Responding to Criticism of our Oregon Report

July 10, 2009

Yesterday we released a report ("The Dam Bursts in the Beaver State: Oregon's Wave of Tax Increases and New Spending") criticizing Oregon's problematic tax increases in its recently passed budget. We noted that Oregon is going beyond closing its budget shortfall and expanding new programs, and that part of its solution was to impose a "millionaires' tax" of 11%—tied for highest state income tax rate in the country—on income over $250,000, plus a 10.8% rate that kicks in at $125,000. They also didn't inflation-adjust those brackets. Our analysis concluded that while these increases will close Oregon's short-term budget shortfall, they will do harm to Oregon's long-term economic growth.

(At least they didn't touch Oregon's status as one of five states with no sales tax. States without a major tax have a dramatic comparative advantage over their neighbors in addition to escape the deadweight loss and administrative complexity associated with a whole other tax.)

A response from Charles Sheketoff, executive director of the Oregon Center for Public Policy, appeared in a good piece by John Buhl in State Tax Today (subscription required):

Asked about the report's claim that the taxes will fund new programs, Sheketoff said that state lawmakers also approved $2 billion in budget cuts.

"People are not happy with the cuts," Sheketoff said. "My comment to the Tax Foundation is, you show me another $1 billion."

We're eager to share our ideas on fundamental tax reform to OCPP and anyone else, and we invite the debate. Identifying cuts in proposed spending is certainly difficult, in part because Oregon has yet to join other states in spending transparency. No doubt there are many important priorities in Oregon's budget, but the state's $15.3 billion two-year general fund budget is still a 5.3% increase over the previous budget. And as we noted in our state budgets report in February, many of the cuts are cosmetic or deliberately tough ones to create the impression that only tax increases can balance the budget even after a spending run-up.

Even so, that's a moot point now, given that Oregon legislators decided that taxes had to go up. The question then becomes whether the tax increases they selected are sound tax policy. They aren't.

More from OCPP:

Sheketoff also called claims that high wage earners would flee the state "totally bogus." After the upcoming biennium, the top income tax rate would only be 0.9 percent higher than the current rate, he said, equaling about one penny on the dollar.

Although the rate increase is not indexed for inflation, that could force lawmakers to revisit the income tax rates and ensure they are set at an appropriate level, Sheketoff said.

Taxes matter and they shape behavior. A $1.4 billion tax increase is not a trivial sum, and coupled with the fact that it is raised in distortive manner, it will have effects on Oregon's economy. (Plus, if Mr. Sheketoff thinks $1.4 billion is trivial, he's welcome to mail me a cashier's check, care of the Tax Foundation.)

As we argued in our recent report on Hawaii's tax increases, states that adopt new taxes on high-income earners are ones where policymakers are persuaded to ignore concerns about long-term economic growth in favor of a short-term budget fix. In New Jersey, while the new millionaires' tax raised revenue for the state and helped reduce a budget shortfall, it reduced the state's overall economic output and harmed its ability to grow during and after the recession.

This is the tradeoff that proponents of taxes on high-income earners usually fail to acknowledge. Yes, such taxes will generally raise revenue in the short term without a sudden exodus of wealthy people fleeing to the state next door, especially in Hawaii. But over the medium term, the taxes will negatively impact location decisions. Other states will become more attractive as entrepreneurs expanding old businesses or creating new ones incorporate the higher cost of doing business in Oregon into their decision-making process. In the long run this will give other states a competitive edge over Oregon in attracting and retaining economic activity.

As to the inflation-indexing and temporary nature of the taxes, that harms individuals' and the state's ability to plan tax obligations into the future. Lawmakers should avoid temporary tax laws because when tax laws are in constant flux, long-range financial planning is difficult and hurts economic growth. Not inflation-indexing may eventually produce the same issues that bedevil the federal Alternative Minimum Tax (AMT).

Good tax policy is simple, transparent, neutral, and stable. Oregon's method of raising $1.4 billion in new revenue, partly for new programs, disproportionately targets one group of people, and will increase the volatility of the state's tax system going forward. As we said in the title of the report, it is short-sighted tax policy that Oregon's neighbors may well capitalize on.

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