The tax cut plans being pushed by Oklahoma lawmakers contain plenty of bad ideas, but one may eclipse them all: Governor Fallin’s tax cliff.
The tax cliff is the result of a badly designed tax bracket structure. Very few other states have such a structure, and for good reason: it creates a major disincentive to work.
In a normal rate structure, the higher rates only apply to income above a certain level. For example, in our current system, families enter the highest bracket of 5.25 percent when they make $15,001 or more in taxable income. However, they don’t pay 5.25 percent on every dollar of income. They pay 5.25 cents out of each dollar at and above $15,001, but they pay only 5 cents of the dollars they earn between $12,201 and $15,000, 4 cents of the dollars between $9,801 and $12,200, and so on.
In Governor Fallin’s plan, entering a new bracket causes the higher rate to apply to every single dollar of taxable income. That means a family with $29,999 in taxable income would not owe any income tax. But if they earned one dollar more, their tax bill would jump to $675. When moving between the second and third bracket, their taxes would jump again by $875.
How does this discourage work? In a typical marginal rate structure, a worker doesn’t hesitate to move into a higher bracket because the extra dollar of earnings will always be worth more than what the worker pays in tax. He or she may get to take home 95 cents instead of 96 cents of that dollar, but either way it’s a net benefit.
Under Governor Fallin’s tax cliff plan, earning more could be economically disastrous. If an extra dollar of earnings hikes your tax bill by $675 or $875, it makes more sense to skip work or turn down that raise. Fallin promises that her plan would boost economic activity, but the cliff would have the opposite effect. It would throw family budgets into turmoil and make Oklahomans afraid to work.
Governor Fallin’s bizarre and unworkable rate structure was no accident. Her administration designed the plan like this because it was the only way to avoid a shockingly high first year cost. When you eliminate the tax cliffs, the first year revenue loss under the Governor’s plan more than triples, going from just over $300 million to $1.069 billion, according to calculations by the Institute on Taxation and Economic Policy.
The drag this would put on the economy goes against everything the tax cut boosters claim to believe about a good tax system. With a core that is more about politics than economics, Governor Fallin’s tax proposal should not be taken seriously.