Step Up Oklahoma plan adds to the consensus that new revenues are essential

Note: This post was edited on Jan. 28th to reflect updated revenue estimates from the Step Up coalition

The new Step Up Oklahoma coalition, a bipartisan group of business and civic leaders and organizations, has put forward a comprehensive plan aimed at stabilizing Oklahoma’s budget and reforming state government. While far from perfect, their plan is a serious and laudable attempt to address the budget problems that have plagued our state for years.

The most significant aspect of the coalition’s plan is its clear recognition that Oklahoma has a structural budget deficit that can be fixed only through approval of substantial new permanent revenue. The proposal is projected to generate $750 million through a combination of higher taxes and the elimination of various tax breaks. In conjunction with an improving budget outlook, this amount would end the longstanding reliance on one-time funds and accounting gimmicks to balance the budget. The plan includes a $5,000 raise for teachers; although other critical spending priorities, including raises for state workers and more support for schools are not spelled out, the plan should generate enough revenue to meet those goals while preserving essential state services.

Overall, the coalition has proposed a well-balanced mix of new revenues.

The four main revenue pillars are a $1.50-per-pack cigarette tax increase, which is projected to generate an additional $243.9 million; a 6¢ per-gallon motor fuel tax increase ($170.4 million); an increase in the initial gross production tax rate from 2 to 4 percent ($133.5 million); and changes to the personal income tax ($144.0 million).

A good case can be made for most of these revenues individually. Increasing the cigarette tax will help save lives by reducing the number of smokers and stabilizing funding for health care services. Oklahoma’s motor fuel taxes haven’t been raised in three decades and have fallen to among the very lowest in the nation; nearly half of the tax increase will be paid by out-of-state motorists, according to an analysis by the Institute on Taxation and Economic Policy. The proposal to raise the gross production tax to 4 percent for the first 36 months of production represents a compromise between the current 2 percent rate on new wells and the standard 7 percent rate, especially as the higher rate would apply to wells that have already been drilled. Oil and gas producers would continue to receive $200 million in annual tax breaks based on current prices and production.  The plan also looks to raise $15 million from a new, unspecified tax on wind, which the wind industry vehemently opposes.

Our most serious concerns are with the proposed changes to the income tax.

The plan keeps the top marginal rate at 5 percent while making a set of five changes to deductions, exemptions, and tax brackets. Three changes would raise additional revenue:

• Cap itemized deductions at $22,000, but exclude charitable deductions from the cap;
• Eliminate the personal exemption, which is currently $1,000 per household member, and
• Reduce the standard deduction to $5,250 for single individuals (currently $6,300), $7,700 for single head of households (currently $9,250), and $10,500 for married couples filing jointly (currently $12,700).

Two changes would lower revenues:

• Two new lower tax rates. While currently all taxable income above $7,200 for single filers and $12,200 for joint filers is taxed at 5 percent,  the plan would create a new 4.6 percent rate for income between $7,200 and $17,999 for single filers and between $12,200 and $35,999 for joint filers and a 4.8 percent rate on income between $18,000 and $49,999 for single filers and between $36,000 and $99,999 for joint filers;
• A new three-tiered, non-refundable income tax credit of $30 to $70 for households with income below $50,000.

According to an analysis from the Tax Commission, the income tax changes would generate net increased revenue of $173 million, with the top third of income filers – those earning $70,000 and up – contributing some 75 percent of the total [note: the revised plan, which preserves the oil depletion allowance and makes other unspecified changes, is now projected to generate $144 million]. However, under the Tax Commission’s analysis, at least half of all taxpayers with income over $32,000 would pay more income tax. Households with two or more children are likely to fare worst because of the elimination of the personal exemption in favor of a per-household credit that does not increase with family size. It’s also unclear that the revenue projections account for the recent federal changes to the standard deduction, which will lead to a steep drop in the number of Oklahoma households that claim itemized deductions.

There are better approaches to reforming the income tax that would be less complicated, more progressive, and have a more certain revenue benefit. These would include some combination of:

• Adding a top rate of 6 percent on income over $100,000 for single filers and $200,000 for married couples;
• Restoring the 5.25 percent top rate that was eliminated in 2016;
• Boosting existing credits (the Earned Income Tax Credit and Sales Tax Relief Credit) that support low- and moderate-income households, rather than adding a new, non-refundable credit;
• Raising the standard deduction in a way that would bring it back into alignment with the federal standard deduction over some period of time;
• Eliminating the capital gains deduction, which gives a tax break to the wealthiest households costing about $100 million annually without creating any clear economic benefits.

The proposed government reforms have promise but need more scrutiny.

The government reforms accompanying the revenue package, which are based on the State Chamber’s OK 2030 plan, include some promising ideas, especially the recommendation to lower the State Question 640 supermajority needed to pass new revenue to 60 percent from the current 75 percent, an obstacle that has contributed to the budget gridlock of recent years and bestows excessive power to a small minority of legislators. Other proposals, including changing the judicial nominating process, expanding the Governor’s appointment authority, and creating a new budget office to root out waste and fraud, deserve careful scrutiny. Although the revenue and reform measures were presented as a single package, with the latter clearly aimed at sweetening the pot for some lawmakers reluctant to support revenue increases, it’s not clear that the Legislature could or would embrace the whole package altogether.

Serious political challenges remain for this plan.

Although Step Up Oklahoma includes prominent Oklahomans from both major parties and major interest groups representing the oil and gas industry, hospitals, teachers, and others, getting its package of revenue measures and government reforms through the Legislature will be no easy task. Gov. Mary Fallin will likely be the plan’s biggest booster, but she enters her final year in office with low approval ratings. Republican lawmakers have become increasingly open to new taxes and are desperate to provide teachers a raise, but some lawmakers will feel politically vulnerable supporting a tax increase of this magnitude in an election year.

Meanwhile, Democrats may be unhappy with specific components of the plan – including the new tax on wind energy and the failure to raise the top income tax rate, do away with the tax break on capital gains, rescind cuts to the Earned Income Tax Credit, or raise the initial gross production tax rate above 4 percent. After winning a string of special elections last year and expecting strong prospects this November, Democrats may also be less than fully enthusiastic about helping Republicans fix the budget.

Nevertheless, the new plan is a serious attempt to address the budget problems that have plagued our state for years. While we may differ over the details, we welcome the Step Up leaders to the growing consensus that new revenues are essential for the state services needed by businesses and all Oklahomans.