Governor Mary Fallin

In her State of the State address, Governor Fallin laid out numerous areas where Oklahoma needs to invest to fix serious problems. She mentioned the shortage of troopers on the highways, the millions still owed to local governments to reimburse emergency expenses, the dilapidated state capitol and medical examiner’s office, crumbling bridges, high infant mortality, a beleaguered foster care system, and unfunded teacher health benefits.

These diverse problems have a common denominator: they are all substantially caused by inadequate funding to core public services after three straight years of budget cuts. Rather than setting a bold course for Oklahoma’s future, we are playing catch-up just to repair what we have allowed to fall apart.

In the same speech, Governor Fallin proposed a huge cut to the personal income tax. The plan is estimated to cost $350 million in the first full year. It also includes triggers to automatically cut taxes again any time the budget begins to recover.

The effect is that for the foreseeable future, tax cuts are shoved to the front of the line. It won’t matter what problems or responsibilities we face as a state. It won’t matter if our infant mortality stays high, if our water isn’t safe, if our schools are failing, if our communities are devastated by extreme weather. Whenever there is additional revenue, the number one priority will always be tax cuts.

That’s reflected in the Governor’s full budget proposal, which was also released yesterday. Going down the list of percentage changes from this year to next, we see a long string of zeroes. The budget is almost totally flat, which really means we can accomplish less due to inflation, rising health care costs, and further deterioration of infrastructure and equipment that we can’t afford to maintain.

The Governor does propose moving money around to fix some of the worst problems resulting from previous cuts. Certainly we should do this. However, since the pie is not any larger, we will inevitably defund other areas as we try to fix what’s already gone wrong.

What new problems will we hear about in next year’s State of the State address? Will we pay for teacher health benefits by defunding school buses? Will we fix our bridges and let dams break? If the Governor’s plan passes, we may never escape this vicious cycle.

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Arthur Laffer

Some Oklahoma politicians have trumpeted a report by economist Arthur Laffer to claim that eliminating the state income tax will fuel an economic boom. Laffer is best known for the Laffer Curve, which he famously sketched on a napkin while meeting with Dick Cheney in a hotel bar. It went on to form the basis of the Reagan administration’s trickle-down economics.

The Laffer Curve makes an obvious point: government revenues peak at a tax rate somewhere between zero and one-hundred percent. In the lower half of the curve, raising taxes will increase revenue, but go too high and the reduced economic activity due to excessive taxation will result in lower revenue.

The argument was not original to Laffer. It had been stated previously by thinkers ranging from 14th Century Arab philosopher Ibn Khaldun to John Maynard Keynes, the founder of modern macroeconomics. What made this idea influential in recent decades was not any special insight into economics, but its powerful appeal for politicians. Rather than explaining how tax cuts (popular) would be paid for by budget cuts or increases in other taxes (unpopular), they could simply claim that the tax cuts would pay for themselves.

However, whether a tax cut will result in higher or lower revenue depends on where you are on the curve. Estimates of the revenue-maximizing tax rate differ, but defenders of tax cuts have a much stronger claim when the top marginal rate is 70 percent, as it was at the beginning of the Reagan administration, than they do when the top rate is 35 percent, as it is today.

Laffer Curve with a maximum revenue point at about a 70% tax rate, based on "How Far Are We From The Slippery Slope? The Laffer Curve Revisited" by Mathias Trabandt and Harald Uhlig.

That doesn’t stop politicians from repeating to the point of absurdity the idea that all tax cuts lead to revenue growth. In Oklahoma, the top marginal rate is only 5.25 percent, and the average family pays an effective rate of less than 3 percent. No credible economist will argue that cuts from such a low starting point can pay for themselves.

To be fair, Laffer doesn’t say this either. His report argues that increases in other tax revenues will replace just one-half of what would be lost by eliminating the personal income tax. Even that much rests on rosy predictions for the economy and the highly questionable assumption that the state income tax is the most important variable for economic success.

Most people realize the picture is more complicated. Oklahoma’s economy is vastly more affected by oil and gas prices, as well as national and global economic trends, than it is by our modest state income tax. Tax cuts won’t put more oil in the ground or protect us from a European collapse.

Laffer also conveniently leaves out the obvious point that budget cuts have a cost. The economic benefit of a modest increase in individual income would be countered by cutbacks in what we can accomplish collectively, with fewer resources to ensure good schools, well-maintained roads, and a safe and healthy community. We have already slashed budgets for three consecutive years, and the result is larger class sizes, fewer officers on the streets, and longer waiting lists for treatment of children with disabilities, to name just a few.

It comes down to this: Arthur Laffer’s work leaves out more than it includes, because his goal is never to provide an accurate economic assessment. It is to tell politicians what they want to hear. As Jay Bookman put it, “It’s like telling someone with an obesity problem that the best way to lose weight is to always eat more ice cream — more times than not, their eagerness to believe overwhelms any skepticism.”

As a result, we keep going further down the tax cut rabbit hole. At least one lawmaker has already said that eliminating the income tax should be the first step towards… more tax cuts. Where does it end?

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Click for larger image.

A proposal by the legislature’s tax reform task force would raise taxes for most Oklahomans, with the worst impact on low-income seniors and families with children, according to a new fact sheet from the Oklahoma Policy Institute. The task force suggested paying for further cuts to the top income tax rate by ending numerous tax credits and exemptions relied on by low and moderate income Oklahomans.

An analysis by the Institute on Taxation and Economic Policy (ITEP) reveals that if this plan were to take effect today, taxes would increase for 55 percent of Oklahomans. Only 31 percent of Oklahomans would receive a tax cut. There would be no change for 13 percent of Oklahomans, a group largely made up of childless singles and married couples with incomes smaller than the standard deduction. [Note: ITEP included about 3/4ths of the credits slated for elimination but did not model tax credits believed to be taken primarily by corporations.]

Among all households, the top 1 percent (those making $357,400 or more) would receive by far the largest benefit, with an average tax break of $2,833. The bottom 60 percent would see an average tax increase of $107.

The largest tax increase among married couples with two children would be for households making $25,000, according to the analysis. They would see a tax increase of $647. Two-child families would not receive a tax cut unless their income was at least $117,000. These families are hit especially hard by the loss of the personal exemption for every household member, including children, as well as the child tax credit and earned income tax credit.

Another group disproportionately affected is low-income seniors, because they would lose the sales tax relief credit and the personal exemption, which is doubled for seniors with incomes below $25,000. Almost all senior couples making less than $50,000 would have their taxes increased.

The sales tax relief credit was claimed on almost one-third (32.3 percent) of all of the tax returns filed in 2009, and it provided a $40 benefit each to more than 1 million Oklahomans. The Oklahoma earned income tax credit was claimed on 307,253 returns in 2009 for an average benefit of about $104. The child care tax credit/child tax credit was claimed on 362,470 returns for an average benefit of about $80. The personal exemption benefits everyone who files an Oklahoma state income tax return; it reduces tax liability for a family of four by more than $200.

Task force member (and OK Policy board member) Don Millican, one of six who refused to endorse the final report, was right to say, ”Basically, you’re taking money from the poor and giving it to the rich. I can’t support that.” We are hopeful that as others learn the facts about this ill-conceived idea, they will reach the same conclusion.

For more on the income tax debate, see our tax reform information page.

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This proposal is a bad deal for hardworking Oklahomans. Doing away with broad-based tax benefits like the personal exemption, earned income tax credit, and sales tax relief credit in exchange for a cut in the top income tax rate would actually increase taxes for a majority of Oklahomans. This would hit hardest the poor and middle class families who are struggling most to make ends meet in a tough economy.

The Task Force recommendations to cut the income tax run counter to the testimony provided by a united chorus of economists and business leaders who strongly rejected the idea that this is the right path to ensure Oklahoma’s prosperity. With revenues already at historic lows and agencies reeling from three successive years of budget cuts, further tax cuts will harm our ability to invest in our workforce, repair our infrastructure, and strengthen our health care system, as well as undermine our efforts to address long-term budget challenges such as our unfunded pension liabilities and understaffed child welfare system.

The recommendations do include several promising ideas, including adopting combined corporate reporting, eliminating the income tax deduction for state taxes, and more actively pursuing taxes owed on remote sales, which should be pursued by the Legislature.

However, we are deeply concerned by the secretive process that led to the Task Force’s final report and recommendations. Although the Task Force held hearings, its report and recommendations were never presented, discussed, or voted on in a public meeting. Several proposals in the report, including eliminating the personal exemption and broad-based tax credits, were never mentioned at the task force’s public meetings and appear to have emerged from a series of private, closed-door meetings of Task Force members. This is not the way that policy recommendations that could have a dramatic effect on all Oklahomans should be developed.

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Elsewhere, people seem to have read a different budget estimate than the one we saw. Two elements of the discussion show a growing disconnect between Oklahoma’s budgetary politics and reality.

First, Governor Mary Fallin and many others continue to advocate for reduction or elimination of the state income tax. A closer look at the budget shows that, of the $400 million forecast revenue growth from FY ’11 to FY ’13, fully  half comes from the income tax. Overall, the income tax is expected to provide $2.5 billion next year for General Revenue, the HB 1017 Education Reform Fund, and the ROADS Fund, which has helped restore the worst of our roads and bridges. Cutting this vital revenue support makes no budget sense. It also makes no economic sense.

Second, the budget “shortfall” was reported as $150 million, the rough difference between revenue growth and loss of one-time budget boosters in the FY ’12 budget. But the shortfall in meeting our public needs is much greater. To determine this, we would have to start with the $600 million difference between the budget for FY ’09, when the recession began, and the estimate for FY ’13. A more realistic calculation would also add at least $100 million for the increase in the cost of providing services over the last four years. So the true budget shortfall is closer to $700 million, not $150 million.  Our recent forecast indicates we won’t reach this level until FY ’15, if we keep the current revenue structure.

And even that calculation is deeply flawed, in that it assumes the FY ’09 level of service should be the target. However, in FY ’08, the most recent available year, Oklahoma state and local governments spent 18 percent less than the national average and ranked 43rd among the states in spending. At least monthly, a new national ranking puts Oklahoma among the bottom states in health, education, transportation, or environment and shows the impact of this chronic under-investment. Our state’s economic and social viability are being eroded by poor budget decisions.

Measuring shortfalls against last year’s budget is a not-so-subtle way of assuming that last year’s budget was the correct one. That could be the case, but probably is not. Instead of letting the available revenue define the budget, Oklahoma should define the budget by the cost of providing the services that are needed to educate children, protect seniors, reduce poverty, maintain infrastructure, and promote economic growth. Current services budgeting and pay-as-you-go policies are used by many states to help define budgetary needs and hold elected officials accountable for whether and how they choose to meet those needs.

Adopting these important reforms would be the right way to begin to get our fiscal house back in order. Cutting income taxes can and should wait until we’ve worked harder at defining what we want and need our state government to do and developed a realistic plan for how to pay for it.

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Before the economic downturn, the income tax brought in more than $2.5 billion a year. In FY 2010, it made up about one-third of all state tax collections. It is the single largest source of support for education, health care, transportation, public safety, and other necessities. The state could not provide basic, essential services without income tax revenue unless other taxes were drastically increased.

The issue brief shows that shifting to greater reliance on other taxes would disadvantage local business, create more risk of revenues not being adequate to needs, and put a disproportionate burden on low- and moderate-income Oklahoma families. Contrary to the claims of its critics, Oklahoma’s income tax is not a hindrance to the state’s business climate or a spur for people to move out of state. In fact, Oklahoma is out-competing most states that lack an income tax.

After three years of repeated cuts to the state budget, the state has fallen further behind in funding teacher salaries and benefits, staffing our prisons and juvenile facilities, and ensuring the safety of children at risk of abuse and neglect, among other vital functions. We face growing obligations to fund our public pensions, protect our water system, repair our crumbling infrastructure, and take care of an aging population. In this context, cutting the income tax is the wrong priority for Oklahoma’s future.

You can download the full 8-page issue brief here. Find more presentations, fact sheets, blog posts, op-eds and newspaper articles addressing Oklahoma’s tax reform debate here.

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What’s up this week at Oklahoma Policy Institute? The Weekly Wonk is dedicated to this week’s events, publications, and blog posts.

This week OK Policy released a paper showing that state costs under the new federal health care law are likely to be modest and could even yield net savings.  Click here to access a 1-page summary of our issue brief: Health Care Reform and the State Budget: Savings Likely to Partly or Fully Offset Modest New Costs.

OK Policy testified this week before the Joint Committee on the Federal Health Care Law.  Click here for our presentation exploring Oklahoma’s options for implementing state health insurance exchanges, a major requirement of the new law.  Read the Tulsa World’s coverage of our paper along with a summary of the committee meeting.

OK Policy intern Emily Callen explains why higher education remains a strong investment for Oklahomans and the state as a whole.  Yesterday’s OK Policy Blog points to evidence that the state’s personal income tax has very little to do with businesses’ decisions to locate in Oklahoma or elsewhere.  Oklahoma Policy Institute was mentioned in a NewsOK piece that called for thorough, numbers-based analysis, not platitudes, in the tax reform debate.

In the Know, Policy Notes

• Economist Mark Thoma explains in MSN Money why we have room to spread the wealth without harming efficiency and growth.
• Economist Nancy Folbre discusses gender differences in economic hardship during the recession.
• An economic historian shows that consumer spending, amplified by government outlays, are what created most growth in the last century, not business investment.
• Stateline reports on how Oregon may become the next national health care model for seeking to control costs while improving public health through community care.
• A new report from the Robert Wood Johnson Foundation finds that the Affordable Care Act will not adversely affect employer-sponsored health insurance coverage.

Numbers of the Week

• 533 – Number of operating school districts in Oklahoma for the 2010-2011 school year, 9th most in the nation.
• 5.9 percent – Oklahoma’s unemployment rate for September 2011, up slightly from the previous month’s rate of 5.6 percent.
• 3,632 – Number of bankruptcy filings in Oklahoma during the 2nd quarter of this year, down 14 percent from the same quarter in 2010.
• 58 – Number of USDA certified organic farms in Oklahoma, representing just one half of one percent of the 10,903 certified organic farms in the United States in 2008.

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ConocoPhillips headquarters in the Energy Corridor area of Houston

Why do some companies choose to locate their businesses  in Texas rather than Oklahoma? During the first two meetings of the Task Force on Comprehensive Tax Reform, co-chair Representative David Dank has stated repeatedly that the absence of the personal income tax accounts for the cases where Texas wins out in relocation and investment decisions.

Finding hard evidence to support his case, however, has proven elusive. At a recent Task Force meeting, Wes Stucky, CEO of the Ardmore Development Authority and a widely respected leader in the economic development field, spoke of his long-standing efforts to bring investment and jobs to Ardmore. Stucky told the Task Force:

For 24 years, I’ve been conducting interviews with executives of companies that we tried to recruit to Ardmore that ended up locating elsewhere. Not once in all those years did a company that rejected Ardmore base its decisions on taxes.

Chairman Dank brought up the case of oil companies such as Conoco and Phillips Petroleum that moved their headquarters from Oklahoma to Houston in recent decades. According to the Tulsa World:

Dank in particular pressed Stucky on the matter, asking why many energy companies have moved their headquarters to Houston in recent years. Dank suggested that it was because top executives did not want to pay personal income tax. Stucky said the moves had more to do with “excellence” and Houston “being the center of the oil industry.”

Stucky’s assessment corresponds with the explanation of the oil company executives themselves. In 2001, Phillips Petroleum, then based in Bartlesville, announced a merger with Houston-based Conoco, Inc., with the new company’s headquarters to be located in Houston. Phillips President Jim Mulva stated:

I will tell you that state income tax had absolutely no impact in terms of the decision of merging the company and where the corporate headquarters is located.

Here is how Mulva explained the decision:

Mulva said the merger “could not happen” unless the headquarters moved from Bartlesville to Houston.

Houston “is viewed as the — almost the world capital for the oil companies, and to some extent also for petrochemical companies. The service industries are there . . and it would be most difficult from the Conoco perspective to be moving the headquarters back.

Being situated in an industry hub will matter for oil companies, as it will for high-tech companies drawn to Silicon Valley or financial companies based in New York. At the same time, many other factors, including proximity to markets, a skilled workforce, cultural amenities, ease of airline travel, climate, targeted business incentives, and the full range of business operating and production costs will influence where companies decide to base their headquarters and create jobs. Substantial economic research on what drives company location decisions consistently ranks taxes as among the least significant considerations.

At the same meeting, former House Speaker Chris Benge, now serving as Vice-President of the Metro Tulsa Chamber of Commerce, stated:

If our ability to educate and train employees for a 21st century economy is damaged through lack of funding, if we can’t maintain our roads and bridges, strong health care system, robust research and technology infrastructure, safe streets, etc., then the benefits of a reduction in the income tax rates may be limited.

In the competition with Texas and other states to attract businesses, Oklahoma is going to win some and lose some. Making sure that we have a quality workforce, infrastructure, health care system, and overall favorable business climate is a far more sensible strategy to generate wins than doing away with the personal income tax.

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What’s up this week at Oklahoma Policy Institute? The Weekly Wonk is dedicated to this week’s events, publications, and blog posts.

This week at OK Policy, we interviewed Steven Dow about recent controversy at the Oklahoma Commission for Human Services.  We pointed out that state leaders can’t rely on growth revenue to fund infrastructure repair and other priorities if they continue to cut (or even eliminate) the income tax.

Former State Treasurer Scott Meacham explains on the OK Policy blog that Oklahoma’s Rural and Small Business Tax Credit initiatives end up costing the state hundreds of millions in tax revenues.  The blog also featured a post on asset-building as an anti-poverty strategy.  Our director David Blatt was a guest this week on Studio Tulsa, discussing the importance of the income tax in adequately funding state government and essential services for Oklahomans.  Oklahoma Policy Institute’s director was also quoted in two articles this week on federal income tax liability for low-income households and the role of unemployment benefits during a recession.

In the Know, Policy Notes

• Tthe Economix blog examines whether it is more cost-effective to direct resources to college students or to preschoolers and kindergarteners in order to increase college completions over the longer term.
• Researchers at the University of Colorado at Boulder discover that immigration is correlated with falling crime rates.
• Bloomberg reports on how municipalities and state agencies, including the Oklahoma Turnpike Authority, are taking advantage of historically low interest rates to refinance bond issues and save money.
• The National Employment Law Project warns that if Congress doesn’t renew extended unemployment insurance by the end of this year, we risk plunging millions into deeper financial crisis and putting yet another obstacle in the path of economic growth.
• The National Academy of State Health Policy released a paper detailing efforts by state agencies to identify and act on racial and ethnic health disparities.

Numbers of the Week

• 16.43 inches – Amount statewide average precipitation was below normal this water year (October 1-September 30), the 2nd driest year on record for Oklahoma.
• 1,865 – Number of foreclosures in Oklahoma in August, down 5.8 percent from the same month in 2010
• $31,600 – Minimum amount in salary and fringe benefits earned by a first-year Oklahoma public school teacher with a bachelor’s degree, 2011-2012
• 80.3 – Number of primary care physicians per 100,000 people in Oklahoma, compared to 120.5 nationally.  Oklahoma ranked 49th in availability of primary care physicians, 2010
• 29 percent – Percentage of Oklahoma’s K-12 children who are on their own after school, 2009

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Highway 51 Bridge between Wagoner and Coweta. Photo by flickr user doug_wertman used under a Creative Commons License.

Last week, Gov. Fallin announced a plan to fix the state’s decaying bridges by 2019. The proposal involves putting more money in the ROADS fund, which receives a portion of income tax revenues that would otherwise go to the state’s General Revenue Fund.

OK Policy released a statement on the Governor’s plan that was mentioned by both The Oklahoman and The Tulsa World:

We welcome Governor Fallin’s focus on fixing Oklahoma’s crumbling bridges. However, we must note that her proposal would be paid for entirely by diverting more income tax revenues from an already cash-strapped state budget. At the same time, Governor Fallin and other state leaders are promoting further cuts or outright abolition of the income tax. This should remind us that the income tax remains vital for funding Oklahoma’s needs and that we cannot meet our obligations to pay our bills while undermining our revenue base.

The Oklahoman included a response from the Governor’s spokesperson that the effort to fix bad bridges “does not reflect a lack of commitment to other areas of government.” Fallin’s office told The Oklahoman, “much of the additional transportation funding would come from growth revenue, and Oklahoma has enjoyed nice growth in revenue this fiscal year.”

It’s true that state revenues are increasing, and there is a broad, bipartisan consensus that the state needs this growth to meet all of our obligations. In a discussion of Oklahoma’s long-term water infrastructure needs, which are estimated to cost $81 billion over the next 50 years, Sen. Brian Crain (R-Tulsa) said:

I absolutely believe that the Waters Resources Board needs this additional money. We need more money for monitoring and to gather data. … The problem is we also need more money for health insurance for our teachers; we need more money for our mental health system in order to provide some alternatives to incarceration; we need more money for our roads and bridges.

That is on top of large, unfunded pension obligations and increasing costs due to an aging population.

We don’t disagree with the Governor that decaying bridges are a serious problem for Oklahoma, and we’re glad she has decided to make them a priority. We’re also glad that the Governor recognizes bridges are just one of several areas that need government support. Increasing revenues give lawmakers breathing room to make some of these longer-term investments.

However, we should also remember that the growth is only a partial recovery from historic shortfalls. Budgets have been cut for three successive years, and almost every state agency has seen funding reductions of at least 10 percent. Per-pupil K-12 education spending has gone down 18.7 percent, the 5th largest drop in the nation. Far from having extra money, we’re still playing catch-up.

Meanwhile, increasing revenue brings another temptation: tax cuts. We’ve been here before. During the last boom economy in the mid-2000s, Oklahoma passed large, permanent income tax cuts. These were an easy sell when we had plenty of funds to go around. But when the recession hit, the tax cuts contributed to huge revenue shortfalls.

Then as now, we shouldn’t expect revenue growth to last forever. We need a tax system that is adequate to our state’s needs in both good years and bad. Unfortunately, we don’t seem to have learned from recent history, and the tax cut refrain has begun again. Our constitution and politics make it much easier to lower taxes than to raise them, so tax cuts tend to be permanent. But “growth revenue” never is.

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