Learning from the Crisis (4): Capping and suspending tax breaks

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.