OKPOLICY.ORG
As legislators consider a final vote on a tax cut that would ultimately reduce state revenues by over $230 million, the state could be facing unexpected liabilities in the hundreds of millions of dollars due to a court case challenging Oklahoma’s treatment of capital gains.
A memo circulated earlier this month by Senator Mike Mazzei sets out the potential impact of a ruling in January 2013 by the Oklahoma Court of Criminal Appeals. An out-of-state company, CDR Systems Corporations, challenged an Oklahoma law, enacted in 2005, that exempts all capital gains from the sale of Oklahoma-based property or stocks from state individual and corporate income tax. The Court found that the law violated the Commerce Clause of the U.S. Constitution by giving preferential treatment to Oklahoma-based companies.
The decision, which the Oklahoma Tax Commission is currently appealing, could have enormous consequences for the state’s revenue collections and fiscal outlook. As outlined in the Senate memo, if the initial ruling overturning the law is upheld, there are several possible scenarios, depending on if : (1) the ruling strikes down the exemption for individuals as well as corporations; (2) the ruling applies prospectively only, or retrospectively as well; and (3) the Court determines that no capital gains are deductible, or all gains qualify, regardless of company headquarters. Should the Court rule that no gains are deductible and that taxpayers are liable for tax on capital gains sold over the past three years, the state stands to enjoy a windfall of $124 million, based on OTC estimates. Conversely, under the scenario where the Court rules that capital gains are exempt for all taxpayers, including individuals, and allows taxpayers to reclaim taxes filed in previous years, then the state could be looking at liabilities of over $420 million in amended returns for the past three years, and an annual loss of $140 million going forward.
There are potential solutions being considered that could equalize treatment for all taxpayers within the current cost structure of the exemption. However, with only a month left in session, no agreement has been reached on a fix and it is quite possible that the legislature will choose to take no action until after the courts reach a final decision. If the court were to extend the the capital gains exemptions to all taxpayers, this could leave the next legislature with a several hundred million dollar budget hole.
Even without this new threat to the state budget, our fiscal outlook is highly uncertain. So far this year, general revenue collections are running $50 million below last year, and sluggish sales tax collections are sparking concerns that the state economy may already be stumbling. Given recent revenue reports, the certified estimates being used to build next year’s budget, which assumes next year’s general revenues to be almost $400 million greater than last year, could be extremely optimistic. Meanwhile, the state must be ready to absorb the impact of the federal sequester and significant lost property tax revenue as a result of passage of SQ 766.
With the potentially seismic impact of the capital gains ruling now thrown into the mix, approving a tax cut that would substantially reduce state revenues would be especially unwise.
