This week at OK Policy we reviewed the state’s FY ’12 budget agreement on our blog.  We applaud leadership for protecting our most vulnerable populations by targeting available funds for Medicaid, human services, and mental health, but ask if state agencies facing a third consecutive year of budget cuts are being provided enough resources to continue to perform their core missions.

OK Policy has long called for a balanced approach to the state budget and we urged leaders to avoid further cuts to key public services by choosing among an array of fiscal tools for closing the budget shortfall.  Click here for our spreadsheet tracking state agency appropriations from FY’09 to FY ’12.  Click below to watch OK Policy Director David Blatt discuss the state budget on ONR (Oklahoma News Report) this week on OETA:

Also this week, Oklahoma is teeming with predatory lenders who lure consumers into debt traps with promises of quick cash.  Read our blog post on payday lending to understand how the practice erodes the financial stability of working poor families.  Some states enforce usury laws and interest-rate caps that adequately protect consumers from the worst of these practices but many, including Oklahoma, do not.  We have more payday lenders in Oklahoma than McDonalds and Wal Marts combined.

OK Policy blog kicked-off the week with reflections on a House decision to reject a minor technical revision that would have helped Oklahoma continue to collect millions in tax revenue from out-of-state retailers.  SB 744 had no fiscal impact and created no new tax obligations; it simply clarified the application of taxes on sales that are already taxable.  Monday’s blog post, Phantom Menace: Fear of “lurking taxes” may deepen budget holes, exposed the ‘tax hike’ scare tactics that prevented the technical fix and creates obstacles to a balanced budget.

In The Know Policy Notes

• The American Prospect takes an in-depth look at whether public sex offender registries are doing more harm than good
• A short video from the Center for American Progress explains why states are considering their own immigration legislation
• House GOP budget plan would leave up to 44 million more Americans without health insurance
• Similarities between today’s opponents of high-speed passenger rail and last century’s arguments against a national highway system
• USA Today reports that the U.S. tax burden is at its lowest level since 1958

Numbers of the Week

• 11 percent – Percentage of their income Oklahomans spent on gasoline on average in April 2011; the national average is 8.9 percent
• 14.3 – Average days out of 30 that Oklahoma residents reported not getting enough sleep in 2008.  Oklahoma ranked 4th highest among other states in sleep-deprived residents
• 11.4 percent – Increase in foreclosure filings in Oklahoma between the fourth quarter of 2010 and the 1st quarter of 2011
• 53.5 percent – Oklahoma’s voter turnout in the 2008 presidential election; 41^st in the nation
• 8 – Permanent standing conference committees in the Oklahoma House of Representatives, as of a 2011 rule change

Click here for source citations and archived numbers of the day.

In the Know is a daily synopsis of Oklahoma policy-related news and blog posts.  You can sign up here to receive In the Know in your inbox each weekday morning and the Weekly Wonk each Friday afternoon.

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To make the budget balance and limit the magnitude of cuts, the agreement includes some $370 million more revenue than what was certified as available for appropriation by the Board of Equalization in February. Although full details have not been spelled out, the main revenue enhancements appear to be: $120 million in cash balances that have accumulated this year; some $100 million from the final round of federal stimulus money approved by Congress last summer; and a $100 million transfer from the State Transportation Fund that will be partly made up for by a $70 million bond issue for the Department of Transportation. Additional revenues include transfers from the Unclaimed Property Fund and agency reserve funds, increased tax compliance efforts, and diversion of tax revenues slated for the ROADS program to the General Revenue fund.

Of the ten largest state agencies, Transportation (-7 percent), Higher Education (-6.7 percent) and Career and Technology Education (-6.5 percent)  will receive the largest cuts. Funding cuts were more modest for key agencies in health, human services, public safety, and to a lesser extent, common education. Many other agencies will absorb cuts of 7 to 10 percent in FY ’12 (See our spreadsheet of agency-level appropriations for FY ’09 – FY ’12).

As we talked to agency leaders and advocates at the Capitol yesterday, many expressed relief that the cuts were less than was feared.  We are grateful that leadership heeded the calls of advocates to protect our most vulnerable populations by targeting available funds for Medicaid, human services, mental health, and rehabilitative services, as well as ensuring that education and public safety were spared the full brunt of cuts. The agreement shows that legislative leaders and the Governor worked to minimize the damage, especially where cuts in state funding would have entailed a corresponding loss of federal matching funds. Some agency heads expressed optimism that they would be able to make it through next year without substantial reductions in staffing and services to the public.

However, this agreement is not cause for celebration. State agencies are now facing a third consecutive year of funding reductions and budget cuts, which will continue to corrode their ability to perform their core missions. Overall, next year’s budget is slated to be $622 million, or 8.7 percent, less than FY ’09. Almost all agencies will have seen their funding cut by over 10 percent in this period, and many by over 20 percent, including the Department of Agriculture (-25.9 percent), Arts Council (-22.1 percent), Military Department (-22.0 percent) and Council on Law Enforcement Education and Training (-20.2), among others.

Since FY ’09, no agencies have received funding to address increased employee health care and retirement costs, general inflation, or, in most cases, caseload growth. For example, public school enrollment rose by 15,000 students between 2008 and 2010, yet next year’s appropriation to Common Education will be 10 percent less than in FY ’09. This will again mean fewer teachers and support staff, and larger class sizes.  The Department of Corrections will continue to struggle to stay at even 70 percent of staffing capacity, putting stress on the safety of officers, inmates and communities.  The Health Department, which faces additional cuts of over 4 percent, will have to continue to cut back on services that maintain the state’s public health infrastructure and protect vulnerable families.

This outcome was not inevitable. Those who negotiated the budget will say they played the best hand possible given the cards they were dealt. However, we must recognize that a choice was made not to play with all the cards in the deck. Their decisions not to put serious revenue options on the table and to allow a cut in the top income tax rate to take effect seriously constrained what could be done to limit the magnitude of funding cuts.  It also meant that the revenue enhancements that were adopted were once again primarily one-time fixes that won’t do anything to address the ongoing budget gap and will in fact complicate the budget outlook in subsequent years.

As resources dwindle across state government,  we will continue to fall short of what is needed to provide our children a quality education, protect the public health and environment, assist our most vulnerable families, seniors, and persons with disabilities, and administer justice. Yes, it could have been worse. Yes, we can and must do better.

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Governor Fallin has has made some efforts to minimize cuts to state agencies, especially the core public services of education, law enforcement, health, transportation and corrections. After some of her revenue proposals did not find traction in the legislature, Fallin stated, “If they have a different way of being able to fund the budget and make up for the $500 million budget shortfall, I invite them to bring those ideas forth. There’s room for all kinds of ideas.”

In that spirit, OK Policy has published a new report, titled “Protecting Core Services: Revenue Options for a Balanced Budget,” that sets out a number of options to bolster state revenues for next year. These include budgeting measures to make existing state money available for appropriations, income tax measures such as closing tax loopholes and suspending or cancelling additional cuts to the top income tax rate, and sales tax measures such as requiring online retailers to collect sales tax and eliminating unnecessary exemptions.

These options may not be politically easy to adopt, but compared to the real harm that steep cuts would inflict on Oklahoma, they deserve serious consideration in the remaining weeks of the legislative session. A summary of our proposals continues below, or you can download the full report here.

Budgeting Measures

• Appropriating 5 percent money – If collections come in above 95 percent of projections by the end of the year, the “5 percent money” is saved for appropriation in the following year. At least a portion of this could be used in FY ‘12 to offset cuts as revenues recover. (Legislative leaders have stated they plan to use at least some of these funds.)
• Transferring revolving fund balances – The state maintains over 500 revolving funds with total balances in excess of $1.2 billion. Some of these funds could substitute for state appropriated dollars in next year’s budget or be moved to the General Revenue Fund.

Income Tax Measures

• Deferring more cuts to the top income tax rate – The income tax cut was approved during a time of strong economic growth, yet it is phasing in while revenues and funding levels remain far below pre-downturn levels. Even if not repealed entirely, the tax cut can be deferred until revenues have fully recovered and funding for core services has been restored.
• Limiting itemized deductions – Taxpayers who claim itemized deductions on their federal tax return are allowed to claim the same deduction on state taxes. This primarily benefits upper-income families who need the least help. If legislators decide not to limit all itemized deductions, they can at least do away with the deduction for state income taxes on state tax returns, which has no clear rationale and is allowed in only six states.
• Suspending other income tax deductions – Oklahoma allows for various tax deductions that do not fulfill a vital economic or social purpose, such as deductions for interest and dividends paid on deposits in Oklahoma financial institutions or for contributions to political candidates.
• Adopting combined corporate reporting — Some multi-state corporations seek to avoid paying taxes by shifting income between parent and subsidiary companies. To ensure these corporations pay their fair share of taxes, Oklahoma can adopt a reform known as combined reporting, which has been adopted by more than half of all states that assess a corporate income tax.

Sales Tax Measures

• Suspending sales tax exemptions – Statutes provide nearly 150 exemptions from the general sales tax. Many of these privileges for various industries, sectors and populations lack any clear or consistent rationale.
• Enhancing collection of online sales tax — As a result of US Supreme Court rulings, states are unable to require retailers who lack a physical presence in a state, or “nexus,” to collect tax owed to the state. However, Oklahoma can expand the definition of “nexus” by passing laws that define affiliate programs as sufficient to establish physical presence in the state.

With the significant budget cuts of previous years already disrupting many important public services, we have gone far beyond simply eliminating waste. In addition to addressing next year’s budget crisis, the revenue measures discussed above can make Oklahoma more stable and secure over the long term, while ending arbitrary and inefficient subsidies to special interests. If the legislature and governor want to show responsible leadership, these options need to be on the table.

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With states hurting everywhere, they are also beginning to look at holes in the tax code that lack any good rationale. One glaring example is sales tax collections for online purchasers. Many states, including Oklahoma, require residents to pay taxes for online purchases, but they put the burden on individual taxpayers to identify how much tax is owed when filing their tax return.

Collecting in this way is highly inefficient, and it subsidizes large online retailers like Amazon at the expense of Main Street businesses who directly employ Oklahomans. Since they aren’t required to include sales tax in their prices, online retailers are able to undercut local business and move more money out of the state. Untaxed remote sales also starve state and local governments of resources – an estimated $92.7 million for Oklahoma in 2009, rising to $156.3 million in 2012.

The US Supreme Court ruled in 1992 that retailers who lack a physical presence in a state, or “nexus,” cannot be required to collect tax. In response, several states have expanded the definition of “nexus” to include affiliate programs, such as when Amazon pays a commission for links that result in sales.

Even in states where Amazon does have a nexus, the company has tried to avoid taxes. The Center on Budget and Policy Priorities found that Amazon charges tax in only four out of seventeen states where it operates facilities. Texas recently billed Amazon for $269 million in uncollected taxes when it discovered the company was operating a warehouse in the state through a subsidiary.

The fight is heating up. Every state bordering Oklahoma has either required Amazon to collect sales tax or cracked down on the company’s tax avoidance strategies. Most recently, Arkansas passed a bill to require online retailers that have affiliate programs and make more than $10,000 a year in sales to collect sales tax. Similar legislation has passed in five other states and is being considered in at least 10 more.

Amazon ended affiliate programs in several states and closed down its warehouse in Texas. Yet with more states and local retailers joining the fight against the exemption, it may not be long before Amazon loses the ability to play some states against others.

Oklahoma continues to struggle with balancing its own budget, and Gov. Fallin has called for more ideas on how to protect core services from harmful cuts. Just as difficult budget years can push us to make government programs more efficient, it is a good time to close unfair loopholes in the tax code. While we may end up paying a little more for online purchases, the benefits to local business and the reduced strain on public services will make us all better off.

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When we discuss government budgets, direct spending receives the most attention by far. Less noticed is the substantial expenditure on tax credits and incentives, what some have called the “submerged state.”

That inattention may have allowed several unconstitutional measures to sneak through in Oklahoma. At the end of 2010, outgoing Attorney General Drew Edmondson issued an opinion on the constitutionality of Oklahoma tax credits. The opinion was requested by Rep. David Dank, R-Oklahoma City, who chairs the House Revenue and Taxation subcommittee. An AG opinion does not have force of law–only a court can legally determine constitutionality–but it can provide guidance to lawmakers and the courts.

The AG said that to be constitutional an economic development tax credit must pass a three part test–it needs to (1) serve a public purpose; (2) be supported by adequate consideration; and (3) have adequate controls and safeguards. Public purpose has been defined by the courts as “affecting the inhabitants of the state or taxing district as a community, and not merely as individuals.” Adequate consideration means that the state must receive some concrete benefit from awarding the credit so that it does not constitute a gift. Finally, controls and safeguards are measures to ensure that the first two criteria are met or to revoke the credit if they are not.

An example of a credit not meeting this test was the coast to coast airline tax credit. The credit rewards investment in an airline that has obtained 20 letters of intent to use its nonstop transportation to the east or west coast. Establishment of such a service could be construed as a legitimate public need; however, because the credit could be awarded without the service actually being established, it met neither the public purpose nor the adequate consideration tests.

Similarly, the AG found that the Small Business Capital Formation Incentive Act and the Rural Venture Capital Formation Incentive Act don’t meet the public purpose test, because they reward investment in a business even if it does not result in actual benefit to the community.

The AG also considered transferable tax credits, which can be sold by the entity performing the economic activity that the credit rewards.  The opinion found that transferability was not unconstitutional in itself. However, some existing transferable tax credits do not pass muster, either because the original credit fails the three part test or the transferring is done in a way that prevents enforcement of the three part test.

As an example, the AG discussed a tax credit for rehabilitation expenditures. While it has safeguards on the original recipient, if someone who sold this credit was later found in violation of its terms, a reduction could not be enforced on the entity that purchased it. A credit for construction of energy efficient residential properties fails the test as well, because transferees can receive the credit even if the original taxpayer is out of business.

Some of the tax credits discussed above are temporarily suspended during the state’s budget crisis, but in the past they have cost Oklahoma more than $50 million per year. And if these are at all representative, it’s likely that there are more examples of wasteful or poorly monitored tax credits.

OK Policy has previously made suggestions on how to improve transparency and accountability of Oklahoma’s tax incentives, but our scrutiny should not stop at whether a tax credit is constitutional. By offering a credit of any kind, the state is spending money to advance a goal. We need to carefully consider if those funds would be better used elsewhere. As Andy Spiropoulos put it, “the money funneled to the industry wouldn’t have been otherwise stuck in a mattress – it would have been invested in something else.”

In her State of the State address, Gov. Fallin said that “only tax credits that create jobs will stay.” But simply creating jobs is not good enough. We need a fourth test–do they improve the state more than would investing that money in education, roads, health care, and other public needs? When state spending as a share of the economy is at a 30-year low, and with more cuts on the way, we need to ask whether we can afford any spending that does not go to the most crucial public services. If our children aren’t well-educated, no amount of subsidies to business will get them good jobs.

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The Board  certified $305 million in additional revenues for appropriation in FY ’11. Contrary to certain media accounts of the meeting, this additional revenue was not based on revised projections of tax collections due to changing economic forecasts – the economic forecasts made back in February were final and binding. Instead, the increased expenditure authority for the upcoming FY ’11 budget year reflect additional revenues from changes to laws that were contained in bills passed by the Legislature and signed by the Governor. Agreement on these ‘revenue enhancements’ was a key component of the overall budget deal reached by the Governor and legislative leaders in May.  The $305 million in additional revenues for appropriation from statutory changes included the following main components (bill numbers in parentheses; click here to get to the final enrolled versions of bills):

• Suspending assorted tax credits: $48.7 million (SB 1590, SB 1267, HB 3024)
• Deferring payment of gross production tax rebates: $80.7 million (HB 2432 – see our blog post)
• Enhanced tax collection on Internet sales: $33.2 million (HB 2359 – blog post)
• Electronic ticketing of uninsured motorists: $50.0 million (SB 1561)
• Increased fees: $33.7 million (HB 2359, SB 1556, SB 1574)
• Debt refinancing: $22.3 million (HB 2358)
• Reduction of the sales tax vendor discount: $10.6 million (HB 2359 – blog post)
• Miscellaneous adjustments: $26 million

For at least some of these law changes, it seems rather iffy whether the anticipated amount of new revenue will fully materialize. However, it’s important to bear in mind that the Legislature is allowed to appropriate only 95 percent of projected revenues from certified funds, leaving a 5 percent cushion. In FY ’11, this 5 percent reserve amounts to $249 million, which should more than cover any shortfall from the revenue enhancement provisions. In addition, as we argued earlier this month, there’s good reason to expect that the revenue estimates produced back in February upon which this year’s appropriations are based will underestimate actual collections as the economy rebounds from the economic downturn. Since then, UCO economist Mickey Hepner has crunched the numbers based on recent revenue collection trends and is now projecting next year’s General Revenue collections to come in $154 million above February’s certified estimates.  So, again, we think there’s good reason for agencies and school districts to have confidence that budgets will not again be subject to mid-year cuts.

However, if FY ’11 funding now looks stable, the outlook past this year remains highly troublesome. The $305 million in revenue enhancements that helped bridge the FY ’11 budget shortfall and minimize the severity of cuts to programs and services is divided almost equally between recurring and non-recurring revenues. The moratorium on tax credits is only for two years, and the deferred  payments of oil and gas rebates must be paid out beginning in FY ’13. When the non-recurring revenue enhancements are added to federal stimulus dollars, Rainy Day Fund reserves, and transfers of cash balances, it equals over $1.1 billion of a total FY ’11 appropriated budget of $6.7 billion that involves non-recurring revenue. And that is why when the Board of Equalization meets again next June, they may again have the job of certifying last-minute revenue adjustments that will be needed to bring the budget into balance.

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Under HB 2432, approved as part of the FY ’11 budget agreement, payment of the rebates owed for horizontally drilled and deep wells produced in Fiscal Years 2010 and 2011 will be deferred until July 1, 2012 and then paid out in monthly installments over the next 36 months. The state will be assessed interest at nine percent on any payment that is not made by the end of the month it is due. This does not involve a moratorium or suspension of these tax rebates – just a deferral in payments. This procedure made available an additional $85 million for appropriation in FY ’11 that would otherwise have been paid out in rebates.

In return for this one-time deferral of their rebates, the oil and gas industry extracted three significant changes to the system of tax breaks for production (see this fact sheet for a detailed explanation of the current system). First, beginning in FY ’13, drilling incentives for horizontally drilled and deep wells will be paid out as front-end credits, rather than as rebates that are applied for and refunded after the end of the year. This switch will involve a one-time cost to the state in the crossover years from back-end to front-end payments that is projected by the Tax Commission to be $65 million. It also precludes any future attempt to defer incentive payments.

Secondly, the law changes how horizontally drilled and deep wells are taxed. Under HB 2432, beginning in 2011, deep wells drilled below 15,000 feet will be taxed at 4 percent (compared to 1 percent currently), but the current cap limiting total incentives for deep well drilling to $25 million per year will be abolished. For horizontally drilled wells, HB 2432 strikes the language in current law that makes producers eligible for incentives only until project payback has been completed.

Finally, for other forms of drilling, in which incentives are subject to a price trigger, HB 2432 indexes the trigger to an annual inflation-based increase. Currently, incentives can be claimed for oil production only in years when the average price is below $30 per barrel or for gas production in years when the average price is below $5.00 per MCF; this floor will rise based on the Consumer Price Index.

We fully appreciate the important of the energy industry for Oklahoma’s economy. But this deal leaves us with a pair of troubling questions. The first is, at a time when budgets for almost all government functions are sustaining deep and enduring cuts, does it make sense to extend additional tax breaks for oil and gas producers? While the switch in how deep well drilling is taxed is purported to be revenue-neutral, the lifting of the project payback limit on rebates for horizontally drilled wells is expected to reduce taxes by an additional $13 million. This is on top of the approximately $60 million in gross production tax breaks already going to horizontal drilling, along with oil and gas depletion allowances and other tax benefits. Rather than provide unlimited credits, we should be looking to limit the state’s fiscal exposure and provide greater budget certainty by establishing reasonable caps on the total amounts of credits that can be claimed by producers.

The second question relates to how HB 2432 exacerbates a system where certain forms of production, dominated by large producers, are subsidized regardless of the price of oil and gas. When natural gas is at $3.50 per MCF, tax rebates or credits may, perhaps, make the difference in the decision to drill a well. But should production be fully exempted (in the case of horizontally drilled wells) or partially exempted (in the case of deep well) even  from gross production taxes when gas is at $8.00 per MCF? What about $15.00 per MCF?  The additional concessions granted to these producers by HB 2432 only strengthens the perception that when it comes to the subsidy system for oil and gas drilling, policies are being driven not by geology or economics, but rather politics.

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David Blatt: Remind us of why a bill like HB 2359 is needed? What’s the problem that this legislation is trying to address?

MM: Legislation like this is needed because, like every state with a sales tax, Oklahoma is losing a significant share of revenue because it can’t collect sales taxes from many purchases made from internet sellers, catalog companies, and other so-called ‘remote sellers’. In fact, the best estimate is that Oklahoma is losing over a hundred million dollars a year in potential sales tax revenue from uncollected taxes on remote sales. This is revenue that is already due under existing state law. The state’s failure to collect this revenue makes its budget gap that much bigger and undermines the ability of state and local governments to maintain basic public services. It also makes the sale tax more regressive because most of the people that are avoiding paying this tax are relatively affluent people who have computers and Internet access account and can buy things tax-free online, while low-income people have to pay tax when they shop in stores.

Finally, one of the most important reasons why the non- collection of taxes of internet sales is a serious problem is that it puts local businesses in Oklahoma at a disadvantage in competing with out-of-state remote sellers. If local businesses have to charge Oklahoma sales tax and remote sellers don’t, then remote sellers start off with a built in price advantage.

DB: Why can’t states just assess taxes on these remote sellers?

MM: States can’t directly require remote sellers to collect tax when they have no physical presence in Oklahoma because of a Supreme Court decision from 1992. So even though the tax is technically due from the purchaser, there are some remote sellers that Oklahoma can’t require to collect these taxes. This new legislation is aimed at both increasing the ability of the state to make sure that the purchasers pay the tax and also, in some instances, increasing the incentive for sellers to charge the tax.

DB: Some are referring to this as a new tax or a new tax increase. Would you agree?

MM: This is definitely not a tax increase and I don’t think it can be fairly characterized as one. These are taxes that are due under existing law on remote purchases. Every state with a sales tax has a complementary use tax when the purchaser buys things that are sold across state lines. This tax has existed from virtually the beginning of the time since Oklahoma has had a sales tax. So it’s not a new tax, it’s always been there.

DB: What do you see as the good points about HB 2359 from the perspective of increasing collections from remote sellers?

MM: HB 2359 emulates what a lot of other states have done recently to maximize the amount of use taxes that are paid on remote sales. So, for example, the bill emulates part of a Colorado law passed a few months ago that required remote sellers to disclose to their consumers that they may owe use tax on what they are buying despite the fact that the seller is not charging use tax. It also clarifies that some Internet sellers ought to be collecting the tax because they have a related store in Oklahoma that may be doing things on their behalf that enhance their ability to make sales in Oklahoma. The Supreme Court has made clear that, notwithstanding the physical presence requirement, if you have a related party or an unrelated party that is helping you to make sales in a state, then that state can require you to charge the tax. One provision of the bill is aimed at putting out-of-state sellers that are in that situation on notice that they ought to be charging the tax…

Another thing I like in this bill is a provision that says that paid income tax preparers must tell their clients that they may owe use tax on what they bought…  I think this is a very good thing to do. It’s another opportunity for someone in the position to do so to tell purchasers that they owe tax on what they buy.

DB: What did Oklahoma not do in this bill that it could have done?

MM: Well, I think that there are three significant shortcomings of this bill. As I’ve said, Oklahoma copied a Colorado law passed earlier this year in some respects, but it omitted two key provisions that I think would have been useful. The first is a provision that requires a remote seller to send a report to their customers at the end of each year, reporting the total amount of purchases they made from that seller over the year broken down by categories. This  is another opportunity for the customer to be educated by the seller that they may owe tax on what they buy. HB 2359 requires the seller to provide some disclosure to the consumer on the invoice, but often times the invoice gets thrown in a box and the consumer never looks at it. So if sellers were required to send a separate mailing like they have to do in Colorado that increases the likelihood they would actually be informed by the seller that they owe the tax. In addition, the information on the form actually helps them comply with the use tax; it tells them how much they bought so they don’t have to go back and pull out their credit card bills. So the first major shortcoming of the bill is that it didn’t copy this provision of the Colorado law.

Second, the final version of HB 2359 dropped a provision of the Colorado law requiring remote sellers to report the total annual purchases of their Oklahoma customers to the Tax Commission annually. That would have enabled the Commission to make a follow-up contact with purchasers of big-ticket items like laptop computers and big-screen TVs to collect the tax from them.

Finally, Oklahoma failed to copy a law that was passed two years ago by New York and passed last year by Rhode Island and North Carolina that requires a certain set of Internet sellers to actually charge the tax in the state. New York passed the so-called ‘Amazon law’ that says if a remote seller has a so-called affiliate program, in which they pay commissions to in-state websites for linking customers to the website of the remote seller, then the remote seller has to charge tax because effectively they have an in-state representative. Oklahoma could also have emulated that law and actually require additional Internet sellers to collect the tax and not just report to their customers that the tax may be due.

DB: So based on experiences in other states, what do you expect the reaction to be to HB 2359 from online retailers? Should we expect a full-fledged assault on this bill?

MM: I don’t think so. I think the things that I just recommended that were left out of this bill were more controversial steps that states have taken in the past couple of years to address this problem. Without those three measures I wouldn’t expect a huge amount of opposition to this, but undoubtedly there will be some.

DB: Overall what grade would you give Oklahoma for HB 2359?

MM: Overall, I would give the state a “C.” I think you lost a good opportunity to address the problem a little more forcefully with the Colorado provisions that were omitted and not enacting the New York version of the law. Nonetheless, the state deserves some credit for trying to get more compliance from purchasers and increasing the likelihood that at least some sellers will charge the tax.

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Overall, the proposed budget appropriates at least $6.676 billion in FY ’11. This is $256 million, or 3.7 percent, less than the final FY ’10 budget of $6.931 billion, and $556 million, or 7.7 percent, less than the $7.231 billion initial FY ’10 budget that the Legislature decided upon last session. Most notably, to make the budget balance and limit the magnitude of budget cuts, leadership agreed to appropriate some $1.4 billion in additional revenues that were not initially certified. This total amount includes $496 million in federal funds for education and health care that were part of last year’s Recovery Act and the remaining $372.8 million from the state’s Rainy Day Fund reserve (however, $100 million of this amount is to be set aside for FY ’12). The remaining $630 million of additional revenues is to be generated by a wide variety of mechanisms, including fee increases, enhanced tax collections,  increased bonding, suspending tax credits, deferring payments, and transferring available cash balances.

With a few exceptions, agencies will absorb additional funding cuts in FY ’11 of 7 percent or less beyond those already enacted over the course of FY ’10. Several of the largest agencies providing core state services will see smaller cuts, including Common Education and Career Tech (-2.3 percent), Higher Ed (-3.3 percent), Public Safety (-1.0 percent), Corrections (-3.0 percent) and Mental Health and Substance Abuse Services (-0.5 percent). The Department of Human Services will receive an increase of 4.0 percent compared to its final FY’10 appropriations while Rehabilitation Services will be boosted by 3.7 percent. The Oklahoma Health Care Authority will be appropriated $17 million, or 1.8 percent, less than FY ’10; however, in addition to this basic funding, the agreement also includes $78 million for OHCA from a “1% Health Care Access Payment.” This led the agency to issue a statement (not yet available online) stating that it expects to be able to maintain the Medicaid program in the upcoming year without cutting benefits or provider rates.

Given the daunting challenges they faced in constructing the FY ’11 budget, the bipartisan team of budget negotiators deserves considerable credit for their willingness to propose new revenues to limit the size of overall budget cuts and preserve essential services. This is not the full-fledged catastrophe that many expected and feared, and shows that legislative leaders and the Governor were guided by a genuine desire to minimize the damage. We are especially grateful that leadership heeded the calls of advocates to protect our most vulnerable populations by targeting available funds for Medicaid, human services, mental health and rehabilitative services, as well as ensuring that education and public safety were spared the full brunt of cuts.

At the same time, there are two principal concerns that must be expressed. First, despite the genuine efforts made to limit budget cuts, we cannot expect everything to be fine next year. Many agencies will be facing additional cuts of 5 to 7 percent in FY ’11 on top of the 10 to 14 percent cuts already enacted in FY ’10. Even agencies that have been cut less than the full 15 to 20 percent will face severe challenges in fulfilling their fundamental missions with reduced resources, particularly given mandatory increases for employee health care and retirement costs, general inflation, and in some cases, new mandates and growing caseloads.  It is likely that most agencies will continue to operate under budgetary duress in the coming year, with continued unfilled vacancies and staffing reductions, and potentially continued or increased furloughs and involuntary layoffs, which will continue to corrode the public structures we depend on to ensure the security, health and prosperity of of our families and communities.  The impact of continued cuts and underfunding will need to be closely followed and monitored over the coming months.

Secondly, next year’s budget, like this year’s, is balanced through the use of substantial one-time and non-recurring revenues. While the specifics of all the additional revenue proposals are not yet fully clear from the information that was released yesterday, it’s clear that the major additional revenue sources used to reduce the budget shortfall – federal stimulus dollars, Rainy Day Fund reserves, cash balances – will be either entirely or largely unavailable in FY ’12 and FY’13. We can expect revenue growth to partly fill those holes, but to a considerable extent, this budget only pushes problem further down the road. This dependence on one-time revenues to plug budgets is perhaps the inevitable consequence of the staunch unwillingness of leaders of both parties to consider outright tax increases or more sustainable revenue sources as part of the solution to Oklahoma’s budget crisis, as many other states have done.

Over the final days of session, the Legislature will need to approve budget bills and bills to implement the various revenue proposals. It is likely that there will be continued discussions and debate as details of the agreement come to light, particularly over funding levels for certain agencies and the specifics of some of the key revenue enhancements. For now, the main reactions are likely to be a guarded sense of relief of having been spared the worst and ongoing concern over the continued struggles ahead.

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Along with the Oklahoma Policy Institute’s David Blatt, we’ve been urging lawmakers to use the downturn to find sensible new sources of revenue (such as ending or capping ineffective tax credits) and to better prepare for the next downturn.

This is a meaningful and much-appreciated acknowledgment, as the need for new sources of revenue is a contentious principle  at the Legislature and around the state these days (See this insightful article by Patrick McGuigan on how this issue divides the state’s two policy think-tanks, us and the Oklahoma Council of Public Affairs). But the Oklahoman proceeds to reject one of our main proposals for bridging the budget gap, doing away with the exemption that allows taxpayers who itemize their returns to also claim the deduction for state income taxes from their state taxes. The exemption costs the state an estimated $118 million on income tax revenue annually, which at a time of drastic budget scenarios, could make a major difference in preserving critical public services.

We have noted that the exemption for state income tax benefits only the minority of taxpayers, about one in four, who claim itemized deductions. Their editorial states:

That alone is reason to urge caution — especially considering that some states (most notably Texas) have no income tax and Oklahoma’s maximum personal income tax rate is uncomfortably high at 5.5 percent.

The Oklahoman’s position on the state income tax exemption, which Oklahoma is one of only six states to allow, prompted a response from Citizens for Tax Justice (CTJ), a national tax policy organization that helped alert us to this exemption. On its Tax Policy Digest blog, CTJ makes a compelling point:

But rejecting a tax base-broadener because the rates are too high is getting it exactly backwards. Tax Policy 101 says if you want to avoid increasing tax rates, you should make sure your tax base is sufficiently broad. Leaving aside the very contestable notion that a 5.5 percent top rate is “uncomfortably high”, the fact is that eliminating the state income tax deduction would strengthen the Oklahoma income tax base in a way that would make it a more efficient revenue-raiser, and would reduce the likelihood that lawmakers will be forced to hike rates down the line…
If The Oklahoman’s editorial board really wants to see “ineffective” tax breaks eliminated, it should become one of the most fervent supporters of eliminating an illogical state tax break that exists only because the state happens to have built its income tax rules on top of those in place at the federal level.

Presumably, one can have it all – low top marginal tax rates and generous exemptions that primarily benefit those at the upper end of the income spectrum. But we’ll continue to insist that if the goal at this critical juncture in the budget process is to identify revenue options that can stave off further cuts to prison staffing, mental health facilities, adult protective services, and the like, an option that can avoid raising rates while making the tax system more equitable has much to offer.

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