Stop digging! Top income tax rate cut should be suspended until revenues have recovered

Even assuming that we are in the early stages of what will eventually be a robust economic recovery, Oklahoma’s budget crisis is not going to end anytime soon. Revenue collections this year and next are projected to come in 20 to 25 percent below their levels of FY ’08, the year prior to the onset of the downturn. The Legislature has been able to use substantial amounts of non-recurring revenue from the federal stimulus bills and the state’s Rainy Day Fund to soften the shortfall and thus far avoid the catastrophic impact of budget cuts in the 20 – 25 percent range across the full range of state government.  However, next year’s cuts look to be substantially deeper than this year’s. After FY ’11, most or all of the non-recurring revenues will likely be exhausted. As shown in the chart below, we project that  revenue collections are likely to remain 10 percent below those of FY ’08 in FY ’12, and may not return to pre-downturn levels until at least FY ’13.

There are no easy or painless solutions to the problem of the budget hole that looms once federal stimulus funds have expired and the Rainy Day Fund is no longer available. One thing the Legislature can and should do, however, is not allow the hole to get needlessly bigger by allowing additional cuts to the top income tax rate to kick in automatically in FY ’12.

Back in 2006, the Legislature voted to cut the state’s top individual income tax rate down from 6.25 percent to 5.5 percent over several years. It opted to further cut the top rate to 5.25 percent, but made that final cut contingent on General Revenue collections being projected to grow by at least 4 percent in the upcoming year compared to the current year. However, as soon as that trigger mechanism is enabled, the tax cut becomes permanent.  And more urgently, the trigger can be enabled any time revenues are projected to grow by at least 4 percent – even if projected growth would leave collections below previous levels.

In practice, revenues are likely to rebound in FY ’12 but remain at only 85 percent or 90 percent of where they were four years prior.  Budget cuts are likely to remain in effect and perhaps get even more severe due to the loss of one-time revenues. But barring legislative action this session, the trigger lowering the top rate will go off automatically for Tax Year 2012. According to an analysis conducted for us by the Institute for Taxation and Economic Policy, the fiscal impact of reducing the top rate from 5.5 to 5.25 percent would be $112 million in lost revenue – nearly half of which, incidentally, would benefit taxpayers in the top 5 percent of households, those with annual income above $163,000.

Many of us will disagree over whether our top tax rate is too high or too low and whether it is better for the state’s economic prosperity to lower the income tax or invest more in education and infrastructure.  But at least over the course of the fiscal crisis, there has been a bipartisan consensus that while we are cutting budgets, eliminating programs, and laying off  teachers and state employees, tax cuts must take a back seat. If we can expect to continue to be facing large budget shortfalls past next year, shouldn’t our priority continue to be to attempt to restore funding for education, health care, social services and public safety to close to pre-downturn levels? Or should we be bound by a decision made by legislators years ago and let ourselves be dug over $100 million deeper into the budget hole?