From time to time, we use the OK Policy blog to post submissions we receive from Oklahomans who have interesting perspectives on important policy issues for the state. This entry is from Tom Daxon, an Oklahoma City CPA who served as State Finance Director from 1995 – 2001 under Governor Frank Keating and is a noted conservative voice in Oklahoma. The opinions stated below are not necessarily the opinions of OK Policy, its staff, or its board. This blog is a venue to help promote the discussion of ideas from various points of view and we invite your comments and contributions. To see our guidelines for blog submissions, click here.

State government spends too much money.  It should spend less.  However, even this strong conservative realizes some government is necessary and further, we should pay for it currently.  As former Chief Justice Oliver Wendell Holmes observed, “Taxes are what we pay for a civilized society.”

Good tax policy dictates that when we tax, we should impose the tax on the largest possible base to keep the rate to a minimum.  Unfortunately, all the tax credits, exclusions and preferences that riddle Oklahoma’s tax code have led some to note that our tax code resembles Swiss cheese.

Perhaps we should consider a “TRACC” – tax realignment and credit commission – modeled after BRACC that successfully closed unneeded military bases at the federal level.  TRACC would be a bipartisan committee including both House and Senate members with participation from the Governor’s office.  TRACC would prepare a list of tax expenditures for elimination.  The legislature would then consider the list in a straight up or down vote, without amendment.

If TRACC could meet a target of $300 million, roughly twice the ongoing static impact of reducing the marginal rate on the individual income tax to 4.95%, we could lessen the need for budget austerity and provide helpful tax stimulus.  In other words, conservatives would get to apply half the proceeds toward reducing the marginal rate on the income tax while their liberal brethren could use half for state appropriations along with another $85 million immediately because the income tax reduction would not take effect until the middle of the fiscal year.

A bold step?  You bet!  Oklahoma could fill a big part of its budget hole and also send the rest of the country a message that we are making ourselves more competitive for entrepreneurs who want to pursue business opportunities.  While the rest of the country stumbles, Oklahoma moves boldly forward.

Before my more liberal friends think about seizing this as an opportunity to spend the entire $300 million, this would be my best offer.  After all, the rate is already scheduled to drop to 5.25% when revenues rebound.  But, if our liberal counterparts are willing to meet us half way, we might be able to do something positive for Oklahoma.

There is definitely something in the air. Over the past several weeks, there has been a heavy flurry of attention paid to the state’s system of tax expenditures, the array of over 450 exemptions, credits, deductions and the like that allow taxes not to be paid when they otherwise would. Yesterday, we released an in-depth issue brief which we titled “Let There Be Light: Making Oklahoma’s Tax Expnditures More Transparent and Accountable.” In our press release, we stated:

While the merits of granting tax preferences can be debated as a matter of principle, the reality is that they are unlikely to be abandoned entirely. There is a chance now to build on important progress made in recent years in increasing disclosure and scrutiny of tax expenditures to really get a handle on which tax breaks are worthwhile and effective, and which are wasteful giveaways.

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As a result of Oklahoma’s severe budget shortfalls, every state agency and program is absorbing substantial budget cuts that are having a real impact on Oklahoma families and communities. But tax expenditures – the term encompassing the array of exemptions, deductions, incentive, credits and other forms of preferential treatment in the tax code -  have been left untouched and largely unscrutinized. Tax expenditures, in one’s leading expert’s words,  “may, in effect, be viewed as spending programs channeled through the tax system”; in many cases, they are just different means of pursuing the same policy goals as direct budgetary expenditures. Why, then, should an economic development spending program to promote new technologies take cuts while a tax credit program to accomplish the same purpose is uncapped? Does it make sense that appropriations to DHS for senior assistance programs are slashed while tax preferences for elderly homeowners are untouched?

This post addressing tax expenditures is the fourth and final of a series recommending changes to our budget and tax system.  Our proposals are all intended to enhance the Legislature’s ability to manage budget downturns without having to implement deep cuts to vital state services or enact tax increases. Previous posts recommended enhanced and expanded budget forecasting, strengthening reserve funds, and putting on hold multi-year revenue commitments.

The most recent Tax Expenditure Report prepared by the Oklahoma Tax Commission (OTC) identifies over 450 separate provisions of state law that provide for some reduction in the amount of state taxes that would have been collected but for the preferential tax treatment benefiting some favored activity or category of taxpayer. The total cost of tax expenditures – $5.4 billion in FY ’08 for provisions that could be estimated by the OTC – equal more than 75 percent of total state appropriations ($7.1 billion in FY ’08).

The fact is, there is no way to know how much tax expenditures will affect state revenues during this fiscal year or the next. Unlike budgetary expenditures, which are subject to annual appropriations and to the availability of revenues, tax expenditures tend to be fiscally open-ended. In most cases, any person or business meeting the eligibility criteria can claim a credit, exemption, or deduction, without there being any cap on the total amount made available.

In order to provide more budget predictability and ensure that the impact of budget shortfalls is more broadly and equitably distributed, policymakers should consider subjecting at least some tax expenditures to caps and triggers. A cap would set a total dollar amount that can be claimed under the credit or exemption, while a trigger would make the tax preference subject to the availability of revenues.

There are already some precedents for the state implementing funding caps on tax preferences:

• Incentive payments under the Quality Investment Program created by SQ 725 are limited to $10 million in total, with no single company eligible for more than $5 million in subsidies.
• The total amount of tax rebates claimed on gross production taxes for deep well drilling below 15,000 is capped at $25 million. In situations where eligible rebate claims for deep well drill exemptions exceed the available cap, the statutes and OTC rules specify a process for allocating the rebates among eligible participants.
• Income tax credits for investments in agricultural processing cooperatives are limited to $2 million annually.

In terms of triggers, the Quality Investment Program, which is tied to the balance in the Rainy Day Fund, is the only credit that can be suspended or limited under current law based on the availability of revenues. Between 1998 and 2005, eligibility thresholds for the Sales Tax Relief credit were tied to a revenue trigger, so that in year when revenues were projected to fall, eligibility for the credit was restricted.

Increasing our scrutiny and evaluation of tax expenditures, and subjecting at least some to  fiscal caps, would constitute sound policy regardless of fiscal circumstances. But during this time of crisis, to claim that the priorities we’ve chosen to fund through the appropriations process can be slashed while the priorities we’ve embedded in the tax code are untouchable simply doesn’t make sense.

We’re getting closer to launching the OK Policy Online Guide to Oklahoma Budget and Taxes, a comprehensive resource for understanding state and local government finance in Oklahoma. Most of the guide is factual in nature–how we collect tax dollars, how we spend them, how we make budget decisions, and where you can get more information.

We are an advocacy organization, however, so the Guide points out two major areas where we believe Oklahoma can and must do better. One is the ongoing fiscal gap between our ability to pay for services and our demand for those services. We’ll address that next week. For today, we’ll preview some of the Guide’s discussion of tax fairness.

This graph shows the percentage of income paid in taxes by each of  seven income groups. The regressivity of the system is obvious since the percentage paid in  taxes drops with each increase in income. Those who are in the lowest 20 percent of income earners–making $12,000 or less each year–pay 12 percent (one-eighth) of their income in taxes. The percentage of income paid in taxes falls slightly for each income group above the middle. Those in the top 1 percent–making $250,000 or more each year–pay 8 percent (one-twelfth) of their income.

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If you are thinking about doing most anything in Oklahoma that could possibly be seen as encouraging economic development, chances are you’re eligible for a tax credit. The state offers tax credits for everything from  investing in small business venture capital companies and film production companies to purchasing poultry litter. Until very recently, however, public information about who is claiming these credits and in what amounts was all but non-existent. (The Oklahoma Tax Commission publishes a bi-annual tax expenditure report, but that provides only aggregate amounts and provides no data for many credits.)

The state of disclosure of tax credits has now taken a giant leap forward. In 2007, the Legislature passed SB 1, the Taxpayer Transparency Act, authored by Sen. Randy Brogdon and Rep. Paul Wesselhoft. The bill required the Office of State Finance to set up a website to allow the public access to comprehensive information on state government. The website was to include detailed information on all recipients of  government funds not only through direct budgetary expenditures, but also incentive payments and tax credits. Expenditure information has been available since early 2008 on the Openbooks.gov website.  Last month, tax credit information was added.

Anyone can now go to the site and either call up information by credit or search by taxpayer’s name for 35 income tax credits for the 2007 tax year, along with an unspecified “other credit” category. The database contains over 5,500 entries on both individual and corporate filers who claimed a credit in 2007. The amounts claimed range from a high of $2.4 million for the rural small business capital credit claimed by Donald and Joyce Harvey to $1 claimed for assorted credits by some dozen taxpayers. The largest corporate recipient of a tax credit is listed as Terra International, Inc., which claimed a credit of $2.1 million under the Investment/New Jobs incentive program.

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As states across the nation face a worsening fiscal crisis and the prospect of deep spending cuts, some policymakers and advocates are attempting to shine additional light on the traditionally dark corner in which reside the large and ever-growing array of credits, deductions, and exemptions written into state tax codes. Our friends at the Center on Budget and Policy Priorities have released an important and timely new report on tax expenditures, making the case for states to do a better job at providing information on the provisions written into the tax code that reduce state revenue. Read the rest of this entry »