Why Income Tax Cuts Are Good for Oklahoma

June 01, 2006

Oklahoma would benefit from a major reform of its income tax system that includes a broad-based income tax cut for Oklahoma taxpayers. There are two basic reasons that further income tax reform is needed.

First, Oklahoma's tax burden (commonly defined as a ratio of tax collections to personal income) over the last several decades has been inching up relative to other states - the total state and local tax burden in Oklahoma has been rising faster than in other states. Secondly, Oklahoma's tax structure is quite progressive, meaning that new income is taxed heavily. These two trends need to be reversed.

A rising tax burden puts Oklahoma at a competitive disadvantage with respect to other states. Research shows that states with a slower growth in tax burden experience faster growth in personal income than states with higher growth in tax burden.

In fact, from 1979 to 2000 only seven states had a tax burden that grew faster than Oklahoma's tax burden. Not coincidentally, during the same time period only 14 states had a personal income that grew at a rate slower than Oklahoma's. So not only is Oklahoma a relatively poor state; it is losing ground.

Another feature of Oklahoma's tax structure is its high level of progressivity. While Oklahoma's total state and local tax burden is not relatively high, the amount of taxes that are paid on increases in wealth and income (the marginal tax rate) does seem to be very high. Both empirical research and economic theory suggest that marginal tax rates matter to people's decisions. High marginal tax rates inhibit the mechanism of prosperity by giving people a disincentive to create wealth.

Oklahoma's estimated marginal tax rate (again, the amount of taxes paid by those who earn or create additional income) ranks 14th among states. This certainly discourages the creation of wealth in Oklahoma. More importantly, the level of progressivity in Oklahoma's tax structure is rising relative to other states.

Quite possibly the largest potential benefit from income tax reform would be the tax cut's impact on Oklahoma's population. As evidenced from recently losing a U.S. Representative, Oklahoma's population growth is not keeping pace with other states. Our state government needs to pursue policies that encourage people to want to live and work and create wealth in Oklahoma. It is very likely that tax cuts, especially income tax cuts, would do just that.

People want to live in low-tax places. Perhaps the most famous recent evidence of this is the comment of USC superstar running back Reggie Bush, who recently expressed joy at the prospect of playing football in Texas since Texas has no income tax. (Perhaps unfortunately for Mr. Bush, he will be doing most of his work in Louisiana, a state that has high income taxes.)

The importance of this becomes clear when one considers the problem of providing quality public goods to a shrinking population. Many of the costs of public-goods provision are fixed, so a declining population would not only mean less tax revenue, but that a lower proportion of tax revenue would be left after paying the fixed administrative costs. This could severely limit the quality and amount of services provided by the government.

Answering the Objections
Of course there are many Oklahomans who oppose tax cuts. Usually their arguments fall into three broad categories: (1) we can't afford tax cuts; (2) the tax cuts won't matter; and (3) the tax cuts will go to the wrong people.

Opponents of tax cuts claim that cutting tax rates today will result in a long-term decline in government services. In other words, they say "we" (i.e., the government) can't afford tax cuts. One is reminded of the essayist Joseph Sobran's observation: "Well, I can afford one. How about you?"

But will tax cuts really result in a long-term decline in government services? If tax reform, including a broad-based income tax cut, makes the economy grow more quickly, then one can expect the ability to consume both private and public services to increase. The economy is a dynamic mechanism. What is consumed tomorrow depends on the wealth created today. There is no reason one should believe a long-term trade-off exists between the consumption of public and private goods if the government implements smart policies that encourage wealth creation today.

Secondly, those who oppose tax cuts say tax cuts don't matter. After all, taxes are but one of many costs businesses consider when making decisions to locate or expand. And, it is claimed, state and local taxes are a very small cost when compared to depreciation, interest, Federal taxes, labor, and other factors.

Their logic seems to be that since state and local tax bills are a small cost of doing business, they are an insignificant part of a company's decision to locate in one state or another. In other words, a business will not consider state and local tax bills when making a location decision. Nothing could be further from the truth. The costs that are relatively large (depreciation, the cost of borrowing, Federal taxes, and many others) will be the same in every state. Thus, businesses will not consider them when making a location decision. Indeed, what they will consider are the things that are different across states. State and local taxes will be high on the list.

Finally, opponents of tax cuts often claim that the tax cuts go to the wrong people. In other words it is common to hear that "these tax cuts only benefit the rich." This is a very unfortunate argument for several reasons, not the least of which is the fueling of class warfare, a very counterproductive phenomenon in our society.

A case can always be made that the rich benefit more from any tax cut than the poor. After all, the rich pay more in taxes. Measured in absolute dollars, it will almost always be the case that the rich get a larger reduction and thus a seemingly larger direct benefit from any tax cuts.

The state's largest newspaper understands this principle. A recent editorial (The Oklahoman, 'Tax cut foes miss the point,' April 28, 2006) noted: "Tax cuts for the wealthy? One doesn't have to be wealthy to pay the top income tax rate in Oklahoma. CAP [Community Action Project], drawing on an analysis from the liberal-leaning Institute for Taxation and Economic Policy, says SB 2022 would disproportionately benefit 'the wealthy.' That's the point! Those who pay the most taxes obviously would get more benefit from a tax cut. They would get even more of a benefit by moving to Texas, which has no personal income tax. Should we encourage them to make that move or should we take a small step this year to make Oklahoma more attractive to entrepreneurs?"

Groups that oppose tax cuts will nearly always attack any proposed tax cut on this ground. The only conclusion that one could draw from this is that those opposing the tax cuts on the grounds that they benefit only the rich would oppose any tax cut. Envy is not a sound basis for policy-making.

Oklahoma needs further tax reform. Our system of taxation is prohibitive to wealth creation and needs to be revamped into a system that promotes growth. Any reform needs to address both the increasing relative tax burden Oklahoma taxpayers have endured and the high level of progressivity that chokes off new growth. The benefits of such a redesign would ensure a better life for current and future Oklahomans.

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