More than 20 years ago, during Frank Keating’s second term as governor, he proposed replacing the state’s individual income tax, its sales tax on groceries and its business franchise tax with a 5.9% tax on some 200 additional business activities, from hair cuts to house sales.
Oklahomans liked the idea of no income tax, but not as much as they disliked the idea of paying higher sales tax and paying it on more stuff. So Keating’s fundamental overhaul of the state tax system didn’t happen.
But the subject keeps coming up, largely driven by advocacy groups promising greater economic growth — and usually representing interests in higher income tax brackets. Most recently, Gov. Kevin Stitt renewed the call to phase out Oklahoma’s individual income tax.
Oct. 3, 2023 video. Gov. Kevin Stitt called for a special session to consider cutting taxes. Video via Youtube
In all likelihood, further reductions in state income tax rates, or tax relief of some kind, will be a major issue in the 2024 legislative session.
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Before getting into whether zero income tax actually does spur economic growth, it should be noted that state and local taxes are almost always considered together because of state-to-state variations in responsibility for government functions. For instance, Oklahoma’s state government has assumed a large share of the responsibility for funding common education, while other states leave more of the burden on local governments.
The result is that Oklahoma distributes its public school dollars more evenly than most states, but some complain that it penalizes communities that are willing and able to spend more on their schools.
Also, tax and revenue systems are like trees. They grow and adapt to fit the environment — atop boulders, through sidewalk cracks, around iron spikes and knot holes and squirrel nests. Just as trees find nourishment wherever they can find it, so state and local governments tend to seek out cash from all available nooks and crannies.
States that don’t get money from income taxes get it from somewhere else — property taxes or sales taxes or things not called taxes that nevertheless walk, quack and look like taxes.
Some have higher college tuition. Some charge more for a barrel of whiskey or gallon of gasoline. Some might take longer to process birth certificates or repair a road.
Also like trees, established tax systems must be pruned with care. When Kansas tried to rip out its existing tax system in the 2010s, its state government nearly collapsed.
Fact is, most states without income taxes never had them, or had them in such a diminished form that eliminating them altogether was not such a drastic leap as it would be today. Florida discontinued its individual income tax in 1855 (yes, 1855). South Dakota zeroed out its levy in 1943. A flood of oil and gas revenue allowed Alaska to repeal its individual income tax in 1980.
Oklahoma adopted its state income tax in 1915, shortly after passage of the 16th Amendment made a federal income tax practical. It accounts for 35% to 40% of state tax revenue and, with a 1% state sales tax approved in 1933, allowed the elimination of the state property tax assessment.
Economic growth claims
So then, is there really a link between no individual income tax and economic growth?
Jared Walczak of the venerable Tax Foundation is a “yes” on the question.
“States without an income tax have grown twice as fast over the past decade as those that do,” Walczak said in a recent interview. “Income taxes are a tax on investment and labor.”
Four of 2022’s five fastest growing states, in terms of gross product, have no income tax.
Others say the growth claim is a mirage. Several reports over the past decade by the left-leaning Institute on Taxation and Economic Policy say studies linking state income tax policy to economic policy are skewed.
And the same data that ranked zero income tax states Tennessee, Florida, Nevada and Texas as Nos. 2-5 for 2022 economic growth listed no-taxers South Dakota and Wyoming in the bottom 10 (with Oklahoma) and Washington just outside it.
Richard Auxier, an analyst with the left-center Urban Institute, says states without income taxes tend to shift the burden from higher to lower earners.
“The income tax is the only tax that allows what’s called vertical equity,” Auxier said. “All other taxes are regressive.”
By “regressive,” Auxier means taxes assessed uniformly regardless of income or available resources. So, an 8% state and local sales tax or 19-cent per gallon gasoline tax hits someone with $10 a lot harder than someone with $1,000. Many people argue that consumption taxes, and especially some sales taxes, are patently unfair.
Income taxes, by comparison, are more closely tied to ability to pay. In theory, the amount paid in taxes increases with income. Most income taxes are also graduated to some extent, meaning a higher tax rate on higher income. Some argue that that is unfair, too.
In any event, the higher the income, the more likely someone is to oppose income taxes, and the lower the income the louder the argument for repeal of such things as sales taxes on groceries and other necessities.
A basic tenant of government fiscal policy is that taxation should have a broad base and low rate. In most states, that involves some combination of sales, property and income taxes, with a host of other taxes, many of them designated for specific purposes, supplementing the top three.
But some conservatives argue that income and property taxes are not necessary for a fair or balanced tax system. The Tax Foundation’s Walczak says a consumption tax-based system extended to a broader range of goods and services can be just as equitable.
But as Frank Keating learned, persauding people to pay taxes they aren’t paying now is very difficult.
“The problem with the idea of having a broad sales tax is that it just pisses people off,” said the Urban Institute’s Auxier.
No major effort to reform Oklahoma’s 4.5% state sales tax has been attempted since Keating, except for discussions about actually narrowing it by exempting groceries.
In the meantime, the top income tax rate has been chipped down from a high of 7% in the 1990s and 6.65% at the time of Keating’s proposal to 4.75% now. And the franchise tax Keating wanted to abolish will be gone next year.
Tax system comparisons
So how does Oklahoma’s tax system stack up with other states’?
Probably the best-known yardstick is the Tax Foundation’s annual state tax burden report. It computes both the average amount paid in state and local taxes and state and local tax rates as a share of economic output.
In the latest edition, none of the top four for combined state and local tax rates — Alaska, Wyoming, Tennessee and South Dakota — has a personal income tax. Texas is No. 6.
Oklahoma’s rate of 9% ranked 10th, more than 2 percentage points behind the national average.
In terms of actual taxes paid, however, Oklahoma’s average tab was about $400 less than Texas’.
The Urban Institute doesn’t issue rankings, but it does publish data. It also takes into consideration some things the Tax Foundation and many others don’t. College tuition, for instance, and various fines and fees.
For fiscal year 2021, it estimated that Oklahoma spent less per capita on common education, health and hospitals, public welfare, corrections and policing than the region and the nation as a whole. State and local government expenditures were $8,616 per capita, compared to $11,087 nationally.
State and local general revenue was $9,785 per capita, compared to $12,277 nationally.
Texas state and local governments, by comparison, took in and spent about $1,000 more per person than Oklahoma.
The Institute on Taxation and Economic Policy, which in 2018 ranked states according to the fairness of their tax systems, put Oklahoma in the bottom 10 along with seven of the nine no-individual income tax states.
Conversely, the Tax Foundation, whose Business Tax Climate Index explicitly favors states without corporate income tax, individual income tax and/or state sales tax, ranks four of the no-individual income tax states in its top 10. Oklahoma is No. 23 overall, although it ranks first for workers’ compensation insurance and fourth for corporate taxes.
Auxier said tax policy should be determined by real circumstances, not abstract ideology.
“Talk to communities,” he said. “Ask, ‘What do you need to succeed? What’s the tax that gets in your way?’ Cutting income taxes may be popular, but that doesn’t mean it’s the best way to incentivize growth.”
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