Summer Rerun: Back to Texas? Income tax proposal stirs up some old memories

Recently, Governor Mary Fallin made headlines for saying that while she has no immediate plans to propose more income tax cuts, her long-term goal is to do away with the income tax while finding a way to “restructure the state’s tax system to find new ways to pay for essential public services”. Her statement echoed one made earlier this year by House Revenue and Taxation Chair David Dank, which prompted  this blog post back in February.

“Imagine never having to file an Oklahoma income tax form again, and having no more state income tax withheld from your paycheck.” This is the scenario floated recently in a press release by David Dank, the Chair of the House Revenue and Taxation subcommittee. According to the release:

Dank said he would favor completely eliminating the state personal income tax and replacing that revenue with a higher state sales tax on merchandise other than groceries and prescription drugs.

The main reason behind Dank’s proposal is said to be the need to compete with states that have no personal income tax, especially our southern neighbor:

We are already being left behind in economic and job growth by states like Texas with no income tax,” Dank said. “If we are going to compete in the crucial next few years, we need to stop talking and start acting to dramatically reform our state tax system.”

Rep. Dank’s call to reform Oklahoma’s tax system to look more like Texas, and particularly the endorsement of a complete elimination of the personal income tax, may have a vaguely familiar ring. In the early 2000′s, the state embarked on an extensive tax reform process guided, at least initially, by the goal of making Oklahoma’s tax system resemble that of Texas.  After a year of research, reports, task forces, hearings and recommendations, the final tax reform proposal that emerged from this process was much different than what was initially considered – and wound up going almost nowhere. While much has changed in the intervening eight or nine years, we thought it might be helpful and instructive to dust off our files from that go-around and provide a quick recap of what happened back in 2001-02.

The impetus for serious consideration of doing away with the state income tax initially came in April 2001 from then-Senate President Pro Tem Stratton Taylor, a Democrat, who issued a defiant challenge to do away with Oklahoma’s entire tax system in favor of Texas’. While many questioned the sincerity of Taylor’s support for what was soon dubbed the “Texas Plan”, Governor Frank Keating and Speaker Larry Adair joined Taylor in commissioning a report from leading economists at OU and OSU to suggest options for eliminating the personal income tax, and also doing away with taxation of capital gains and groceries – but in a strictly revenue-neutral fashion.

In June 2001, the economists delivered a 78-page report that set out possible options for meeting their charge. They suggested three revenue sources for replacing the estimated $2.7 billion in lost revenue from eliminating the existing taxes: 1) raising property taxes; 2) expanding the sales tax base to services and increasing the sales tax rate; or 3) enacting a gross receipts tax, which taxes business revenue at all stages of production.  In addition to devising scenarios involving an exclusive reliance on each of these taxes, they also developed two hybrid scenarios involving a combination of revenue sources. Although their proposals all were expected to initially meet the criterion of revenue-neutrality, they conceded that none of their suggested taxes would grow over time as robustly as the personal income tax. It should be noted that they did not consider an exclusive reliance on an increase in the sales tax rate as worthy of serious discussion, on the grounds that as “Oklahoma already has a relatively high combined state and local sales tax rate (7.5 – 8.0 percent), the levy of such an increase may be questionable”.

Following the economists’ report, Governor Keating released a proposal in late 2001 to eliminate the state personal income tax, sales tax on groceries and franchise tax, and replace the estimated $2.7 billion in lost revenue with a 5.9 percent tax on a broad array of services, excluding medical and health services, agricultural and mining services, and a few other exemptions.  After opposition to broadening the sales tax base was voiced by a range of potentially-affected businesses, the Governor, Speaker and Pro Tem appointed a legislative-citizen Task Force that met over the course of the 2002 legislative session to propose revenue-neutral tax reform.

The Task Force’s final report, issued in April 2002, recommended extensive changes to the state’s tax system but stopped short of endorsing the full elimination of the personal income tax. Instead, it proposed a number of tax cuts, including a flat income tax rate of 4.5 percent on taxable income, an increase in the state’s standard deduction and personal exemption, lower rates on capital gains and retirement income, changes to the estate tax, and additional credits for low-income families. Altogether the revenue impact of the tax cuts totaled $976 million. To replace part of this lost revenue, the Task Force proposed raising the tax rate on cigarettes, motor fuel and insurance premiums, and eliminating the sales tax exemption on cigarettes and newspapers. But the lion share of new revenues – some $776 million – was expected to come from broadening the sales tax to untaxed services at the same rate (4.5 percent) as other goods and services.

Even though most Oklahomans were expected to benefit from the various tax cuts proposed by the Task Force, those sectors that faced new or higher taxes were much more vocal and active in reacting to the proposed changes. Legislation to implement the Task Force’s recommendations was drafted in 2002 but was never considered.  By the time Brad Henry assumed the Governor’s office in 2003, comprehensive tax reform was off the table – although many of the tax cuts proposed by the 2002 Task Force were implemented in subsequent years without revenue offsets.

Due to term limits and shifting political fortunes, only nine of the 149 legislators who were House and Senate members in 2001-02 remain in office today. It will be interesting to see whether the current crop of  legislators will choose to journey back down the road to Texas – and if they run into similar potholes and dead-ends along the way.