kingwood, while Cullen Frost Bankers claims San Antonio as home. Metal products maker Trinity Industries of Dallas rounds out the list of Texas based companies among the 100 largest employers in the state.
The largest companies operating in the state in other important industries, such as retail and manufacturing, generally are not headquartered in Texas. The prominence of these out-of-state corporations reflects increased integration among the regions of the state and the integration of Texas in the national economy.
The list also shows the considerable importance of the travel and chain restaurant industries. Three national airline carriers and the country's dominant travel reservation company are headquartered in the state. The airline and air travel industry has benefited from Texas's fortuitous location roughly halfway between the two coasts, and from the state's burgeoning and increasingly urbanized population.
The presence of several corporate chain restaurant companies (including Church's, Popeye's, Chili's, Red Lobster, and Luby's, among others) in the table of top employers in the state suggests how the dining and entertainment business is linked to the national highway system, and, in turn, the proliferation of suburbs and exurbs across the state. Extensive retail activity follows the expansion of residential developments, which in turn are connected by new highways and roads. The result is a group of linked economic interests that support the continuation of a model of economic development that hinges on autos, roads, and expansion beyond "the city limits."
3.2 Economic Geography
Changes in the profile of economic activity in Texas have been accompanied by changes in the state's economic geography. For much of the twentieth century, the economic dynamism of the state followed the oil industry. The gradual diversification of the state's economy propelled (and was in part propelled by) the development of the state's transportation network as well as its cities and suburbs. The image of Texas as a rural state of oil wells, sleepy small towns, ranches, and a couple of big cities (Houston and Dallas) became increasingly outdated. If Texas once epitomized the large frontier state, recent decades have seen Texas fall more into the pattern of California .
Oil still dominates some regions of the state, as this chapter's map Black Gold illustrates. Note that the oil and natural gas industry in Texas also has experienced a geographic shift away from the storied east Texas oil fields - Spindletop, Sour Lake, Batson-Old, Humble, and Goose Creek - to west Texas, with additional smaller concentrations in the northern panhandle and south Texas. This migration reflects the depletion of oil in those east Texas fields and the discovery of even more substantial reserves in the western part of the state.
But while oil exploration migrated generally westward other economic transformations were occurring that added new dimensions to the economic geography of the state. Most notable among these changes has been the rapid growth of the industrial and service sectors of the economy, which in turn have produced rapid urbanization and suburbanization.
Today the Texas Comptroller's office identifies thirteen distinct regions in the state for which it tracks regional economic trends and directions for growth. These thirteen regions are clearly based on physical location, with most regions drawn in relatively compact dimensions (only the South Texas Border region is much longer than it is wide). But, these regions are also drawn according to economic activity and population density. Areas like the High Plains (some would call it the Panhandle) and West Texas are sparsely settled, with the former dedicated primarily to ranching and agriculture, while the latter is the heart of oil country within the state. Despite being sparsely settled, these two regions contain some important regional urban centers, including Amarillo and Lubbock in the High Plains and Midland in West Texas.
The comptroller's regionalization scheme also includes the two major border areas identified here as the South Texas Border (the eastern portion of which is commonly referred to "the Valley") and the Upper Rio Grande. These areas are also sparsely populated, but nevertheless boast vibrant cities including Brownsville, Laredo, Del Rio, and El Paso. These two regions are also characterized by strong Mexican-American majorities and growing cross-border trade.
East Texas spans a wide territory from the coastal plains (Southeast Texas) to the rolling hills in the northeast corner of the state (Upper East Texas). These two regions were among the first areas settled and also led the transformation of the state into a major oil producer. But, both the oil economy and the population centers in the state have shifted westward.
Meanwhile the Metroplex, Capital, Alamo and Gulf Coast regions are built around the five major urban centers in the state - Dallas and Ft. Worth-Arlington (combined in the Metroplex region), Austin, San Antonio, and Houston.
These five major cities and their now sprawling suburbs have become the state's economic engines. As the pie chart on metropolitan and regional employment shares in the feature entitled Where the Jobs Are - and Good Wages shows, the five major metropolitan areas accounted for two-thirds (66.7 percent) of all employment in the state in 2005. Just two huge urban centers, Houston and the combined metroplex of Dallas-Ft. Worth-Arlington, accounted for over half (52.7 percent) of all state employment.
Not only do the state's metropolitan areas provide the vast majority of jobs, they also provide the best wages, as seen in the line chart on metropolitan and regional per capita incomes in this chapter's feature on jobs and wages in Texas.
The highest per capita incomes over the past few decades have been in Houston, Dallas-Ft. Worth and Austin, all of which have regularly exceeded the state's average per capita income. (Of course, the cost of living in these areas is also generally higher than in the rest of the state.) Incomes in Dallas and Houston have even routinely exceeded the national average for incomes, which has generally been higher than our average state income. It is worth noting the sharp upturn and subsequent downturn in average incomes in Austin in the latter half of the 1990s when the technology industry bubbled, then burst.
It used to be that incomes in the Oil Patch in west Texas were even higher than in Dallas and Houston. But after the oil business collapsed in the mid-1980s, incomes for the region never recovered to their previously high levels relative to the major metropolitan areas. San Antonio incomes have been the lowest among the largest urban centers. Meanwhile, incomes in El Paso and the border region have been far below the statewide average.
This overview of the economic geography of Texas provides a general idea of the breadth and variety of economic experience in the Lone Star State. The next section zeros in on some recent economic transformations, illustrating how technology and the increasing integration of Texas with the global economy have spurred major changes in the state.
3.4 Recent Transformations
As the U.S. and the global economies have been transformed in the last three decades, the Texas economy has changed along with them. The primary changes for Texas have been greater economic diversification, growth of the technology and transportation sectors, and increased integration with both the national the international economies. As a result of these changes, Texas has been less subject to cycles of boom and bust than in the past. These changes have also affected politics in the state, as new economic actors have sought representation of their interests in the political system.
The diversification of the state's economy has been most evident in the dramatic expansion of the microelectronics industry. Three major players in this industry have called Texas home: Dell Computer Corporation, Texas Instruments, and EDS. This last company was built by H. Ross Perot into a powerhouse in the IT consulting industry. Mr. Perot sold much of his stake in EDS, but later founded another powerful competitor names Perot Systems. Others companies, including microchip makers Intel and AMD, established large chip fabrication operations in the state. By the end of the 1990s, most major computer software firms had a significant presence in Texas.
The computer and information technology industries grew rapidly in the second half of the 1990s, fueled in part by massive amounts of venture capital funding and speculative stock investing, but suffered a sharp downturn when the so-called "technology bubble" burst in beginning in 2000. This caused considerable retrenchment for the sector, with many startups declaring bankruptcy. Most large, established companies survived, but cut back or delayed investment in new projects intended for Texas. Many small firms, including many of the fabled "start-ups" of the mid 1990s, failed completely.
The technology bust, the major effects of which lasted through 2003, caused the loss of over 150,000 jobs in Austin, Dallas, and Houston - the three major technology centers in the state. The Austin area lost 6.7 percent of its private sector jobs; Dallas lost 6.4 percent, and Houston lost 3 percent. This represented billions of dollars of private industry wages annually. 
The other dramatic development for Texas is greater integration with the international economy. The data table in this chapter's feature Selling to the World reveals that international exports from Texas slightly more than doubled between 1991 and 2001, and continue to increase at a steady rate. This integration was initially evident in the increase in production and trade between the United States and Mexico. This started out in the 1970s and 1980s with the creation of the maquiladora, or assembly, industry on the Mexican side of the border. In the 1970s the Mexican government had decreed that goods could be imported duty free as long as the goods were re-exported after being processed. Machinery imported for such processing also enjoyed exemptions from import duties.
These new import-export arrangements spawned the development of "twin plants" up and down the border between the US and Mexico. The plants in the US would complete the capital-intensive part of a particular production process (typically using expensive machinery), while the Mexican plants would complete the labor-intensive part (involving less expensive machinery). Initially the Mexican plants performed mostly simple assembly of electronic goods, like television sets, or wiring harnesses for automobiles. Some clothing was also produced in the region.
Eventually, considerable new capital investment flowed to both sides of the border. The volume of commercial traffic over the border blossomed. This experience, and the growing integration of the border economy, helped propel the formation of a regional free trade area in which import tariffs would eventually be eliminated. The North American Free Trade Agreement (NAFTA), which included Canada, Mexico and the United States, was inaugurated on January 1,1994. This new market included at the time over 350 million people and approached $10 trillion in gross production. Recently the NAFTA population counts more than 400 million people, with gross production of over $11.7 trillion.
As a result of NAFTA, the volume of trade between Texas and Mexico skyrocketed, while the volume of goods "transshipped" between other states and Mexico through Texas saw similar increases. Texas's total exports to all countries rose by 36 percent between 1997 and 2000, surpassing the $100 billion mark in 2000 for the first time ever. In the same period, exports to Mexico rose 66 percent to almost $48 billion. Exports to Mexico represented 46 percent of all Texas exports in 2000, and continued to grow as a percentage of total exports - albeit much more slowly - in 2001 and 2002.
Although Texas trades with many countries in the world, the concentration of its trade with Mexico means that it is particularly vulnerable to any downturns in that country. Fortunately, the very same free trade agreement that has contributed so much to the vitality of Texas foreign trade also seems to be helping to stabilize the Mexican economy. But the migration of industries such as garments and electronics to areas like Southeast Asia, or even Central America, may make Mexico more vulnerable to economic cycles.
These trends toward greater diversification and global integration have had an important consequence: Texas at the turn of the 21st century was no longer quite so susceptible to crises induced by the collapse of oil prices.
Twice in the last two decades of the century, the state of Texas was struck by powerful economic contractions due to sudden and sustained drops in oil prices, first in 1985-86 and again in 1991-1992. These were especially difficult recessions because business and governments in the state had begun to invest heavily in commercial real estate development and related infrastructure. When oil revenues to both the state and private corporations in the petroleum sector declined sharply, there was a ripple effect throughout the entire economy.
A decade later in 2001, oil prices again fell precipitously. This time, however, the state did not suffer the severe economic recession of previous oil price declines. The boom and bust cycles of commodity dependence, whether related to cotton or oil, seemed to have finally disappeared from the Texas economy.
Changes in economic structure, policy actions, and political strategy work in tandem to continue driving change in the states political economy. The Emerging Technology Fund briefly discussed in section 2.1 provides an example of how these macro-level economic transformations can shape institutions and policy, and provide opportunities for political and business leaders to pursue their policy and political goals. The Emerging Technology Fund was spurred in part by the state's entry into high tech enterprise; in turn, these developments served to encourage the development of policies that advanced more high technology public-private partnerships. It also provided the governor's office with the opportunity to publicly promote such ventures, as well as to influence the distribution of those funds to important interests and regions of the state.
5 "Austin, Dallas Felt Downturn Most," Austin American Statesman, August 24,2003.
4. Financing Government
The revenue and spending provisions of all governments - whether national, state or local - constitute their fiscal policy. Revenues can come from many sources, including taxes, user fees, interest income, intergovernmental transfers, sales of assets, and more.
For many governments the primary source of revenue is taxes, which in turn can take many forms, including income taxes, sales taxes, property taxes on houses, ad valorem tax taxes for automobiles, and excise tax (a kind of sales tax on things like cigarettes, alcohol, and gasoline - sometimes referred to as "sin taxes").
Income taxes may apply to stock dividends, capital gains (the profit from selling stock, real property or other assets), wages, and salaries. Taxes on these last two forms of income (wages and salaries) commonly take the form of payroll taxes. Payroll taxes are withheld each time the income is paid - usually weekly, bi-weekly or monthly.
Payroll taxes include additional taxes that are not paid on other types of income such as stock dividends and capital gains. These additional taxes include Social Security and Medicare taxes. Below is a list of the three types of taxes on payrolls:
Income taxes - Texans pay only federal income taxes, as Texas is one of only seven states that do not levy state taxes on individual income.
Social Security - This is a federal payroll tax that includes old-age, survivors, and disability insurance (OASDI); sometimes this is referred to as FICA (Federal Insurance Contribution Act) on paycheck stubs. In 2003, employees paid a flat rate of 6.20 percent on all income up to $87,000 for Social Security. Income above this level is not taxed for Social Security purposes.
Medicare - This is another federal payroll tax that is also specified by the FICA law, but is usually identified as a separate line item in payrolls. Taxes for Medicare are calculated using a flat rate of 1.45 percent for all income, with no upper limit.
These payroll taxes (income, Social Security, and Medicare) apply to all members of the workforce who receive a regular payroll check, and are usually "withheld" from each check as the wages of salaries are earned. This is why we commonly refer to income and social security tax withholding. For obvious reasons, that part of one's salary or hourly wages that is not withheld is referred to commonly as "take home" pay.
Social Security and Medicare taxes are not assessed on income from other sources like stock dividends, interest income, or capital gains. The only one of the three main types of federal income tax assessed on these other sources of income is the regular income tax, with some limited exemptions on capital gains. Notably, regular income taxes are not automatically withheld when non-payroll income is earned, as is the case for payroll income. So, most individuals do not have to pay taxes on non-payroll income until April 15 of the year after the income was earned. This deferral of tax payment allows individuals earning such income to put more of their income to productive uses for a longer period of time.
Most people rely primarily or even solely on payroll income, and therefore must pay all three types of federal taxes on most of their income. Also, they must pay those taxes immediately as their earnings are paid (no deferral).
[image]433676[/image]States and localities (i.e., counties and cities) derive considerable revenue from property taxes and sales taxes. Since Texas does not levy taxes on individual incomes, it must rely ever the more so on these other sources of revenue. This reliance on property and sales taxes instead of income taxes has generated perpetual concerns about the equality and fairness of the tax system.
Generally speaking, wealthier individuals pay a bigger share of their incomes on income taxes, while the less wealthy pay a bigger share of their income on sales and property taxes (taxes on consumption). In debates about different approaches to taxation, tax schemes are characterized as either progressive or regressive. Progressive taxes require those with higher incomes to pay higher percentages of their income on those taxes. Regressive taxes require those with lower incomes to pay higher percentages of their income on those particular taxes. This chapter's feature Progressive and Regressive Tax Systems provides more in-depth discussion and illustrations.
4.1 Sources of Revenue
So, where does Texas government get the money to operate its three branches and its numerous social and economic programs? Just less than half of total revenue comes from state taxes (45 percent in 2004). The rest comes from various other non-tax sources, including federal government transfers which account for just slightly more than 35 percent of total state revenue - as this chapter's feature The State's Income shows.
The $27.91 billion in taxes collected by the state in 2004 represented 70 percent of the $40.14 billion in state-sourced revenue. State sales taxes constituted the biggest portion of those taxes, bringing in $15.42 billion and accounting for over 55 percent of all taxes (and 38 percent of all state-sourced revenue).
The amount of revenue generated by sales taxes in the state is much higher than that reported here, because counties, municipalities and other special tax districts can add a total of up to two percent in sales taxes.
Other big sources of tax revenue come from taxes on vehicle sales/rental and housing sales ($2.74 billion in 2004), motor fuels ($2.92 billion), franchises ($1.84 billion), and insurance occupation ($1.18 billion). Though taxes in these four areas added up to a considerable sum - $8.68 billion - they totaled much less than the revenue raised by just the sales tax alone.
The other eight areas of taxation listed in the table represented only 6.1 percent of state revenue, and 13.7 percent of all state taxes in 2004.
The majority of state government revenue comes from sources other than state taxes. The largest component of state government income comes from the federal government for funding of programs in education, healthcare, and transportation, to name a few. Just less than one-third of all Texas state revenue comes from the federal government. This federally-sourced revenue can take the form of outright grants or matching funds.
The second major source of non-tax revenue - and the third most important among all sources - is from state licenses, fees, permits, fines and penalties. This is a broad category, to be sure. It can include personal licenses such as drivers' and hunting licenses, as well as professional and business licenses.
During the 2003 legislative session lawmakers responded to the state fiscal crisis in part by raising the cost of a broad range of licenses, permits, and user fees. A similar broad round of fee increases occurred during the state's last major recession in 1991. Even though some licenses and fees apply to large corporations, many of them apply to individuals. As a result, raising the cost of licenses or fees based on a flat rate only exacerbates an already regressive system of revenue generation.
The tendency to raise the cost of user fees and licenses in the face of budget shortfalls reflects the difficulty - or really the near impossibility - of raising tax rates or introducing new taxes in the state. Neither the business community nor the general population is likely to accept the introduction of an income tax, and even raising the sales tax rate is extremely difficult. Although user and licensing fees are merely taxes by another name, it allows politicians to claim that they did not raise taxes. It also allows supporters of such fee increases to defend their policy preferences by pointing out that the users of a specific service should pay for it. Campers should pay camping fees, hunters should pay for hunting privileges, students should pay for university libraries and technology services, etc. How much fairer can you get? User fees can be justified as paying for a service rather than paying a tax for the use of public resources, since not all taxpayers use these resources equally.
However we regard the charging of user fees for public facilities, we should recognize that this need to raise fees indicates the lack of politically viable options for increasing the state's revenue raising ability. Despite having a state economy that ranks among the top ten countries in the world, Texas cannot respond to economic downturns with any more vigorous measures than raising drivers' license fees or tuition at state universities.
4.2 Limitations of the Sales Tax
Beyond concerns about the regressive nature of sales taxes, the reliance on such revenue sources (and license and user fees) raises critical issues. It restricts the capacity of a country-sized state like Texas to respond to short-term fiscal shortfalls. It also slowly debilitates the state over the long run.
Though Texas is much more diversified than it was just a decade or two ago, short term economic recessions can cause considerable mischief to state fiscal policy. The revenue shortfalls in the 2003-2004 budget cycle, as we saw in the discussion of the Texas Enterprise Fund near the beginning of this chapter, forced painful cuts on a wide range of programs that are critical to the well being of Texas citizens and the broader Texas economy.
The core problem is that sales taxes, licenses and fees can only be raised so much. Advocates of this approach to taxation argue that limiting the flexibility of the government to raise revenue forces it to stay lean and resist "program creep" (incremental expansion of government programs) in good times as well as bad. But taking this approach to taxation also means that critical programs must be cut in bad times. It also means that cutting state expenditures carries with it even greater losses to the state because of diminished matching federal funds for many programs.
Successive legislatures and governors have been forced to face the possibility that reliance on these limited sources of revenue reduces the capacity of state government in the long run. Revenue from sales taxes, licenses and fees grows far less rapidly than total personal income in the state. Yet the growth in personal income reflects a growing, increasingly diverse population and a more complex economy that requires new and expanded public programs in education, health, transportation, and regulation. As the Center for Public Policy Priorities (CPPP) states:
Our basic problem is that state and local tax revenue does not keep up with the growth of the Texas economy [if we are] measuring economic growth by growth in personal income, which shows the ability of Texans to pay taxes. The growth in personal income also generally reflects the need for public services, tracking the growth in population and inflation. In addition, higher personal income mirrors changes in the nature of the economy, which now demands higher skills from workers, requiring more students to continue their education through high-school graduation to post-secondary institutions. 
As the CPPP notes, the state sales tax in Texas was adopted in 1961 when most sales involved goods - tangible items - as opposed to services. Consequently, many services were excluded from taxation. But as the state economy has grown and become more diversified, services have come to represent a much larger share of economic transactions. In other words, "Over time, the sales tax has applied to a shrinking percentage of all sales transactions in the state. Sales volume has grown faster than sales tax receipts." 
A significant source of the decline in the share of transactions subject to taxation is the growth in the value of professional services not taxed, including: legal services, architecture and engineering, accounting, advertising, financial services, construction labor and personal services, among others. In the modern Texas economy these professions and services account for a substantial and growing percentage of all commercial transactions. More generally, they represent large sectors of the economy that remain essentially untaxed. Taxing these sectors would broaden the base of the state's primary means of raising revenue, while achieving some measure of increased fairness in the distribution of the tax burden.
Short of introducing an income tax in the state, the CPPP report recommends "sunsetting" the tax code - that is, mandating a periodic review and updating of the tax code. Each department of the state's executive branch is reviewed every twelve years to justify its continuation and current functioning. So should each tax exemption, exclusion, and discount. The reason sales of many services continue untaxed is, in part, because there is currently no such regular review.
4.3 State Expenditures
One well known political scientist once defined his field as the study of "who gets what, where, when, and how?" The political struggle over who gets what from the state budget is just as contentious as the struggle over who pays what in the form of taxes, licenses and fees. Fights over budget allocations might be even more contentious, since tax related debates are rarely initiated, and those that are don't go very far. People naturally don't like taxes. But, everybody likes to get a slice of the budgetary pie. This chapter's feature on the budget process provides a more detailed examination.
By any standard, the State of Texas spends a lot of money - $74.5 billion in 2007. Interestingly, only a small portion of this huge sum is dedicated to running the general functions of the three branches of government. Together, the executive, legislative, and judicial departments consumed only $2.3 billion. This seems like a lot of money in absolute terms, but only about 3 percent of total expenditures.
The largest of the three branches, the executive, accounted for a very large portion of the general government expenditures. Over $1.76 billion (or 86 percent) of the $2.04 billion general government expenditures was budgeted for the general functioning of the executive branch.
The budget for general government is exceeded by five specific state programs, listed below in descending order of magnitude:
In 2007 education program expenditures were $26.3 billion and health and human services expenditures were $27.8 billion. Their magnitude reflects the extensive reach of these programs, which directly touch the lives of large numbers of Texans across the entire state. In general, education and healthcare require massive infrastructure, large numbers of service providers, and a substantial bureaucracy to monitor these complex and highly structured services.
5. Politics, Economics, and Representative Government
Now that we have a high-level view of the major sources of revenue and overall distribution of expenditures we can take a closer look at how additional dynamics of the state's political-economy shape public policy outcomes.
Our public policies are shaped by the broad patterns of taxation and spending described above. But each area of public policy has its own unique history and inherent dynamics. Below we review three policy areas - transportation (highways construction), public safety and corrections, and education. Each gets a lot of public and private attention because of the considerable sums spent on them and because of their overall impact on society.
How the political system allocates money or otherwise designs and enforces public policies (whether in the legislature, the executive or the judiciary) profoundly affects the structure of the economy and society, which in turn feeds back into the political system.
Consider the construction of roads as an example of this feedback loop. Good roads create the conditions for both expanded automobile ownership and suburban development. As the physical landscape is transformed and automobile-related and road construction businesses grow over the years, both the need for roads increases and their advocates multiply. As these advocates in business and society become more powerful, they exert increasing pressure on the political system, which in turn results in public policies that are generally more favorable to road construction.
The same dynamic applies to public support of prisons, hospitals, schools, convention centers, airports, state parks, professional sports stadiums, oil drilling, petroleum refining, suburban development, police and fire protection, the information technology industry, manufacturing plants, downtown redevelopment, and more.
The following subsections are not meant to be a comprehensive discussion of public policy issues. Instead, they provide thumbnail sketches to the policy outcomes that have emerged from the intersection of government and economics described in the sections above. The discussions in following sections do, however, contain links to more extensive analysis of the policy areas touched upon.
5.1 Transportation and State Highways
The state spends vast sums on transportation. In 2004 Texas spent 8.6 percent (or, one dollar of every 12 in the budget) on transportation. Furthermore, more than two-thirds of those transportation dollars ($3.77 billion of the total $5.25 billion) were spent on highway construction, maintenance and repair.
As observed in the chapter on the Texas Constitution, part of the reason we spend so much on Texas highways is because the so-called Good Roads Amendment to the state constitution (adopted in 1946) requires that that three-fourths of all revenue from state gasoline taxes be "used for the sole purpose of acquiring rights of way, constructing, maintaining, and policing "public road ways" and for the administration of traffic safety laws.
This amendment is a classic demonstration of how policy and budgetary decisions creates winners and losers. While nobody wants to pay taxes, even the most ardent conservative will fight doggedly for a share of government expenditures. Since there is only so much money to spend, budget politics is essentially a zero-sum game: the money that one group gets is lost to others vying for a share of the government budget. If you add to one expense area, you must subtract the same amount from other expense areas.
The creation of winners and losers may happen on a vertical basis between rich and poor, business and consumers, etc. But conflict between competing well-funded business interests also creates its share of winners and losers. For instance, in 2003 a plan was put in motion to sell licenses to pump subsoil water in west Texas to a private group interested in sending it via pipeline to more distant areas. This pitted a very well connected new group of investors against established farming and ranching interests in the area.
The Good Roads Amendment also illustrates how the struggle among competing interests is continuous. What you win during one legislative session, for instance, may be taken away during the next round of budget deliberations. The key is to create barriers that inhibit others from turning your winnings into their winnings. The best way to win and secure one's access to lucrative sources of state funds is to create mechanisms by which other competing interests in society cannot compete for "your" funds. In the case of highways, the solution to this challenge involved creating a so-called dedicated fund (a public fund paid for by revenue from a particular source that is dedicated to a particular use) and then enshrining it in the fundamental document of state government (the Texas Constitution) ensured a steady stream of work for industries connected with highway construction.
Despite the Good Roads Amendment, the Texas Constitution still prohibited public borrowing for the purpose of building roads. In essence, Texas had a "pay-as-you-go" approach to road building. In 2001 the legislature presented voters with a proposed amendment to the constitution that would create a new fund exclusively for highway construction that would permit public borrowing. Voters approved the proposed State Mobility Fund, which allowed the issuing of bonds to fund new highways, toll roads, and other transportation systems.
5.2 Public Safety and Corrections
The fourth largest expenditure area in the Texas budget is public safety and corrections. Approximately 5.4 percent (or $3.28 billion) of total net state spending was directed to this area in 2004. This represented a slight decrease from previous years, after rapid growth over the course of the 1990s, during which increasing concern with crime and security among voters, combined with stricter sentencing and rapid overall population growth, swelled the number of people in the state prison system.
Incarceration rates shot up over the decade of the 1990s, from 257 per 100,000 Texas residents in 1989 to over 700 for each year from 1989-2001. The total number of those incarcerated is even more stunning when we consider that the overall population of the state grew considerably over the decade.
Consequently, the budget for the Texas Department of Criminal Justice (TDCJ, which includes the Texas Department of Corrections) grew at double-digit rates for every year but one from 1991 through 1996, and at rates higher than the rate of inflation for the remainder of the decade (see table).
The dramatic expansion of funding for the state prison system in Texas over the course of the 1990s demonstrates additional aspects of the politics of fiscal policy in any jurisdiction, whether it be a state, county, municipality, of even the federal government. More extensive discussion of public safety and corrections can be found in the Texas Politics chapter that focuses on the Criminal Justice System.
Education in Texas does not compare well to the other states - a situation the political leadership in the state has grappled with for decades. Despite years of discussion, political wrangling, and judicial coercion, Texas ranks in the bottom half of the fifty states in state-level spending on primary and secondary education. In per capita spending it ranks 33rd and in percent of personal income spent on education it ranks 29th. 
These below-average expenditures, combined with the specific challenges of immigration and poverty that Texas confronts, are reflected in educational performance measures like the SAT. In 2003 the state ranked 46th among the 50 states in its mean combined score for the verbal and math components. The Lone Star state's mean score of 993 was more than one hundred points below the national average. This chapter's feature Educated Enough? provides a more extensive look at SAT and ACT test scores in Texas, and how they compare to other states.
The state has made tradeoffs in favor of funding public safety and corrections instead of investing in public universities and post secondary education. The state's own Comptroller of Public Accounts points out that from the 1984-1985 state budget through the 2000-2001 the state increased real public safety and corrections spending by 258 percent, but increased real public and higher education spending by only 82 and 39 percent, respectively, during the same period. 
These trade-offs in the uses of state expenditures can have a profound impact on the overall performance of the state's economy. According to the State Comptroller Carole Keeton Strayhorn, "Every dollar invested in our state's higher education system pumps more than five dollars into our Texas economy. It is a remarkable return on our money for Texans today and a vital stake in the future for successful generations of Texans tomorrow." This analysis should also be considered in the context of significant political contention over education. How to fund education equally has been a significant political issue in Texas as successive legislatures have attempted without success to comprehensively address a public policy issue that has steadily gained in public scrutiny. Public concern about education has grown in almost all areas connected to the issue, from equality of funding - as this feature from the Constitution chapter chapter explores - to the overall amount of funding, to the effectiveness of public schools.
The political economy encompasses an extensive, multi-layered, and complex structure that includes the government, economy, and society. Even those social groups and geographic areas that are relatively excluded from the benefits of the political economy constitute key components of the larger system that distributes the society's resources.
Complex interactions shape the character of the Texas political economy. Powerful interests compete (horizontally) with each other as much or more than they compete (vertically) with the lower and middle classes. This may be because the lower and middle classes are much less influential in proactively driving the agenda of state government. The struggle over who gets what and pays what, where, when and how, provides the animating energy for state and local politics. Your land for a highway is my state park. My healthcare industry funding (and, coincidentally, health insurance for the poor) is your business development fund. The well water for your ranch is my opportunity to sell to thirsty customers hundreds of miles away. And so on. Aside from conflicts over the allocation of existing resources, the overall size of the pool of rewards remains limited by the broad insistence on limiting taxation.
The performance of the Texas political economy within these constraints is at best mixed. Yes, the gross output of the state economy is huge. And, yes, the overall productive structure rests on a much broader and diversified base than even just two decades ago. Still, some of that success resulted from the state's considerable natural resource endowment and from the increasing integration of the national economy in the post World War II period - factors beyond the reach of state-level decision making.
In the areas of social development and fairness, the Lone Star State's political economy can be fairly judged as dismal. The state system for raising revenue relies primarily on regressive mechanisms like the sales tax, user fees, and licenses. Investment per capita in education is low, resulting in poor overall performance of Texas students on national tests like the SAT. State support for health care for the poor is limited. Huge numbers are locked away in state prisons. The state's environmental record is poor. Even the state court system has been shown to systematically favor business interests over those of consumers and the public at large.
The prospects for improvement of the quality of services such as public education, for any substantial increase in the fairness of our state political economy, and for improvements in the well-being of poor and working class Texans are dim. The political economy has evolved over decades, and any fundamental changes will come slowly. New opportunities for popular political organization, participation, and activism could help blunt some of the system's worst tendencies. Yet any changes hinge not only on organization and participation, but also on changes in some of the fundamental matters of agreement among Texas - chief among them the fundamental reluctance to create the new, broad-based sources of revenue necessary to dramatically improve the delivery of services that would benefit large numbers of Texans.