The Economic and Fiscal Impact from Phasing Out Oklahoma's Personal Income Tax

Jonathan Small, C.P.A.

Executive Vice President Oklahoma Council of Public Affairs

Wayne Winegarden, Ph.D.

Sr. Fellow in Business and Economics, Pacific Research Institute Editor, EconoSTATS, a Project of George Mason University Partner, Capitol Economic Advisors

Foreword by John Tidwell

State Director, Americans for Prosperity-Oklahoma

Dave Bond

CEO, OCPA Impact

Co-Signers David C. Houghton, Ph.D.

Dean, Paul Dickinson College of Business Lloyd G. & Betty E. Minter Chair of Business Oklahoma Baptist University

Larry Mills, Ph.D., C.M.A. School of Business Southern Nazarene University

Kirk Jackson

Dean, Chesapeake Energy School of Business Oklahoma Wesleyan University

February 2015

About the Authors Jonathan Small

Executive Vice President, Oklahoma Council of Public Affairs Jonathan Small, C.P.A., serves as Executive Vice President of the Oklahoma Council of Public Affairs and joined the staff in 2010. Previously, he served as a budget analyst for the Oklahoma Office of State Finance, as a fiscal policy analyst and research analyst for the Oklahoma House of Representatives, and as director of government affairs for the Oklahoma Insurance Department. His policy expertise has been referenced by The Oklahoman, Tulsa World, National Review, the Los Angeles Times, The Hill, the Wall Street Journal, and the Huffington Post. Small holds a B.A. in Accounting from the University of Central Oklahoma and is a Certified Public Accountant.

Wayne H. Winegarden, Ph.D.

Sr. Fellow in Business and Economics, Pacific Research Institute Contributing Editor, EconoSTATS, at George Mason University Dr. Winegarden has 20 years of business, economic, and policy experience. His policy research examines the impact from fiscal and regulatory policies on economic growth. Dr. Winegarden’s columns have been published in the Wall Street Journal, Chicago Tribune, Investors’ Business Daily, and Forbes.com. Dr. Winegarden’s consulting practice advises clients on the economic, business, and investment implications from changes in broader macroeconomic trends and government policies. Clients leverage his insights to improve their corporate strategies, public policy positions, strategic planning, and investment strategies.

Clients have included Fortune 500 companies, financial organizations, small businesses, state legislative leaders, and policy and trade associations. Dr. Winegarden has testified before the U.S. Congress; was previously economics faculty at Marymount University; worked as a business economist in Hong Kong and New York City; and worked as a policy economist for policy and trade associations in Washington, D.C. Dr. Winegarden received his Ph.D. in Economics from George Mason University.

Co-Signers This research study on the economic and fiscal impact from phasing out Oklahoma's personal income tax is co-signed by the following individuals:

David C. Houghton, Ph.D.

Dean, Paul Dickinson College of Business Lloyd G. and Betty E. Minter Chair of Business Oklahoma Baptist University

Larry Mills, Ph.D., C.M.A. School of Business Southern Nazarene University

Kirk Jackson

Dean, Chesapeake Energy School of Business Oklahoma Wesleyan University

Table of Contents Foreword....................................................................................................................................................................................4 Introduction..............................................................................................................................................................................7 The Proposed Income Tax Phase Out ................................................................................................................................................8 Economic Literature Finds Rising or High Taxes Negatively Impacts Economic Performance .........................................9 A Review of Oklahoma’s Fiscal and Economic Trends ..............................................................................................................14 Total Expenditures in Oklahoma Are around All-Time Highs ...................................................................................................14 Oklahoma’s Volatile Personal Income Tax ...................................................................................................................................15 Changes in Oklahoma’s Personal Income Tax Rates and Oklahoma’s Relative Economic Performace .........................17 A Larger Economy Also Grows Government Revenues ........................................................................................................20 Summarizing Oklahoma’s Historical Experience .....................................................................................................................21 A Static Revenue Analysis of the Income Tax Phase Out ........................................................................................................22 Estimating the Economic Impacts ................................................................................................................................................25 A Dynamic Analysis of the Impact on Oklahoma’s Tax Revenue..............................................................................................29 Conclusion...............................................................................................................................................................................32 Endnotes..................................................................................................................................................................................34

Foreword: Empower Future Oklahoma Generations by Providing Greater Opportunity

By John Tidwell and Dave Bond

Since 1994, Oklahoma has accomplished much to help grow the state’s economy: Right to Work, death tax repeal, personal income tax reductions, repeal of taxes on intangible property, lawsuit reform, workers’ compensation reform, prioritizing transportation and infrastructure needs, and government employee retirement reform.

All these efforts will help to empower future Oklahoma generations by providing greater levels of individual economic opportunity than what their parents and grandparents enjoyed in this state in decades past.

The key to any Oklahoman releasing his or her full potential is the ability to work and to lead a productive life. Unfortunately, Oklahoma assesses a penalty on the work and productive activity of most Oklahomans in the form of a personal income tax.

Research and human behavior demonstrate that, more than any other type of tax, income taxes result in the reduction of output and of a worker’s ability to fully realize the fruits of his or her labor. The superior economic performance, over at least the past 25 years, of states with no personal income taxes compared to states with high personal income tax rates is undeniable.

Oklahoma faces a crossroads. Of the six surrounding states, four have lower personal income tax burdens than Oklahoma. From 1992 to 2011, Oklahoma lost a net of nearly $1 billion in personal income and private capital as a result of Oklahoma taxpayers migrating to other states, according to Internal Revenue Service data.

It’s no coincidence the two states that gained the most taxpayers, income, and opportunity from Oklahoma in that span were no-­‐‑income-­‐‑tax Texas and Florida, together receiving $1.6 billion in personal income from our state.

Oklahoma has demonstrated success with personal income tax reductions. Income tax rate cuts from 2005 through 2012 played a role in significant growth in Oklahoma’s economy and in disposable income. As well, Oklahoma’s total state government spending and total state tax collections are at all-­‐‑time highs, indicating that tax cuts have not decimated available revenue for government.

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

It’s not just Oklahoma, though. As noted by Creighton University economist Ernest Goss: In 2012, Kansas Governor [Sam] Brownback pushed the Legislature to whack individual tax rates by 25 percent, to repeal the tax on sole proprietorships, and to increase the standard deduction. In 2013, the Legislature cut taxes again. Since passage in 2012, how has the Kansas economy responded to these dramatic tax cuts? Kansas grew its personal income by 2.92 percent, which was higher than the U.S. gain of 2.85 percent and was greater than the growth experienced by each state bordering Kansas except Colorado.

[Colorado has received an influx of Californians fleeing record-­‐‑high state income tax increases; prior to January 1, 2015, Colorado also still had a personal income tax rate below that of Kansas.] Additionally in terms of average weekly earnings, Kansas experienced an increase of 4.82 percent, which was almost four times that of the U.S., more than four times that of Missouri, approximately seven times that of Nebraska, and nearly four times that of Oklahoma. ….

Kansas job and income data since the tax cut show that, except for Colorado, the state economy has outperformed, by a wide margin, that of each of its neighbors and the U.S. To remain competitive, expect Kansas’ neighbors to reduce state and local taxes in the years ahead.

Consider Hertz and Dollar Thrifty relocating their managers and decision-­‐‑makers from Oklahoma to no-­‐‑income-­‐‑tax Florida. Consider Hilti Corp. relocating its managers and decision-­‐‑makers from Oklahoma to income-­‐‑tax-­‐‑free Texas. It is clear Oklahoma’s personal income tax inhibits our state’s ability to make jobs available to those who desperately need them.

Now is the time for Oklahoma to fully commit to gradually and responsibly eliminating our state’s “penalty on work,” the personal income tax.

Across Oklahoma, families are faced with rising health insurance deductibles, out-­‐‑of-­‐‑ control medical costs, out-­‐‑of-­‐‑control higher education costs, rising food prices, and numerous other financial pressures. This year there will be Oklahomans who are forced into debt to pay medical bills or cover other necessities.

By taxing personal income, state lawmakers are taking away financial freedom from Oklahoma families – in order to continue growing the size of state government.

If Oklahomans don’t act to remove our state’s penalty on work, no-­‐‑income-­‐‑tax states will continue to have an advantage over Oklahoma.

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

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If things remain as they are, when our children and Oklahoma’s future generations are faced with the decision of where to go for the highest levels of opportunity, we will be forced to be honest with them and say that places like Dallas, Houston, Frisco, Lewisville, Plano, Orlando, Fort Myers, and elsewhere hold better promise on average than Oklahoma City, Tulsa, Edmond, Broken Arrow, Enid, or Bartlesville.

By gradually and responsibly phasing out Oklahoma’s penalty on work over an extended period of time – two decades, in fact – the state can ensure funds are available for core services, such as schools, infrastructure, and public safety, while transitioning our economy into one that can’t be easily matched.

By committing to steady, quarter-­‐‑percent reductions in the personal income tax rate, just as our state has previously done, Oklahoma can provide a new economy with opportunity in greater abundance for our children and grandchildren.

This gradual approach also serves to minimize, and quite likely eliminate, any conceivable need to increase property taxes or extend sales taxes to service industries in order to complete the transition. Oklahoma’s low property tax burden and our lack of a sales tax on most service industries should be seen as assets worth preserving.

For the sake of future generations and to unleash the full economic potential of all Oklahomans, our two organizations remain steadfastly committed to ensuring that Oklahoma gradually phases out our state’s penalty on work, the personal income tax.

John Tidwell is State Director of the Oklahoma chapter of Americans for Prosperity, the nation’s premier grassroots organization of citizen leaders working at the national, state, and local levels to protect and advance the individual right to economic freedom. More: www.afpok.org Dave Bond is CEO of OCPA Impact, an Oklahoma-focused, nonpartisan issue advocacy organization that serves as the action partner of the Oklahoma Council of Public Affairs. More: www.ocpaimpact.com

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Introduction Taxes are an important tool for any government. Without taxes, the Oklahoma government could not build the roads, hire the police, or maintain the public schools the citizens of Oklahoma rely upon every day. But, there is a downside to taxes as well.

Taxes reduce workers’ take home pay; they lower returns for investors and savers; and, taxes burden businesses with higher costs. These negative consequences reduce an economy’s vibrancy and lower its potential growth rate.

Oklahoma must balance these competing interests. Oklahoma’s tax system must be able to raise sufficient revenues, to fund the necessary government services; but, in raising the necessary revenues the tax system should minimize its negative economic consequences. Additionally, steeply progressive income tax systems encourage excessive growth in state expenditures.

When state expenditures exceed their efficient levels, the value of the government spending to the taxpayers is lower, and the tax burden is higher than necessary, creating unnecessary barriers to economic growth.

Based on the criteria of maximizing Oklahoma’s relative economic growth rate, the Oklahoma Council of Public Affairs is proposing a tax reform for Oklahoma that would reduce Oklahoma’s personal income tax rate by 0.25 percentage points each year over the next 20 years until it is eventually phased out in 2036 (the proposal). This proposal would ensure adequate revenues for the state, impose fiscal discipline on spending, and, most importantly, improve the incentives to work, save, and produce in Oklahoma. These improved incentives will accelerate the state’s economic growth rate and help diversify Oklahoma’s economy beyond the oil and gas and agricultural sectors.

When coupled with the current super-­‐‑majority requirements to raise taxes, the proposed income tax phase-­‐‑out sends an important signal to businesses and investors. It says that the after-­‐‑tax rate of return from operating in Oklahoma will gradually improve over time. The proposal also makes the state tax environment in Oklahoma more predictable for businesses and individuals. For many business decisions, predictability in the tax environment is an important attribute that makes one location more attractive than others.

From a government revenue perspective, due to the gradual phase-­‐‑out of the income tax, there would not be a year-­‐‑over-­‐‑year decline in tax revenues even on a static basis – only a reduction in the growth of state tax revenues.

However, as detailed below, Oklahoma’s government expenditures are around all-­‐‑time highs relative to the size of the private sector. The phase-­‐‑out of Oklahoma’s income tax imposes fiscal discipline on the budget process; combining this fiscal discipline with effective budget reform will create a more efficient state government sector that effectively provides needed government services while avoiding those activities that are either unnecessary or better left to the private sector.

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

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While the proposed tax reform should be coupled with effective budget reform, this paper assesses the economic and fiscal implications from the changed economic incentives created by the tax reform only. Summarizing the findings, if the proposed tax reform is implemented: •

• • •

The growth in personal income will accelerate. By 2036, the growth rate of personal income will be 1.8 percentage points higher and total personal income will be 11.6 percent larger than the baseline scenario; There will be 111,000 more jobs in 2036 compared to the baseline scenario; Adjusted for inflation, state tax revenues will increase 38 percent compared to 2013 levels, and Local tax revenues will be $1.0 billion higher than the baseline scenario.

The Proposed Income Tax Phase-Out Oklahoma’s current top marginal personal income tax rate is 5.25 percent. Due to a ruling by the Oklahoma Supreme Court, the tax rate will decline to 5 percent in 2016 (assuming certain revenue targets are met).i However, even at 5 percent, Oklahoma’s top personal income tax rate does not create a distinguishable comparative advantage compared to other states.

Assuming a 2017 implementation date, the top personal income tax rate schedule that would result from phasing out Oklahoma’s personal income tax by 0.25 percent per year until the personal income tax is completely eliminated in 2036 is illustrated in Figure 1.

Figure 1 Proposed Top Personal Income Tax Rate in Oklahoma 2015 - 2036

2036

2035

2034

2033

2032

2031

2030

2029

2028

2027

2026

2025

2024

2023

2022

2021

2020

2019

2018

2017

2016

2015

5.25% 5.00% * 4.75% 4.50% 4.25% 4.00% 3.75% 3.50% 3.25% 3.00% 2.75% 2.50% 2.25% 2.00% 1.75% 1.50% 1.25% 1.00% 0.75% 0.50% 0.25% 0.00%

* Scheduled to decline to 5.0% by current law.

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Due to the gradual lessening of Oklahoma’s top personal income tax rate, the near-­‐‑term consequences on government revenues are lessened compared to a tax reform that eliminated the personal income tax all at once. The large impact on government revenues from eliminating the personal income tax all at once, as well as the destabilizing impacts that such a sudden change can cause, argues for a more gradual implementation schedule.

On a static basis, year-­‐‑over-­‐‑year revenues, adjusted for inflation, would continue to grow under the proposed tax reform, albeit less than the baseline revenue growthii (see Static Revenue Impact section, page 22 below). When the benefits from increased economic growth are incorporated, the year-­‐‑over-­‐‑year revenue growth would be even higher, albeit still below the baseline revenue growth (see Dynamic Revenue Impact section page 29 below).

The primary reason to gradually eliminate Oklahoma’s personal income tax is the beneficial economic growth impacts such a policy will create. These potentially beneficial impacts are substantiated by the large number of economic studies that have found a negative (positive) impact from increasing (lowering) taxes, particularly personal income taxes, on economic growth.

Economic Literature Finds Rising or High Taxes Negatively Impacts Economic Performance In a comprehensive review of the academic literature that has examined the relationship between taxes and economic growth, McBride (2012) found that …the results consistently point to significant negative effects of taxes on economic growth even after controlling for various other factors such as government spending, business cycle conditions, and monetary policy. In this review of the literature, I find twenty-­‐‑six such studies going back to 1983, and all but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth. Of those studies that distinguish between types of taxes, corporate income taxes are found to be most harmful, followed by personal income taxes, consumption taxes and property taxes.

These results support the Neo-­‐‑classical view that income and wealth must first be produced and then consumed, meaning that taxes on the factors of production, i.e., capital and labor, are particularly disruptive of wealth creation.iii Table 1 in McBride (2012) summarizes the results from all 26 studies reviewed. Box 1 reproduces the summaries from Table 1 for the 10 U.S.-based studies (federal or state) from McBride (2012).

Box 1: U.S.-Based Empirical Studies on the Effects of Taxes on Economic Growth Source: McBride, William (2012) “What Is the Evidence on Taxes and Growth?” the Tax Foundation, Special Report No. 207, December 18; http://taxfoundation.org/article/what-­‐‑evidence-­‐‑taxes-­‐‑and-­‐‑growth

Karel Mertens and Morten Ravn, “The dynamic effects of personal and corporate income tax changes in the United States,” American Economic Review 103(4): 1212-­‐‑47 (2013).

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Examined: U.S. post-­‐‑World War II exogenous changes in personal and corporate income taxes.

Findings: A 1 percentage point cut in the average personal income tax rate raises real GDP per capita by 1.4 percent in the first quarter and by up to 1.8 percent after three quarters. A 1 percentage point cut in the average corporate income tax rate raises real GDP per capita by 0.4 percent in the first quarter and by 0.6 percent after one year.

Robert Barro and C.J. Redlick, “Macroeconomic Effects of Government Purchases and Taxes,” Quarterly Journal of Economics 51-­‐‑102 (2011).

Examined: U.S. (1912 to 2006) Findings: Cut in the average marginal tax rate of 1 percentage point raises next year’s per capita GDP by around 0.5 percent.

Christina Romer and David Romer, “The macroeconomic effects of tax changes: estimates based on a new measure of fiscal shocks,” American Economic Review 763-­‐‑801 (2010).

Examined: U.S. Post-­‐‑World War II (104 tax changes, 65 exogenous) Findings: Tax (federal revenue) increase of 1 percent of GDP leads to a fall in output of 3 percent after about 2 years, mostly through negative effects on investment.

Robert Reed, “The robust relationship between taxes and U.S. state income growth,” National Tax Journal 57-­‐‑80 (2008).

Examined: U.S. states (1970-­‐‑1999, 5-­‐‑year panels) Findings: Robust negative effect of state and local tax burden. Multi-­‐‑year panels mitigate misspecified lag effects, serial correlation, and measurement error.

N. Bania, J. A. Gray, and J. A. Stone, “Growth, taxes, and government expenditures: growth hills for U.S. states,” National Tax Journal 193-­‐‑204 (2007).

Examined: U.S. states Findings: Taxes directed towards public investments first add then subtract from GDP. Marc Tomljanovich, “The role of state fiscal policy in state economic growth,” Contemporary Economic Policy 318-­‐‑330 (2004).

Examined: U.S. states (1972 to 1998, multi-­‐‑year panels) Findings: Higher tax rates negatively affect short run growth, but not long run growth.

Olivier Blanchard and Robert Perotti, “An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output,” Quarterly Journal of Economics 1329-­‐‑1368 (2002).

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Examined: U.S. Post-­‐‑World War II (VAR/event study) Findings: Positive tax shocks, or unexpected increases in total revenue, negatively affect private investment and GDP. Howard Chernick, “Tax progressivity and state economic performance,” Economic Development Quarterly 249-­‐‑267 (1997).

Examined: U.S. states (1977 to 1993) Findings: Progressivity of income taxes negatively affects GDP growth.

John Mullen and Martin Williams, “Marginal tax rates and state economic growth,” Regional Science and Urban Economics 687-­‐‑705 (1994).

Examined: U.S. states (1969 to 1986) Findings: Higher marginal tax rates reduce GDP growth.

Jay Helms, “The effect of state and local taxes on economic growth: a time series-­‐‑cross section approach,” Review of Economics and Statistics 574-­‐‑582 (1985).

Examined: U.S. states (1965 to 1979) Findings: Revenue used to fund transfer payments retards growth.

The results from other academic and policy studies that have examined the relationship between taxes and economic activity substantiate the conclusion of McBride (2012), and are summarized below.

•

•

•

Prescott (2002):iv Edward Prescott, Nobel laureate, leverages a Growth Accounting framework to evaluate the impact from alternative tax rates on labor, capital, and technology on economic growth – tax policies impact the incentive to work, innovate, and accumulate capital. Countries whose tax policies discriminate against any of these factors of production discriminate against economic growth. Countries that impose significantly onerous tax policies (such as the labor taxes in France or the tax discrimination against productivity in Japan) risk “economic depressions.”

Mankiw and Weinzierl (2005): v Mankiw and Weinzierl found that because lower tax rates appreciably increased the economy’s rate of growth, tax cuts are partly self-­‐‑financing.

Ohanian, Raffo, and Rogerson (2008):vi Ohanian, Raffo, and Rogerson found that cross-­‐‑country differences in tax rates explain the majority of the changes in the average hours worked per adult in OECD countries.

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•

•

•

•

•

•

•

•

Barber and Odean (2003):vii Barber and Odean examine whether “individual investors consider taxes when making asset location decisions,” finding evidence that investors are sensitive to the tax implications of asset allocations.

Desai and Gentry (2003):viii Desai and Gentry investigate whether corporations respond to capital gains taxes, finding that capital gains’ taxes significantly influence companies’ investment and financing decisions, the allocation of capital across firms, the timing of corporate decisions, and corporate tax planning activities.

Viard (2009):ix Viard illustrates that when income is comprehensively measured, taxes have negative and significant impacts on economic growth.

Gruber and Saez (2002):x Gruber and Saez estimated that the elasticity of income to taxation for taxpayers with incomes above $100,000 is around -­‐‑0.6; the elasticity of income for taxpayers with lower incomes was estimated at approximately -­‐‑0.2.

Carroll (2009): xi Carrol estimated the economic costs created by income taxes or what is called the excess burden of the income tax (in this case the federal income tax), finding these costs to be very large – approximately 11 to 15 percent of total income tax revenues.

Becsi (1996): xii Becsi focused on whether state and local taxes affect relative state economic growth. Becsi found “…that relative marginal tax rates have a statistically significant negative relationship with relative state growth averaged for the period from 1961 to 1992.”xiii Poulson and Kaplan (2008): xiv Poulson and Kaplan directly examined the impact of higher average marginal state taxes on economic growth, finding “…that higher marginal tax rates had a negative impact on economic growth in the states. ... Furthermore, states that held the rate of growth in revenue below the rate of growth in income achieved higher rates of economic growth.” xv Dye (1999):xvi Dye examined the relative economic growth impacts on those states following the adoption of an income tax. Overall, Dye found “…strong econometric evidence that an income tax does indeed drive up the size of state government. Further, it has a significant adverse effect on the state’s economy.”xvii

•

12

Robbins and Robbins (1996):xviii Robbins and Robbins, through a series of papers, illustrates that there is an elastic response between taxes and capital accumulation; they estimate that the elasticity of savings was between 0.7 and

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

1.1. Consequently, Robbins and Robbins (1996) finds that tax reforms that reduced the disincentives to save would have a large and positive impact on economic growth.

Overwhelmingly, these studies find that high or rising taxes reduce economic growth, and low or declining taxes increase economic growth.xix Based on the results of these studies, it should be expected that phasing out Oklahoma’s personal income tax will increase Oklahoma’s economic growth rate. While the focus of this paper is to evaluate the impact on economic growth from phasing out the income tax, additional beneficial impacts arise from the proposal by imposing fiscal discipline on overall government spending.

While some government expenditures create a net benefit to Oklahoma even after the negative impacts from taxation are considered, this does not imply that all government expenditures create a net benefit. And, as the size and scope of Oklahoma’s government sector have increased, the net economic benefit taxpayers receive from the government has declined. There are several reasons why.

First, the additional value consumers receive from a good or service, any good or service, declines as the consumption of that good increases.xx Therefore, as the relative size of Oklahoma’s government has increased, the value taxpayers receive from those government services has decreased.

Second, as conglomerates in the private sector are consistently rediscovering, the effectiveness of an organization decreases as its scope expands beyond its core competencies. Oklahoma has expanded its operations into areas beyond its core competencies of producing public goods and services. The state’s effectiveness in providing these expanded goods and services is lower; consequently, the overall effectiveness of the government’s operations has declined.

Last, as anyone who has visited the local DMV can attest, the government sector does not face the same market pressures to consistently pursue productivity-enhancing innovations as the private sector. These muted incentives to innovate have reduced the value of government goods and services as well.

Several studies that have evaluated the economic impact from government expenditures have found that government spending does not stimulate growth, including: Landau (1983), Barro (1991), Gwartney, Lawson, and Holcombe (1998), Mitchell (2005), Scully (2006), Barro and Redlick (2011), Gemmell, Kneller, and Sanz (2011), and Young (2013).xxi As McBride (2013) summarizes, the empirical literature has found that government spending reduces economic growth because “most estimates of spending ‘multipliers’ are less than 1, meaning an additional dollar of government spending translates into something less than an additional dollar of GDP.”xxii

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Scully (2006) is worth emphasizing due to the fiscal discipline benefits from the proposal.

Scully evaluated the relative size of government taxation (therefore government expenditures) that would maximize the nation’s economic growth rate. The total size of government that Scully estimated included federal, state, and local taxes. Scully’s results illustrated: …that the growth-­‐‑maximizing tax rate for the United States over the 1960–1990 period was an estimated 19.3 percent of GDP. During that time, however, federal, state and local governments consumed a much higher percentage of GDP, and the economy grew more slowly than it would have at the growth-­‐‑maximizing level. For instance: •

•

At the mean tax rate of 30.7 percent, the growth rate predicted by the model was about equal to the observed mean GDP growth rate of 3.4 percent.

At the optimal tax rate of 19.3 percent of GDP in the Scully model, the growth rate would have been 6.97 percent per year.xxiii

For perspective, as of 2011 (the latest state and local tax burden data published by the Tax Foundation), the federal, state, and local tax burden in Oklahoma was 35.8 percent – more than 80 percent larger than the optimal tax rate estimated by Scully.xxiv The proposed phase-­‐‑out of Oklahoma’s income tax provides a mechanism to realign the size of Oklahoma’s government sector closer to a growth maximizing level.

A Review of Oklahoma’s Fiscal and Economic Trends A review of Oklahoma’s fiscal and economic performance reveals several important trends with respect to the proposed income tax phase-­‐‑out. When taken together, these trends confirm the findings from the academic and policy studies reviewed above – the proposed phase-­‐‑out of the personal income tax will benefit Oklahoma’s economy while providing sufficient resources for the state.

Total Expenditures in Oklahoma Are around All-Time highs Figure 2 presents Oklahoma’s total direct expenditures adjusted for inflation and the size of Oklahoma’s population between 1977 and 2012 as measured by the U.S. Census of Governments (the black solid line). The black dotted line presents the average growth in real expenditures over this time period. The data illustrate a consistent upward trend in the real resources the state of Oklahoma is commanding over time, even after population growth is considered.

Additionally, the data in Figure 2 illustrate a spike in inflation-­‐‑adjusted expenditures per capita following the 2001 recession. It is noteworthy that the new expenditure level became part of the government’s baseline, illustrating that upward surges in Oklahoma’s spending are never temporary. Instead, temporary spending increases find their way into Oklahoma’s permanent spending baseline.

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Figure 2 Total Direct Expenditures Per Capita Adjusted for Inflation xxv 1977 - 2012 $2,500.00

$2,000.00

$1,500.00

y = 35.503x + 741.37 R² = 0.89856

$1,000.00

$500.00

$0.00

Based on the trends illustrated in Figure 2, even if the proposed tax reform froze resources at their current levels, expenditures would remain around their current historic highs. And, including the dynamic impacts of the proposed tax reform, tax revenues will grow after adjusting for inflation and population growth. Therefore, the proposed phase-­‐‑out of Oklahoma’s personal income tax will allow expenditures to increase from their current levels.

Given the fact that expenditures are currently at historic highs, the proposal, which lowers the growth rate of revenues but still maintains growth rates above inflation and population growth, does not limit the ability of the state government to provide core government services.

Oklahoma’s Volatile Personal Income Tax According to the 2013 CAFR, total primary government expenditures in 2013 were $18.0 billion, or 60 percent higher than the 2004 total expenditures of $11.2 billion. However, the recession of 2008-­‐‑09, and changes in the personal income tax rate throughout this period, had important impacts on revenues, expenditures, and personal income growth. These trends are summarized in Table 1.

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Table 1 Growth in Taxes, Expenses, and Personal Income in Oklahoma xxvi 2004 - 2013

2004-­‐‑08 2008-­‐‑10 2010-­‐‑13 Income Taxes-­‐‑Individual 13.4% -­‐‑28.5% 45.0% Income Taxes-­‐‑Corporate 176.2% -­‐‑68.9% 247.0% Sales Tax 29.8% -­‐‑6.0% 27.4% Gross Production 70.0% -­‐‑37.0% -­‐‑27.0% Motor Vehicle 5.6% -­‐‑8.9% 24.6% Fuel Taxes 9.3% -­‐‑8.4% 6.3% Tobacco Taxes 348.3% -­‐‑1.1% 16.0% Insurance Taxes -­‐‑41.9% -­‐‑12.9% 65.6% Beverage Taxes 26.3% -­‐‑3.4% 25.9% Other Taxes 25.4% 71.4% -­‐‑24.4% TOTAL TAXES EXPENSES PERSONAL INCOME GROWTH

29.4% 31.8%

-­‐‑20.3% 14.5%

28.4% 5.9%

34.1%

-­‐‑2.3%

19.4%

Table 1 illustrates several noteworthy trends with respect to the proposal. Starting with the personal income tax, total personal income tax revenues grew slower than total taxes during the 2004-­‐‑08 period. As Figure 3 illustrates, the slower growth rate of personal income tax revenues between 2004 and 2008 was due to the legislated reductions in the top marginal personal income tax rate. Combining Table 1 with Figure 3, it is apparent that even as the top marginal personal income tax rate declined, the growing economy led to higher personal income tax revenues during the 2004-­‐‑08 period. Therefore, historically, a declining tax rate is consistent with rising personal income tax revenues year-­‐‑over-­‐‑year, with the caveat that personal income in the state is growing.

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Figure 3 Top Marginal Personal Income Tax Rate in Oklahoma 1977 - 2015

7.00%

6.75%

7.00% 6.25%

6.00% 5.50%

5.25%

Since 2008, the reductions in the personal income tax rate slowed significantly. As a result, the inherent volatility of the personal income tax as a revenue source becomes evident. The personal income tax exhibited significantly greater volatility in revenues since 2008 than overall tax revenues, and most other tax revenue sources. During the 2008-­‐‑09 recession, personal income tax revenues plummeted 28.5 percent; during the subsequent 2010-­‐‑13 recovery, personal income tax revenues surged 45 percent. Oklahoma’s corporate income tax, whose rates were not changed during this period, also exemplifies the revenue volatility problem income taxes create. Oklahoma’s corporate income tax exhibited even greater revenue volatility than the personal income tax throughout the entire 10-­‐‑year period. The inherent volatility of income tax sources makes budgeting more difficult compared to revenue sources that exhibit less volatility, and diminishes the value of these tax sources.

Table 1 also illustrates the relative revenue stability of Oklahoma’s sales tax revenues in comparison with income tax revenues. This result is consistent with a general consensus that sales taxes tend to exhibit less volatility due to the consumption tax base being more stable through the business cycle than the income tax base (see Felix, 2008 as an example).xxvii Changes in Oklahoma’s Personal Income Tax Rates and Oklahoma’s Relative Economic Performance Oklahoma’s economic performance responds to changes in its marginal personal income tax rate in a manner that is consistent with the literature cited above. Based on the literature, Oklahoma’s share of the national economy should be expected to increase following a reduction in its personal income tax rate, and decrease following an increase in its personal income tax rate. Figure 4 presents these data. The gray bars in Figure 4 illustrate Oklahoma’s top marginal THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

17

personal income tax rate. The lines represent three different measures of Oklahoma’s relative economic performance. The blue line shows Oklahoma’s share of total U.S. GDP, the red line shows Oklahoma’s share of total U.S. GDP excluding the oil sector, and the black line shows Oklahoma’s share of U.S. personal income.

Figure 4 Top Marginal Personal Income Tax Rate in Oklahoma Compared to Oklahoma’s Share of U.S. Personal Income and Oklahoma’s Share of U.S. GDP (Excl. the Oil and Gas Sector) xxviii 1977 - 2015 1.60%

7.00%

1.50%

6.75%

6.00%

6.25% 5.50%

1.40%

5.25%

1.30% 1.20% 1.10% 1.00% 0.90% 0.80%

Top PIT (LHS)

OK Non-­‐oil GDP Share U.S. (LHS*)

OK Share of U.S. PI (LHS)

OK Share U.S. GDP (LHS*)

* There is a discontinuity in the BEA’s state GDP data in 1997 due to the transition from the SIC industry classification scheme to the NAICS. This transition changes the measured level and growth rates of each state’s economy. The BEA, consequently, warns against comparisons across the different industry classification schemes. The solid lines are SIC-­‐based GDP data, the dotted lines are NAICS-­‐based GDP data.

Due to the importance and volatility of the oil and gas sector to Oklahoma’s economy, however, it is also important to account for changes in this sector. Figure 5 provides this perspective by presenting the inflation adjusted average price of regular gasoline on a monthly basis from January 1976 through November 2014. Figure 5 shows that gas prices, adjusted for inflation, surged in the late 1970s, early 2000s, and the 2010s. Due to Oklahoma’s position as a major oil producer, these price spikes should benefit Oklahoma’s economy.

18

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Figure 5 Monthly U.S. City Average Retail Price for Unleaded Regular Gasoline Adjusted for Inflation

January 1976 – November 2014

xxix

$5.00 $4.50 $4.00 $3.50 $3.00 $2.50 $2.00 $1.50 $1.00

Jul-­‐14

Jan-­‐11

Oct-­‐12

Jul-­‐07

Apr-­‐09

Jan-­‐04

Oct-­‐05

Jul-­‐00

Apr-­‐02

Jan-­‐97

Oct-­‐98

Jul-­‐93

Apr-­‐95

Oct-­‐91

Jan-­‐90

Apr-­‐88

Jul-­‐86

Oct-­‐84

Jan-­‐83

Apr-­‐81

Jul-­‐79

Oct-­‐77

$0.00

Jan-­‐76

$0.50

Several important trends are illustrated in Figures 4 and 5. In response to the gasoline price spikes of the late 1970s early 1980s, Oklahoma’s share of the U.S. economy soared as measured in Figure 4 by Oklahoma’s share of national GDP, Oklahoma’s share of national GDP excluding the oil and gas sector, and Oklahoma’s share of U.S. personal income. As oil prices receded during the mid-­‐‑1980s, Oklahoma’s share of the national economy receded in step as measured by all three economic measures.

Following the increase in Oklahoma’s top marginal personal income tax rate in 1991, Oklahoma’s share of the national economy continued to decline. Gasoline prices were relatively stable during this time period, however. Therefore, changes in gasoline prices are an unlikely explanation for Oklahoma’s continued relative economic decline. On the other hand, as evidenced by the above literature review, the expected economic consequence from raising the personal income tax rate is diminished relative economic performance.

Beginning in the early 2000s Oklahoma began a period of sustained reductions in its marginal personal income tax rate and gasoline prices began a period of sustained growth.

Corresponding with both of these positive economic trends for Oklahoma, Oklahoma’s share of the national economy began growing again.

Summarizing these trends, over the 1977-­‐‑2013 time period, rising gas prices and lower marginal income tax rates were associated with Oklahoma’s economy growing faster than the national average. Declining gas prices and rising marginal income tax rates were associated with Oklahoma’s economy growing slower than the national average. These experiences also THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

19

illustrate the sensitivity of Oklahoma’s economy to the volatile oil and gas industry. While the oil industry provides great benefits to the state, greater diversification of Oklahoma’s economy will help the state manage the volatility inherent in this sector.

A Larger Economy Also Grows Government Revenues Governments can increase their tax revenues in two ways. One method is to raise taxes to try to take a bigger slice of the economic pie. The other method is to promote policies that grow the entire economic pie. Oklahoma’s experience illustrates that, when the entire economic pie is growing, there is a positive feedback effect on overall tax revenues – also referred to as dynamic revenue impacts.

Specifically, the growth in total inflation-­‐‑adjusted tax collections per capita is correlated with the growth in inflation-­‐‑adjusted personal income per capita (see Figure 6). The solid black line in Figure 6 shows the annual percent change in total inflation adjusted tax collections per capita in Oklahoma. The black dotted line shows the same metric for total sales tax collections. The red dotted line presents the annual percent change in inflation adjusted per capita personal income in Oklahoma.

While discrepancies occur, and the magnitudes differ, changes in tax collections are correlated with changes in personal income – as income grows, tax revenues grow; as income declines, tax revenues decline. This connection confirms the common sense notion that the government must rely upon a health private sector to fund its operations. Therefore, when the private sector is thriving, the government’s revenues benefit from the prosperity. Alternatively, when the private sector is poorer, there are less resources available to fund the government’s operations.

20

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Figure 6 Percent Change in Total Tax Revenue Per Capita Adjusted for Inflation and Percent Change in General Sales Tax Revenue Per Capita Adjusted for Inflation Compared to Percent Change in Personal Income Per Capita Adjusted for Inflation 1978 - 2013

xxx

40% 30% 20% 10% 0% -­‐10% -­‐20% -­‐30%

Change Real Tax Revenues per Capita Change Real Sales Tax Revenues per Capita

Change Real PI per Capita

There is a historical connection between changes in Oklahoma’s marginal personal income tax rate and economic growth. Therefore, reductions in marginal income tax rates that raise Oklahoma’s rate of personal income growth should be expected to increase the dollar amount of tax collections from other tax sources. The increase in other tax revenues will not fully offset the lower tax revenues generated from a reduction in the marginal income tax rate. But, as Mankiw and Weinzierl (2005) argue, the beneficial increase in economic activity that results from a reduction in marginal tax rates will cause tax revenues from other tax sources to partially offset the static revenue loss.xxxi Importantly, these increased tax revenues occur not because of a higher tax burden on the private sector, but because the private sector is wealthier and better positioned to afford these costs.

Summarizing Oklahoma’s Historical Experience The relative size of Oklahoma’s government is around historical highs. Consequently, even if the revenue impact from phasing out the state’s personal income tax reduced government revenues from their current levels, the state would retain the ability to provide valued services.

And, as demonstrated in the next three sections, the proposed tax reform will increase revenues from today’s levels even after adjusting for inflation and population growth. But, the reason to phase out the income tax is not to help the government sector, it is to help grow the economy.

Oklahoma’s own experience with changes to the personal income tax rate illustrates that the state’s relative economic growth rate improves when tax rates are cut and worsens when tax THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

21

rates are increased. Furthermore, growth in personal income and growth in tax revenues are correlated. Consequently, the government sector will also benefit from the acceleration in growth encouraged by the phasing out of Oklahoma’s personal income tax.

A Static Revenue Analysis of the Income Tax Phase-Out Before accounting for any dynamic revenue impacts, a static revenue analysis provides an important starting point for assessing the revenue implications of the tax phase-­‐‑out proposal.

In order to create a static analysis, the analysis begins by creating a tax revenue baseline. Total tax revenues excluding income tax revenues in 2013 were $5.5 billion.xxxii These revenues were assumed to grow at their inflation-­‐‑adjusted compound annual growth rate over the past 10 years (2.8 percent) throughout the forecast period, see Table 2.xxxiii Total income tax revenues were $2.9 billion in 2013.xxxiv In order to accommodate the phasing out of the income tax, the growth in the baseline revenues for the income tax was calculated differently. First, revenues per percentage point of the income tax were calculated, which was $543.9 million in 2013.xxxv By construct, multiplying the top income tax rate, or 5.25 in 2013, by the tax revenues per percentage point of the income tax in 2013 equals the total income tax revenues in 2013.

Income tax revenue growth was then based on two parts: growth in the income tax revenues per percentage point of the top income tax rate, and the applicable top income tax rate.

Revenues per percentage point of the top income tax rate were assumed to grow at its inflation-­‐‑ adjusted compound annual growth rate over the past 10 years (3.2 percent). The tax rates in the baseline assumes that the scheduled reduction in the top personal income tax rate to 5.0 percent in 2016 occurs, and then holds steady throughout the forecast period; see Table 2.xxxvi Total tax revenues, which were $8.4 billion in 2013, was simply the addition of income tax revenues and all other tax revenues; see Table 2.xxxvii

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Table 2 Baseline Revenue and Personal Income Tax (PIT) Rate Assumptions 2013 – 2036 (in 2013 $)

Total Tax Revenues Minus PIT Revenues

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036

$5,514,979,000 $5,790,547,000 $5,590,547,000 $5,730,310,675 $6,158,352,088 $6,330,597,151 $6,507,659,794 $6,689,674,764 $6,876,780,572 $7,069,119,607 $7,266,838,239 $7,470,086,930 $7,679,020,355 $7,893,797,509 $8,114,581,840 $8,341,541,364 $8,574,848,796 $8,814,681,683 $9,061,222,540 $9,314,658,982 $9,575,183,874 $9,842,995,477 $10,118,297,594 $10,401,299,731

PIT Tax Rate 5.25% 5.25% 5.25% 5.25% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%

Income tax per top rate

PIT Revenues

Total Tax Revenues

$543,906,476 $543,924,000 $505,828,762 $518,474,481 $617,871,187 $637,883,504 $658,544,004 $679,873,679 $701,894,204 $724,627,955 $748,098,033 $772,328,287 $797,343,337 $823,168,604 $849,830,329 $877,355,604 $905,772,399 $935,109,590 $965,396,988 $996,665,368 $1,028,946,504 $1,062,273,199 $1,096,679,316 $1,132,199,818

$2,855,509,000 $2,855,601,000 $2,655,601,000 $2,721,991,025 $3,089,355,933 $3,189,417,522 $3,292,720,019 $3,399,368,395 $3,509,471,021 $3,623,139,777 $3,740,490,166 $3,861,641,433 $3,986,716,686 $4,115,843,020 $4,249,151,644 $4,386,778,020 $4,528,861,997 $4,675,547,952 $4,826,984,939 $4,983,326,840 $5,144,732,521 $5,311,365,993 $5,483,396,581 $5,660,999,092

$8,370,488,000 $8,646,148,000 $8,246,148,000 $8,452,301,700 $9,247,708,022 $9,520,014,672 $9,800,379,813 $10,089,043,159 $10,386,251,593 $10,692,259,384 $11,007,328,405 $11,331,728,364 $11,665,737,041 $12,009,640,529 $12,363,733,484 $12,728,319,384 $13,103,710,793 $13,490,229,635 $13,888,207,478 $14,297,985,821 $14,719,916,395 $15,154,361,470 $15,601,694,176 $16,062,298,823

Table 2 illustrates that if the inflation-­‐‑adjusted average growth in revenues over the past decade were to persist through 2036, then total tax revenues in Oklahoma (adjusted for inflation) will grow 2.9% a year, reaching $16.1 billion in the year 2036 – nearly double the expected revenues in 2015.

The static revenue analysis then repeats the procedures for estimating the baseline total tax revenues through 2036, the only difference being that the personal income tax rate is gradually reduced by 0.25 percentage points a year until it is completely phased out in 2036. These results, presented in Table 3, are the estimated static revenues raised, including the impact of the proposed income tax phase-­‐‑out.

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

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Table 3 Static Revenue Estimates and Personal Income Tax (PIT) Rate Assumptions From Proposal to Phase-Out Oklahoma’s Personal Income Tax 2013 – 2036 (in 2013 $)

Total Tax Revenues Minus PIT Revenues

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036

$5,514,979,000 $5,790,547,000 $5,590,547,000 $5,730,310,675 $6,158,352,088 $6,330,597,151 $6,507,659,794 $6,689,674,764 $6,876,780,572 $7,069,119,607 $7,266,838,239 $7,470,086,930 $7,679,020,355 $7,893,797,509 $8,114,581,840 $8,341,541,364 $8,574,848,796 $8,814,681,683 $9,061,222,540 $9,314,658,982 $9,575,183,874 $9,842,995,477 $10,118,297,594 $10,401,299,731

PIT Tax Rate 5.25% 5.25% 5.25% 5.25% 4.75% 4.50% 4.25% 4.00% 3.75% 3.50% 3.25% 3.00% 2.75% 2.50% 2.25% 2.00% 1.75% 1.50% 1.25% 1.00% 0.75% 0.50% 0.25% 0.00%

Income tax per top rate

PIT Revenues

Total Tax Revenues

$543,906,476 $543,924,000 $505,828,762 $518,474,481 $617,871,187 $637,883,504 $658,544,004 $679,873,679 $701,894,204 $724,627,955 $748,098,033 $772,328,287 $797,343,337 $823,168,604 $849,830,329 $877,355,604 $905,772,399 $935,109,590 $965,396,988 $996,665,368 $1,028,946,504 $1,062,273,199 $1,096,679,316 $1,132,199,818

$2,855,509,000 $2,855,601,000 $2,655,601,000 $2,721,991,025 $2,934,888,137 $2,870,475,769 $2,798,812,016 $2,719,494,716 $2,632,103,266 $2,536,197,844 $2,431,318,608 $2,316,984,860 $2,192,694,178 $2,057,921,510 $1,912,118,240 $1,754,711,208 $1,585,101,699 $1,402,664,386 $1,206,746,235 $996,665,368 $771,709,878 $531,136,599 $274,169,829 $0

$8,370,488,000 $8,646,148,000 $8,246,148,000 $8,452,301,700 $9,093,240,225 $9,201,072,920 $9,306,471,810 $9,409,169,480 $9,508,883,838 $9,605,317,451 $9,698,156,847 $9,787,071,791 $9,871,714,532 $9,951,719,019 $10,026,700,080 $10,096,252,572 $10,159,950,495 $10,217,346,069 $10,267,968,774 $10,311,324,349 $10,346,893,752 $10,374,132,076 $10,392,467,423 $10,401,299,731

Table 3 illustrates that, even on a static basis, total inflation-­‐‑adjusted revenues in Oklahoma would grow throughout the entire period when the income tax is being phased out. The growth, which is 0.8 percent per year, is significantly lower than the baseline scenario, where inflation-­‐‑adjusted revenues grew 2.9 percent per year.

This static revenue analysis is not the full story. Static tax analyses rely on an unrealistic assumption – that changes in tax policies do not change economic behavior. As illustrated above, when Oklahoma’s economic growth rate accelerates, the revenues collected by the state government is higher than static estimates indicate, partially replacing some of the lost revenues from the proposed tax rate reductions on a static basis. The static analysis does create a lower-­‐‑ bound estimate of the revenue impact from the proposal on Oklahoma’s state tax revenues, however.

24

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Estimating the Economic Impacts The primary reason for phasing out the personal income tax in Oklahoma is to accelerate economic growth in the state. The literature cited above, along with Oklahoma’s historical experience, indicates that the proposed income tax phase-­‐‑out should increase Oklahoma’s underlying economic growth rate.

To estimate the potential economic impacts from the proposed income tax phase-­‐‑out, the econometric model developed by Koester and Kormendi (1989) (the K&K model), and used by Becsi (1996) and Poulson and Kaplan (2008), referenced above, was applied. xxxviii The K&K model was chosen because it directly examines the impact from changes in marginal tax rates at the state level. The K&K model performs a regression analysis on state income tax revenues and state personal income to estimate each state’s marginal tax rate. The estimated marginal tax rates can then be used to evaluate the relationship between a state’s marginal tax rate and its economic growth rate.

As part of the specification for this analysis, variables were included that controlled for other influences on relative state economic performance including: regional economic performance; whether the state imposes an income tax (excluding states that tax dividends and interest); and, income convergence across the states (the theory that because the U.S. is one open economy, the wealth across state economies should be similar). The variables were expressed as log differences from their national averages. Due to the discontinuity of state GDP data in 1997, growth in state personal income is used to measure economic growth in each state.xxxix The specific equation examined was: RG = c + b1RMTR + b2PIT + b3GLP + b4W + b5PCPI1977; where, c is a constant term, and, b1, b2, b3,b4, and b5 are coefficients on the independent variables. RG is each state’s relative personal income growth rate difference from the national average between 1977 and 2012; RMTR is the relative marginal tax rate estimated for each state between 1977 and 2012 using the Koester and Kormendi (1989) methodology; PIT is a dummy variable that denotes whether the state levies a personal income tax on labor income, dividends, and interest income; GLP is a dummy variable that denotes whether the state is in the Great Lakes or Plains region as categorized by the Bureau of Economic Analysis; W is a dummy variable that denotes whether a state is in the Western region as categorized by the Bureau of Economic Analysis; and PCPI1977 is each state’s relative per capita personal income in 1977 (to control for the impacts of income convergence). Based on this specification, the results from the regression analyses are summarized in Table 4.

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

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Table 4 Static Revenue Estimates and Personal Income Tax (PIT) Rate Assumptions From Proposal to Phase-Out Oklahoma’s Personal Income Tax

C

MTR

PIT_DI

REG_GLP

REG_W

PCPI1977

R2

1 -­‐‑2.8391 (0.0154) -­‐‑0.1254 (0.0576)

0.0708

Coefficient (Std. Error) 2 3 -­‐‑2.7407 -­‐‑2.7730 (0.0376) (0.0393) -­‐‑0.1202 -­‐‑0.1312 (0.0539) (0.0458) -­‐‑0.1147 -­‐‑0.0737 (0.0405) (0.0369)

-­‐‑0.0891

(0.0300)

0.0636

(0.0300)

0.1896 0.4195

4 -­‐‑2.7711 (0.0390) -­‐‑0.1164 (0.0469) -­‐‑0.0878 (0.0382) -­‐‑0.0820 (0.0302) 0.0724 (0.0305) -­‐‑0.1167 (0.0897) 0.4283

The results show that states that impose higher marginal income tax rates experience slower relative economic growth – results that are consistent with Oklahoma’s past experiences. These results are also consistent with the findings of Koester and Kormendi (1989), Becsi (1996), and Poulson and Kaplan (2008).

Phasing out the personal income tax in Oklahoma reduces the estimated state marginal tax rate, and, in so doing, will accelerate income growth in the state. The change in Oklahoma’s marginal tax rate was estimated based on the expected impact on revenues, and the declining sensitivity of tax revenues to changes in income due to the phasing out of Oklahoma’s personal income tax. This sensitivity grows over time as the top marginal personal income tax rate continues to decline. However, initially, the growth impacts are more muted due to the smaller impacts on the state’s marginal tax rate.

The growth impacts from phasing out the personal income tax are evaluated against a baseline scenario that assumes inflation-­‐‑adjusted personal income grows at its average rate between 2003 and 2012 of 3.0 percent. The proposed tax phase-­‐‑out increases the annual rate of growth in Oklahoma, thereby increasing total economic activity in the state. The growth in personal income in Oklahoma due to the tax phase-­‐‑out proposal relative to the baseline scenario is illustrated in Figure 7.

26

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Figure 7 Increase in Oklahoma’s Inflation Adjusted Personal Income Due to Proposed Income Tax Phase-out Compared to Baseline Inflation-Adjusted Personal Income Growth 2017– 2036 $35.11

$28.21 $23.97 $20.16 $16.78 $13.84 $11.31 $9.14

$0.04 $0.14 $0.30 $0.53

$1.84 $0.85 $1.28

$2.54

$3.40

$4.47

$5.75

$7.30

2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036

Figure 7 illustrates that in 2017 (the first year the tax phase-­‐‑out is assumed to occur), personal income growth, and the level of total personal income relative to the baseline scenario, would be only marginally higher. Overall, personal income in Oklahoma would be expected to be $40 million higher in 2017 compared to the baseline scenario. The growth differential expands, such that within 5 years, total personal income would be 0.4 percent (or $850 million) higher than the baseline scenario; within 10 years, total personal income would be 1.9 percent (or $4.5 billion) higher than the baseline scenario; and, within 20 years, when the personal income tax is completely phased out, total personal income would be 11.1 percent (or $35.1 billion) higher than the baseline scenario. The overall path of personal income growth under the baseline and tax phase-­‐‑in scenarios can be seen in Figure 8.

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

27

Billions

Figure 8 Oklahoma’s Inflation-Adjusted Personal Income Due to Proposed Income Tax Phase-out Compared to Baseline Inflation-Adjusted Personal Income Growth 2017– 2036 $400 $350 $300 $250 $200

Personal Income including Income Tax Phase-­‐out

2036

2035

2034

2033

2032

2031

2029

2030

2028

2027

2026

2025

2024

2023

2022

2021

2019

2020

2018

$100

2017

$150

Baseline Personal Income

Importantly, by 2036 the annual rate of real personal income growth would be 1.8 percentage points higher than the baseline scenario. Consequently, the economic dividends would compound as Oklahoma’s economy would then continually grow faster than it would have otherwise due to the phase-­‐‑out proposal.

Economic growth and employment growth are closely related. A growing economy will naturally create more jobs than a stagnant economy. As discussed above, the health of the oil and gas sector is also critical to the health of Oklahoma’s employment market. Accounting for both future growth in the U.S. oil and gas sector and the increased growth in personal income due to the tax proposal compared to the baseline scenario, Oklahoma’s economy would add an additional 111 thousand jobs by 2036 compared to the baseline scenario – or an employment market that is 3.5 percent larger than the baseline scenario; see Figure 9.xl As the employment gains are based on the growth in the economy, a similar phase-­‐‑in of the employment benefits is evident in Figure 9.

28

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Figure 9 Percentage Increase in Oklahoma’s Total Employment Compared to Baseline Scenario Due to Proposed Income Tax Phase-Out 2017– 2036 3.51%

2.92% 2.57% 2.23% 1.92% 1.63% 1.38% 1.15% 0.95% 0.77% 0.62% 0.48% 0.37% 0.28% 0.20% 0.14% 0.09% 0.01% 0.02% 0.05%

2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036

The estimated economic impacts are consistent with both the vast economic literature cited earlier and Oklahoma’s own experience. Reducing Oklahoma’s marginal personal income tax rate will raise Oklahoma’s rate of economic growth, and these growth impacts compound over time. Due to the phase-­‐‑in of the tax rate reductions, there is no year-­‐‑over-­‐‑year decline in inflation-­‐‑adjusted government revenues on a static basis. However, the cost of the gradual phase-­‐‑in is to lower the near-­‐‑term economic benefits.

The government revenues that were estimated on a static basis do not incorporate the economic benefits from the proposal. When these economic considerations are incorporated, the year-­‐‑ over-­‐‑year inflation-­‐‑adjusted revenue gains are larger. The potential dynamic revenue impacts are illustrated in the next section.

A Dynamic Analysis of the Impact on Oklahoma’s Tax Revenue Incorporating the proposal’s beneficial economic growth impacts provides a more comprehensive, or dynamic, estimate of the expected tax revenues the state will raise during the period when the state’s income tax system is being phased out. A comparison of the dynamic revenue estimates to the baseline estimates is summarized in Figures 10 and 11. All state revenue figures are adjusted for inflation.

Figure 10 compares the estimated total inflation-­‐‑adjusted tax revenues under the proposed income tax phase-­‐‑out scenario over the 20-­‐‑year implementation schedule to the estimated tax revenues under the baseline scenario. Under the baseline scenario, real tax revenues are

THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

29

projected to grow 2.9 percent per year. By 2036, total government tax revenues would be $16.1 billion, or 91.9 percent larger than total tax revenues in 2013.

In comparison, if the proposed income tax phase-­‐‑out were implemented, then inflation-­‐‑adjusted government tax revenues are expected to grow 1.3 percent per year. By 2036, total government tax revenues would be $11.6 billion, or 38.0 percent larger than total tax revenues in 2013.

Figure 10

Billions

Total Inflation-Adjusted Tax Revenues under the Proposed Income Tax Phase-Out Compared to the Total Inflation-Adjusted Tax Revenues under the Baseline 2017– 2036 $18.0 $16.0 $14.0 $12.0 $10.0

2036

2035

2034

2033

2031

2032

2029

2030

2028

2027

2026

2025

2024

2023

2022

2021

2019

2020

2018

$6.0

2017

$8.0

Total Inflabon Adjusted Tax Revenues Phase-­‐out Scenario incl. Economic Growth Impacts Total Inflabon Adjusted Tax Revenues Baseline Scenario

Starting in 2036, total tax revenues will solely reflect the growth in Oklahoma’s other tax sources excluding income taxes. These other tax sources will be growing faster than the growth in total tax revenues. As a consequence, once the income tax has been fully phased out by 2036, the growth in Oklahoma’s inflation-­‐‑adjusted total tax revenues will be faster than the 1.3 percent average growth rate during the 2017-­‐‑2036 period.

Figure 11 adjusts the inflation-­‐‑adjusted government tax revenues for population growth. Per capita government tax revenues, adjusted for inflation, would grow 1.9 percent per year under the baseline scenario, compared to 0.3 percent per year if the proposed income tax phase-­‐‑out were implemented. Therefore, in 2036, total inflation-­‐‑adjusted tax revenues per capita under the baseline scenario, would grow from the current $2,174 to $3,357. Under the proposed tax phase-­‐‑out scenario, total inflation-­‐‑adjusted tax revenues per capita would grow to $2,415 in 2036, compared to $2,174 in 2013. The per capita tax burden, adjusted for inflation, under the baseline scenario would be 39.0 percent larger than the same burden under the proposed income tax phase-­‐‑out scenario.

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

Figure 11 Total Inflation-Adjusted Tax Revenues Per Capita under the Proposed Income Tax Phase-out Compared to the Total Inflation-Adjusted Tax Revenues Per Capita under the Baseline Scenario 2017– 2036 $3,600 $3,400 $3,200 $3,000 $2,800 $2,600 $2,400 $2,200 $2,000

Total Inflabon Adjusted Tax Revenues per capita Phase-­‐out Scenario incl. Economic Growth Impacts Total Inflaton Adjusted Tax Revenues per capita Baseline Scenario

Figures 10 and 11 illustrate that once the dynamic economic impacts are included, the real tax resources available to the government of Oklahoma will increase throughout the implementation of the income tax phase-­‐‑out. The growth in real resources will be significantly lower than the revenue growth expectations that would occur under the baseline scenario.

However, given that total expenditures per capita are around all-­‐‑time highs (see Figure 2), there is a strong argument to be made that greater fiscal discipline is beneficial.

The acceleration in personal income growth will also increase local revenue sources, on a dynamic basis, in addition to the beneficial impact on state revenues. Based on total local government revenues as reported by the U.S. Census of Governments, the median (average) total tax revenues of Oklahoma’s local governments between 2004 and 2012 was 2.92 percent.xli To get a sense of the benefit local governments would receive from the income tax phase-­‐‑out, a baseline of total local tax revenues was estimated based on the estimated, baseline level of personal income in Oklahoma, and the average local tax revenues share of personal income.

The proposed income tax phase-­‐‑out increases the size of Oklahoma’s personal income levels throughout the entire income tax phase-­‐‑out period. Consequently, the expected revenues under the proposed income tax phase-­‐‑out if local government tax revenues remained 2.92 percent of personal income will be higher. This difference is presented in Figure 12.

Figure 12 exhibits the same growth pattern as the change in personal income and employment.

The increase in local revenues is initially small (a $1.2 million increase in 2017), but grows over time such that by 2036 total local government tax revenues would be $1.0 billion higher than the

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baseline scenario. Figure 12 illustrates that local government revenues will benefit significantly from the increase in personal income created by the phase-­‐‑out of the state personal income tax.

Millions

Figure 12 Increase in Inflation-Adjusted Local Tax Revenues Due to the Proposed Income Tax Phase-Out Compared to Inflation-Adjusted Local Tax Revenues under the Baseline Scenario 2017– 2036

$1,025.3

$823.9 $700.0 $588.7 $490.2 $404.3 $330.2 $266.8 $213.2 $168.0 $130.4 $99.4 $74.0 $37.5 $53.6 $24.9 $15.5 $8.6 $1.2 $4.0

Conclusion The purpose of this paper was to evaluate the economic and fiscal implications of a pro-­‐‑growth tax reform – phasing out Oklahoma’s personal income tax over a 20-­‐‑year period. The economics literature, Oklahoma’s historical experience, and the results of an analysis based on the K&K model all indicate that the proposal will increase the state’s rate of income growth and increase total government revenues on a year-­‐‑over-­‐‑year basis – compared to the baseline growth in state revenues, the proposal imposes significant fiscal discipline on the state.

Reducing Oklahoma’s personal income tax improves the incentives to work, produce, and invest in the state. The result is greater economic activity, higher incomes, and greater employment growth in Oklahoma compared to what would have otherwise occurred. Based on the economic impacts estimated in this paper, total income in Oklahoma will be 11.1 percent larger (or $35.1 billion) by 2036 compared to the baseline scenario. And, that additional income growth should also translate into more jobs – an additional 111 thousand jobs.

This is the raison d'ʹetre for phasing out Oklahoma’s personal income tax. It makes Oklahoma a more economically competitive state for business, and it provides tax predictability for workers,

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small businesses, and investors. The tax reform will also strengthen the non-­‐‑oil sectors of Oklahoma’s economy, helping the state further diversify its economic base.

Phasing out the income tax, as opposed to eliminating the tax all at once, lessens the short-­‐‑term revenue impacts on the government. In the case of the current proposal to start phasing the income tax out in 2017 by 0.25 percentage points a year, tax revenues of the Oklahoma state government will continually grow on a year-­‐‑over-­‐‑year basis – adjusting for inflation and population growth, total tax revenues increase 0.3 percent per year. In other words, as Oklahoma’s current income tax is being phased out, the real resources available to the state government will increase.

While the real resources grow, the growth rate is constrained relative to the current trends. As a consequence, the proposal should be combined with effective budget reform in order to establish a more fiscally responsible budget. On net, the proposal to phase out Oklahoma’s personal income tax promotes a stronger economy and ensures that the state has enough resources to finance important government services it needs to provide.

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Endnotes

Murphy, Sean (2014) “Oklahoma Supreme Court says income tax cut is OK” the Washington Times, December 2; http://www.washingtontimes.com/news/2014/dec/2/oklahoma-­‐‑supreme-­‐‑court-­‐‑says-­‐‑income-­‐‑tax-­‐‑cut-­‐‑is-­‐‑ok/?page=all. i

The baseline tax revenues are based on the assumption that without any changes in Oklahoma’s personal income tax, that revenues will grow at the average growth rate in tax revenues over the past 10 years. ii

McBride, William (2012) “What Is the Evidence on Taxes and Growth?” the Tax Foundation, Special Report No. 207, December 18; http://taxfoundation.org/article/what-­‐‑evidence-­‐‑taxes-­‐‑and-­‐‑growth. iii

Prescott, Edward C. (2002) “Prosperity and Depression: 2002 Richard T. Ely Lecture” Federal Reserve Bank of Minneapolis Research Department, Working Paper 618, January; and, Kehoe, Timothy J., and Prescott, Edward C. “Great Depressions of the Twentieth Century” Federal Reserve Bank of Minneapolis Research Department. iv

Mankiw, Gregory N., and Weinzierl, Mathew (2005) “Dynamic Scoring: A Back-­‐‑of-­‐‑the-­‐‑Envelope Guide” Working Paper, Revised: April 7, 2005. v

Ohanian, L., Raffo, A., and Rogerson, R. (2008), “Long-­‐‑Term Changes in Labor Supply and Taxes: Evidence from OECD Countries, 1956-­‐‑2004.” Journal of Monetary Economics, 55(8): 1353-­‐‑1362. vi

Barbera, Brad M., and Odean, Terrance (2003) “Are individual investors tax savvy? Evidence from retail and discount brokerage accounts” Journal of Public Economics 1 (2003) 000 –000. vii

Desai, Mihir A., and Gentry, William M. (2003) “The Character and Determinants of Corporate Capital Gains” Working Paper prepared for the Tax Policy and the Economy Conference. viii

Viard, Alan D. (2009) “The Case Against the Millionaire Surtax” Tax Notes, December 21; http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2218513##. ix

Gruber, Jonathan, and Saez, Emmanuel (2002) “The Elasticity of Taxable Income: Evidence and Implications” Journal of Public Economics, Vol. 84, pp. 1-­‐‑32. x

Carroll, Robert (2009) “The Excess Burden of Taxes and the Economic Cost of High Tax Rates” Tax Foundation Special Report, #170, August. xi

xii

Becsi, Zsolt (1996) “Do State and Local Taxes Affect Relative State Growth?” Economic Review, March/April.

xiii

Ibid.

Poulson, Barry W., and Kaplan, Jules Gordon (2008) “State Income Taxes and Economic Growth” Cato Journal, Vol. 28 No.1. xiv

xv

Ibid.

Dye, Thomas R. (1999) “The Economic Impact of the Adoption of a State Income Tax in New Hampshire” Heartland Institute, October 1; http://heartland.org/policy-­‐‑documents/economic-­‐‑impact-­‐‑adoption-­‐‑state-­‐‑income-­‐‑tax-­‐‑new-­‐‑ hampshire. xvi

xvii

Ibid.

Robbins, Gary, and Robbins, Aldona (1996) “Accounting for Growth” Institute for Policy Innovation, Policy Report 138; Robbins, Gary, and Robbins, Aldona “Eating Out our Substance: How Taxation Affects Saving” TaxAction Analysis, Policy Report #131; Robbins Gary and Robbins Aldona “Eating Out Our Substance II: How Taxation Affects Investment” TaxAction Analysis, Policy Report 134. For an early estimate of the dynamic impact from labor supply response see: Boskin, M. (1973) “The Economics of the Labor Supply” in Cian, Glen G., and Watts, Harold W., eds., xviii

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Income Maintenance and Labor Supply., Chicago: Rand McNally. Boskin also examined the dynamic impact with respect to capital and savings in: Boskin, M. (1978) “Taxation, Saving and the Rate of Interest” Journal of Political Economy Volume 86, April 1978 pp. S3 – S28.

There are some groups that will disagree with this consensus. For an excellent rebuttal of these groups see: Fruits, Eric, and Pozdena, Randall (2013) “Tax Myths Debunked” ALEC; http://www.alec.org/docs/Tax_Myths.pdf.

According to Fruits and Pozdena, the purpose of their report is to “identify the dangerous fallacies that are promulgated by progressive advocates for [a] return to high tax rate policies and [a] greater reliance on government sector activity and control.” These fallacies include: increased government spending stimulates the economy during recessions; lower tax rates are bad for the economy in a recession; raising tax rates will not harm economic growth; austerity in the form of spending cuts will harm growth and employment; real household income has not grown in the past 20 years; the distribution of income is increasingly inequitable; and, raising tax rates on the rich will not harm the economy. xix

To illustrate this concept, the typical classroom example evaluates the utility (or happiness) a consumer receives from consuming a good such as hamburgers. The first hamburger a consumer eats provides a great deal of happiness. However, because he consumed the first hamburger, the second hamburger will provide less happiness, the third even less value. Eventually, if the consumer keeps eating hamburgers, there comes a point where more consumption actually reduces his happiness. What is true for hamburgers, is true for all other goods and services – they exhibit diminishing marginal value. The same economic valuation process occurs for public goods. xx

Landau, Daniel L. (1983) “Government Expenditure and Economic Growth: A Cross-­‐‑Country Study” Southern Economic Journal, 49: January; Robert J. Barro (1991) “Economic Growth in a Cross Section of Countries,” Quarterly Journal of Economics, Vol. 106, No. 2 May; Gwartney, James, Lawson, Robert, and Holcombe, Randall (1998) “The Size and Functions of Government and Economic Growth” Joint Economic Committee, U.S. Congress, April; Mitchell, Daniel J. (2005) “The Impact of Government Spending on Economic Growth” Heritage Foundation, Backgrounder #1831, March 15; Scully, Gerald W. (2006) “Taxes and Economic Growth” National Center for Policy Analysis, NCPA Policy Report No. 292, November; Barro, Robert, and Redlick, C.J. (2011) “Macroeconomic Effects of Government Purchases and Taxes” Quarterly Journal of Economics 51-­‐‑102; Gemmell, Norman, Kneller, Richard, and Sanz, Ismael (2011) “The Timing and Persistence of Fiscal Policy Impacts on Growth: Evidence from OECD Countries” Economic Journal F33-­‐‑ F58; and, Young, Andrew (2013) “Why in the World Are We All Keynesians Again? The Flimsy Case for Stimulus Spending” Cato Policy Analysis No. 721, February 14. xxi

McBride, William (2013) “Economic Effects of the Sequester and the Proposed Alternatives: What is the Evidence on Spending and Economic Growth?” Tax Foundation Fiscal Fact No. 363, March 4; http://taxfoundation.org/article/economic-­‐‑effects-­‐‑sequester-­‐‑and-­‐‑proposed-­‐‑alternatives-­‐‑what-­‐‑evidence-­‐‑spending-­‐‑and-­‐‑ economic-­‐‑growth#_ftn10. xxii

Scully, Gerald W. (2006) “Taxes and Economic Growth” National Center for Policy Analysis, NCPA Policy Report No. 292. xxiii

The state and local tax burden estimated by the Tax Foundation is available at: http://taxfoundation.org/article/annual-­‐‑state-­‐‑local-­‐‑tax-­‐‑burden-­‐‑ranking-­‐‑fy-­‐‑2011. The federal tax burden is estimated by dividing 2011 total outlays from (http://www.whitehouse.gov/omb/budget/Historicals) by total U.S. Personal Income from (www.bea.gov). xxiv

U.S. Census and Bureau of Labor Statistics. Nominal revenues are inflation adjusted using the CPI-­‐‑U, 1982-­‐‑84 = 100 data series. xxv

xxvi

Comprehensive Annual Financial Report, for the Fiscal Year Ended June 30, 2013.

Felix (2008) examined the volatility of different tax sources in the Federal Reserve’s 10th District, which includes Oklahoma; Felix, R. Alison (2008) “The Growth and Volatility of State Tax Revenue Sources in the Tenth District” Federal Reserve Bank of Kansas City; http://www.kansascityfed.org/publicat/econrev/pdf/3q08felix.pdf. Felix’s xxvii

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estimates showed that sales taxes generally experienced less volatility with respect to changes in personal income compared to personal income taxes and corporate income taxes in Oklahoma, the entire Federal Reserve’s 10th District, and the U.S. in both the short run and long run. The only exceptions were the long-­‐‑run volatility of corporate income taxes in the U.S. and the entire 10th District – the long-­‐‑run volatility of corporate income taxes was higher than the long-­‐‑run volatility of sales taxes in Oklahoma. xxviii

U.S. Bureau of Economic Analysis, Regional Accounts; www.bea.gov.

Gas prices are from: U.S. Energy Information Administration; www.eea.gov. Prices are deflated based on the Consumer Price Index (CPI-­‐‑U); www.bls.gov. xxix

xxx

U.S. Census, Bureau of Labor Statistics, and Bureau of Economic Analysis.

Mankiw, Gregory N., and Weinzierl, Mathew (2005) “Dynamic Scoring: A Back-­‐‑of-­‐‑the-­‐‑Envelope Guide” Working Paper, Revised: April 7, 2005. xxxi

xxxii

Comprehensive Annual Financial Report, for the Fiscal Year Ended June 30, 2013.

The growth rate for inflation-­‐‑adjusted revenues is based on data from the U.S. Census of Governments, http://www.census.gov/govs/; and inflation data from the Bureau of Labor Statistics, www.bls.gov. xxxiii

xxxiv

Comprehensive Annual Financial Report, for the Fiscal Year Ended June 30, 2013.

Author calculations based on Comprehensive Annual Financial Report, for the Fiscal Year Ended June 30, 2013.

Due to the progressive nature of Oklahoma’s tax system, not all income is taxed at the top rate of 5.25 percent.

However, the top tax rate is effective for single filers earning more than $7,500, and couples filing jointly earning more than $15,000. Based on 2012 data from the IRS Statistics of Income, tax filers earning $15,000 or less accounted for 3.0 percent of total adjusted gross income. Consequently, for the static calculations, the total income tax revenues per percentage point of the top tax rate was used. xxxv

xxxvi

The ten-­‐‑year average was calculated as the compound annual growth rate.

xxxvii

Comprehensive Annual Financial Report, for the Fiscal Year Ended June 30, 2013.

Koester, Reinhard B., and Kormendi, Roger C.. “Taxation, Aggregate Activity, and Economic Growth: Cross-­‐‑ Country Evidence on Some Supply-­‐‑Side Hypotheses.” Economic Inquiry (July 1989): 367-­‐‑86; Becsi, Zsolt (1996) “Do State and Local Taxes Affect Relative State Growth?” Economic Review, March/April; and, Poulson, Barry W., and Kaplan, Jules Gordon (2008) “State Income Taxes and Economic Growth” Cato Journal, Vol. 28 No.1. xxxviii

According to the BEA: “There is a discontinuity in the GDP-­‐‑by-­‐‑state time series at 1997, where the data change from SIC industry definitions to NAICS industry definitions. This discontinuity results from many sources. The NAICS-­‐‑based statistics of GDP by state are consistent with U.S. gross domestic product (GDP) while the SIC-­‐‑based statistics of GDP by state are consistent with U.S. gross domestic income (GDI). With the comprehensive revision of June 2014, the NAICS-­‐‑based statistics of GDP by state incorporated significant improvements to more accurately portray the state economies. Two such improvements were recognizing research and development expenditures as capital and the capitalization of entertainment, literary, and other artistic originals. These improvements have not been incorporated in the SIC-­‐‑based statistics. In addition, there are differences in source data and different estimation methodologies. This data discontinuity may affect both the levels and the growth rates of GDP by state. Users of GDP by state are strongly cautioned against appending the two data series in an attempt to construct a single time series for 1963 to 2013 (emphasis added) (http://bea.gov/regional/docs/product/). For this reason, state personal income was used as the proxy for economic growth in this analysis. xxxix

To estimate the impact from the growth in personal income to employment, a regression that relates changes in Oklahoma’s employment market to changes in Oklahoma’s inflation-­‐‑adjusted personal income and changes in the inflation-­‐‑adjusted output of the U.S. oil and gas industry was run. There is a statistically significant relationship xl

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THE ECONOMIC AND FISCAL IMPACT FROM PHASING OUT OKLAHOMA’S PERSONAL INCOME TAX

between changes in Oklahoma’s inflation-­‐‑adjusted personal income and changes in Oklahoma’s employment market.

Based on the average inflation-­‐‑adjusted growth in the U.S. oil and gas industry during non-­‐‑boom times, the size of Oklahoma’s employment market was estimated for the baseline personal income growth scenario and the tax phase-­‐‑ in personal income growth scenario. The difference between these estimates is presented in Figure 9.

Author calculations based on total local government data from the U.S. Census of Governments, http://www.census.gov/govs/; and total personal income data from the Bureau of Economic Analysis, www.bea.gov. xli

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Oklahoma Council of Public Aairs

www.ocpathink.org

www.afpok.org

www.ocpaimpact.com