Why Oklahoma needs an income tax

With the Governor and legislative leaders talking about doing away with Oklahoma’s state income tax, it’s worth taking a look at how the tax affects Oklahomans and why it is important. In an OK Policy fact sheet released today, we explain the basics of how the tax works. Here are three compelling reasons to preserve Oklahoma’s income tax:

1) The income tax is a crucial revenue source for education, transportation, public safety, and other key services.

Oklahoma’s individual income tax is the largest source of revenue the state has to fund education, transportation, public safety and other important services that help create jobs, build a strong economy, and promote a good quality of life.

It made up roughly one third of all state tax collections in the 2010 budget year. That’s big – but the income tax used to make up an even bigger share of state revenues before recent tax cuts took their toll. Lagging income tax collections are part of the reason that we continue to see shortfalls in the revenue necessary to meet Oklahoma’s needs, even as the economy improves.

While it’s usually popular for politicians to call for tax cuts, the reality is that the state as we know it could not function without income tax revenue unless some other tax was drastically increased. Governor Fallin has admitted that eliminating the income tax without finding another source of funding would undermine our schools, transportation infrastructure, public safety, and every other core function of government. Before the economic downturn, the income tax brought in more than $2.5 billion. Of course we have to make sure government always spends our tax dollars effectively and accountably, but it would be impossible to make up anywhere close to $2.5 billion simply by rooting out waste.

So the question becomes not, “should we do away with the income tax?” but, “if we do away with the income tax, what do we replace it with?” That’s what hung up previous efforts at eliminating the income tax. Texas, the model often cited for why Oklahoma should end its income tax, compensates with very high property taxes. Those are even more unpopular than the income tax in Oklahoma, and lawmakers are busy trying to implement more property tax limitations.

2) Losing income tax would shift responsibility for supporting public services to the low- and moderate-income families who can afford it least.

Oklahoma’s income tax is important not just as a vital revenue source, but because it is the only major part of our state and local tax system that is based on the ability to pay. The more money a household makes, the higher the proportion of their income they pay in income tax. Sales and property taxes are just the opposite: the lower a family’s income, the higher the share of it is paid in those taxes. The income tax is important to balance out the impact.

By contrast, over-reliance on sales and property taxes in Texas means the lowest income Texans pay almost four times more of their incomes in state and local taxes than do the wealthiest. While Texas as a whole ranks 41st in state and local taxes as a share of income, the poorest 20 percent of non-elderly Texans (with an average income of $11,200) pay the 5th highest taxes in the nation. The next 20 percent of Texans, with average incomes of $24,500, pay the 17th highest taxes.

 3) Despite misconceptions, the state income tax is modest.

The top rate of Oklahoma’s state income tax is 5.25 percent. Because that rate takes effect at the income level of $8,700 for individual filers and $15,000 for couples, many mistakenly believe that anyone making more than those amounts pays 5.25 percent of all their income. But as the fact sheet explains, that’s incorrect for two reasons:

1. The brackets only apply to taxable income. That’s the amount a family makes after deductions and exemptions are taken out. So unmarried Oklahomans automatically pay no tax on the first $5,800 of income and married filers pay nothing on their first $11,600, plus another $1,000 exempted for each person in the household.
2. When your income moves into a higher tax bracket, only the income above that amount is taxed at the higher rate. A married couple with two children reaches the top 5.25 percent bracket when they make more than $30,600, but they don’t pay that rate on all of their income. Their first $2,000 in taxable income would still be taxed at the bottom rate of 0.5 percent, and so on through all of the brackets, with only earnings above $30,600 taxed at the top rate.

When you figure in exemptions and deductions that reduce taxable income and account for the fact that each bracket applies only to income above that level, Oklahoma’s income tax as a percentage of a household’s total income is relatively low. For example, a family making $75,000 a year pays just 3.63 percent of its total earnings in state income tax. The below chart shows the effective tax rates for Oklahoma families at several income levels:

Where Does that Leave Us?

Oklahoma’s income tax certainly has flaws that should be addressed, and we will share our ideas for improving the income tax in a subsequent blog post. But those who say Oklahoma should get rid of the state income tax have a big burden. They have to say what taxes they would increase or what services they would reduce to make up more than $2.5 billion in lost revenues. They should be very specific, because Oklahomans know there is no free lunch. If we’re going to seriously consider drastic changes in the state’s tax system, we owe it to everyone to have an open and honest discussion with real-life numbers and the real-life impacts on people.