OKPOLICY.ORG
Oklahoma’s state budget was thrown into turmoil this year when much less money came to the General Revenuef fund than was expected. For the full year, General Revenue was 4.8 percent below the estimate; if the shortfall had reached 5 percent, nearly all state services could have been forced to make budget cuts in the middle of the year. The problem is not just with this year’s budget either. A report by the Center on Budget and Policy Priorities ranked Oklahoma last in the nation (tied with South Dakota) for how well the state does long-term budget planning.
In response, a new report by the Oklahoma Tax Commission analyzes Oklahoma’s forecasting failures and makes recommendations for what the state might do to avoid them in the future. The Tax Commission identified several trends that have made forecasting more volatile in recent years:
“Off-the-top” spending
The Tax Commission pointed out that an increasing number of off-the-top spending mandates have diverted money away from the General Revenue Fund and increased the magnitude of the shortfall when collections miss estimates. Because the off-the-top mandate amount is the same no matter what happens with the rest of the budget, any shortfalls have a disproportionate effect on General Revenue. In fiscal year 2013, nearly $360 million in personal income tax revenue and $150 million from the gross production tax on oil were diverted, primarily for education, roads and bridges, and Quality Jobs program business subsidies.
As we pointed out in this blog post, another major off-the-top diversion of funds has been for rebates and incentives to the oil and gas industry. In fiscal year 2012, Oklahoma initially collected $530.2 million more from oil gross production taxes. The first $150 million was diverted to education capital needs. Another $199.1 million was paid back to the industry as rebates and tax incentives. That left only about one-third of collections ($181.1 million) for General Revenue.
More reliance on volatile revenue sources
In fiscal year 2004, 43.7 percent of General Revenue came from personal income taxes. In fiscal year 2013, just 36.7 percent did. This decline was even more dramatic for gross production taxes. In FY 2004, this tax made up 9.6 percent of General Revenue, compared to just 4.0 percent in fiscal year 2014. The mix of contributors to General Revenue has shifted away from these sources because of the off-the-top spending discussed above, as well as large income tax cuts phased in over the past decade and a generous tax break for horizontal drilling, which was made permanent this year. That’s left the state relying more on sales tax and corporate income tax.
Although sales tax has been Oklahoma’s most stable revenue source, corporate income tax is especially erratic. Between 2004 and 2013, the average year-to-year change in corporate income tax collections was 42.5 percent. The report finds that for all taxes, the average annual fluctuation in money going to General Revenue was 7.8 percent. But if you start to take out taxes from the mix, the fluctuation increases. The Tax Commission wrote:
It is important to note the impact that Oklahoma’s diverse revenue structure has on revenue stability. Calculating the change rate excluding Sales and Use taxes results in a rate of 9.4% while excluding the personal income tax results in a rate of 8.9%.
In other words, undercutting legs of Oklahoma’s revenue stool makes it more wobbly. Further reducing or eliminating the personal income tax would make it wobblier still. This directly contradicts claims made by tax cut boosters that an income-tax free state would have more stable revenue.
So why is corporate income tax so volatile?
The Tax Commission finds there is little relationship between the overall state and national economy and reported corporate earnings. There is also surprisingly little relationship between corporations’ earnings and their tax liability. The Tax Commission said one factor contributing to the disconnect is the “large numbers of credits and refunds available and the ability of corporations to carry losses forward and backwards. The Investment Tax Credit can be claimed for up to 20 years after it is initially earned. Under federal law, which Oklahoma follows, net operating losses can be carried forward 20 years.”
Corporations can also change their structure in ways the shift liabilities away from the corporate income tax, accelerate earnings to take advantage of changes from one tax year to the next, and shift profits to out-of-state tax shelters. That’s why even though Oklahoma’s official corporate income tax rate is 6 percent, the state’s largest corporations typically pay less than 2 percent. In our current tax system, any state that relies too much on corporate income taxes will be subject to the whims of some very talented lawyers and accountants.
What can we do about it?
The Tax Commission is implementing several reforms (summarized here) to improve Oklahoma’s forecasting. They are seeking to expand the review process and bring in more economists and industry experts to evaluate the forecasting assumptions. (Previously the forecast model has been developed by a single economist at Oklahoma State University.) The Tax Commission will collect more data from corporations and oil and gas drillers from which to make corporate income tax and gross production tax estimates. They also plan to provide more information about their assumptions and conduct an annual review of the forecasting methodology to see how it may be improved. The reforms will meet some of the best practices for revenue forecasting identified in an upcoming report from the Center on Budget and Policy Priorities.
These are all important changes that hopefully give Oklahoma a more reliable basis to plan investments in our future. But we should do even more. Other reasonable reforms include making multi-year forecasts for both revenue and spending, to encourage lawmakers to think longer than the next budget (or the next election). The state also needs to greatly improve oversight over tax expenditures and business subsidies like the Quality Jobs Program that are allowed to grow without limit, no matter what the revenue picture looks like for core services.
Lawmakers also need to end the irresponsible practice of scheduling spending increases and tax cuts for years in the future, when we don’t know what Oklahoma’s needs and obligations will be. As State Treasurer Ken Miller argued recently:
There’s no economic reason to pass a measure today predicated on a future event, when one can simply wait for that event to occur and then preserve the flexibility. It’s difficult to explain the mechanics of the trigger and it’s certainly difficult to communicate to the taxpayers what their taxes are going to be.
Policy changes can give lawmakers better information about our state’s future. But we also need those lawmakers to start looking out for the long-term interests of Oklahomans and to make decisions based on something more than political expediency.
