Cutting the top income tax rate: Who benefits?

[UPDATE: You can download ITEP’s analysis here.]

Yesterday the Senate voted to abolish the state income tax after Sen. Tom Adelson (D-Tulsa) introduced the measure as an amendment to another bill. With public services heavily dependent on income tax and no immediate revenue prospects to replace it, the language will likely be removed before the bill is finalized. Democrats introduced the amendment (which they do not support) in an attempt to show that the tax cut rhetoric of the Republican majority is not compatible with responsible budgeting and the needs of public services.

While that is a political fight that will not have immediate repercussions on policy, it mirrors the trend of successive smaller cuts that have significantly reduced the income tax over time. From 2004 to 2006, the top income tax rate was cut from 6.65 percent to 5.5 percent. Unless the legislature acts to stop it, another state income tax cut will take effect January 1, 2012. The cut, which was triggered when the state projected that revenue will rise by more than 4 percent next year, would reduce the top rate to 5.25 percent.

Oklahoma was a different place when the tax cuts were approved. The devastating national recession had yet to strike, and the state was enjoying budget surpluses. Lawmakers did not expect that the revenue trigger would be the result of what amounts to only a partial recovery from historic lows. Next year’s revenues are projected to remain 13 percent below 2008, and the state faces a budget shortfall of $500 million. State spending as a share of the economy is at a 30-year low. So at a time when the state lacks the resources to meet growing needs, this next tax cut is projected to further reduce available revenues for FY ’12 by $38 million. When the cut is fully phased-in, revenues will be reduced by $120 million.

The serious revenue problem Oklahoma still faces hasn’t deterred Gov. Fallin and the majority in the legislature from supporting the tax cut going forward. In the midst of a budget crisis, with increasing harm to Oklahomans due to declining public health, cash-strapped law-enforcement, and crumbling infrastructure, the push for more tax cuts proceeds with little dissent or debate.

The loss of much-needed revenue isn’t the only problem with letting this tax cut go forward. Another major issue is how the tax cuts are distributed. The Institute on Taxation and Economic Policy did an analysis for OK Policy that shows the benefits going disproportionately to the wealthiest Oklahomans:

• The lowest 20 percent of households (incomes less than $17,300) see no change in taxes;
• The second 20 percent (incomes of $17,300 to $31,200) get an average cut of $6, though many within that group would not see any change;
• The middle 20 percent (incomes of $31,200 to $51,800) receive an average of $24;
• The fourth 20 percent ($51,800 to $85,800) get an average cut of $67.

But for those making over $85,000 a year, the cuts are significantly more. It’s instructive to break this 20 percent of Oklahomans into smaller groups to see the full impact:

• The bottom 15 percent of the top 20 percent (incomes of $85,800 to $176,000) take an average of $148;
• The next 4 percent ($176,000 to $399,100) get an average of $295;
• The top 1 percent of Oklahomans (households with incomes higher than $399k) receive an average of $1,930.

Those figures refer to the average per household cut within income groups.  Another way to look at the numbers is how much of the overall cut goes to each group as a whole:

As seen above, the top 20 percent of Oklahomans take home almost 3/4ths of the tax cut. More than a third of that goes to the top 1 percent. The bottom 60 percent of Oklahomans together receive only 9 percent of the benefit. Forty-three percent of Oklahomans would receive no tax cut at all.

By taking so much revenue away and giving the benefits to a relatively small group, the state will be shifting a larger proportion of the cost of providing services onto lower- and middle-income Oklahomans.  Low- and middle-income people already pay a larger part of their income in state and local taxes than the wealthy, and they suffer most when reduced revenue leads to elimination of state services. This tax cut takes us even further in that direction.

As discussed recently in OK Policy’s issue brief on the sales tax, a well-functioning tax system should both provide adequate revenues for core public services as well as treat all Oklahomans fairly.  This tax cut fails on both counts. That’s important to keep in mind as we consider how to pay for the state’s current and future needs. We need to examine our priorities and make careful choices to ensure that our prosperity is widely shared.

[This information is available as a PDF fact sheet here.]