High-income surcharge would help solve budget emergency

The evidence is now undeniable that Oklahoma is facing a full-fledged emergency. With each passing day, the toll of budget cuts on Oklahoma families, schools, businesses, and communities becomes more alarming. Given the enormity of the budget shortfall, it’s widely understood that the budget can’t be balanced primarily through deeper spending cuts. The income tax needs to be part of a fair and sustainable solution to the budget emergency, and out of many hard choices about the budget, adding a high-income surcharge would do the least damage to our economy and to Oklahoma families’ quality of life.

Overall, Oklahoma’s state and local taxes are regressive, with low and moderate-income Oklahomans contributing a greater share of their income in taxes than wealthier households. The income tax is the one progressive component of our state and local tax system, serving  to partly offset the regressivity of sales and excise taxes. But state income tax cuts over the past dozen years have made our tax system more regressive and contributed to current and ongoing  budget strains.

As we discussed in this report, cuts to the top income tax rate have reduced state revenue collections by over $1 billion. These tax cuts have overwhelmingly benefited the wealthiest Oklahomans, with 72 percent of the tax cut going  to the highest fifth of taxpayers and just 28 percent to the bottom 80 percent. The tax cuts have contributed to the state’s ongoing inability,  even when oil was at $100 a barrel and our economy was thriving, to provide teacher pay raises, reduce waiting lists for those with mental illness and developmental disabilities, ensure adequate staffing of our prisons, and make other critical investments. Now the most recent tax cut, which lowered the top income tax rate from 5.25 to 5.0 percent this past January, is contributing to the current budget shortfall. Cancelling the most recent tax cut would provide $147 million in additional revenue, according to the Oklahoma Tax Commission — this should be the first and most obvious solution to help ease the budget shortfall.

A high-income surcharge would ensure that those who benefited most from tax cuts contribute to solving the current emergency

Along with reversing the last tax cut, we should also consider a high-income surcharge that would restore the top rate on upper-income households back to where it was prior to the tax cuts of the 2000s, at least temporarily.

Two options would be:

• Restore the 5.25 percent bracket; raise rates to 6 percent on taxable income over $200,000 for a married couple ($100,000 for a single individual) and to 7 percent on taxable income over $400,000 for a couple ($200,000 for singles).
• Restore the 5.25 percent bracket; raise rate to 6.65 percent on taxable income over $300,000 for a married couple/$150,000 for a single individual.

The first option would generate $299.7 million in additional state revenue, according to an analysis conducted for OK Policy by the Institute on Taxation and Economic Policy, while the second option would generate $263.7 million. Of these totals, restoring the top rate to 5.25 percent generates about $138 million, with the remainder from the new top rates. In either case, the increase in state income tax liability would be offset by reduced federal tax liability due to the deductability of state income taxes.

A high-income surcharge would have little to no effect on low- and middle-income families

Under the plan that includes new 6 percent and 7 percent brackets, the median-income household earning $47,900 would pay just $33 more per year ($31 year after the federal offset), while those in the highest 1 percent would pay $11,307 more ($7,352 after the federal offset). Forty-one percent of households would see no increase at all because none of their income falls under the top income tax rate.

[pullquote]“As we confront a crisis that is affecting all Oklahomans and threatening potentially irreparable damage to our state, cancelling the last income tax cut and assessing a temporary high-income surcharge would help ensure that all of us are contributing to a fair solution.”[/pullquote]

Although the top income tax rate would revert to historical levels under these options, taxpayers would still pay substantially less income tax than they would have prior to the tax cuts. That is because the proposed surcharge would apply only to income above a high threshold, whereas previously, taxable income at much lower levels ($10,000 – $21,000) all fell under the top bracket.

Compared to our other options, a high-income surcharge would do the least harm to Oklahoma’s economy

State leaders have proposed various ideas to address the budget shortfall. The Governor’s budget, developed before the shortfall ballooned from $900 million to $1.3 billion, proposed almost $1 billion in recurring revenues. Its revenue measures included a $1.50 per pack increase in the tobacco tax, a broadening of the sales tax to more services, elimination of sales tax exemptions, and various changes in how revenues are apportioned. Gov. Fallin did not call for any increase to the income tax, although she did endorse eliminating the “double deduction” for state income tax for those who claim itemized deductions on their state income tax return. SB 1073, authored by Sen. Mazzei, attempted to delay the tax cut by clarifying that it could not take effect in a year when the Board of Equalization declared a revenue failure. The bill passed out of the Senate Finance Committee but was denied a hearing on the Senate Floor.

These ideas should all be considered, but it will take multiple strategies to the budget emergency. Temporary higher top rates on high incomes should be part of the solution. Out of the difficult options that we have, the high-income surcharge does the least damage to struggling Oklahoma families and asks for a contribution from those who can afford it with little impact on their quality of life. There’s also strong evidence from economists that, out of many bad options during a budget shortfall, tax increases on top earners will do the least damage to our economy. As we confront a crisis that is affecting all Oklahomans and threatening potentially irreparable damage to our state, cancelling the last income tax cut and assessing a temporary high-income surcharge would help ensure that all of us are contributing to a fair solution.