An obvious example of taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. triggers working as designed is when a portion of revenue growth is automatically put toward tax relief. A less obvious, but equally important, example of triggers doing what they’re intended to do is when a scheduled tax cut is delayed because state revenues are inadequate to support it.
Tax triggers, for the uninitiated, are a series of tax reductions or tax policy changes implemented over time subject to meeting pre-established revenue (or similar) targets, and they’re an ever more common feature of state tax reform legislation.
Nearly half the states are facing substantial budget shortfalls heading into 2017, and Oklahoma is one of them. Because of that, a scheduled reduction of the state’s individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. from 5.0 to 4.85 percent will be delayed at least one year. The trigger worked.
Tax triggers, after all, are about increasing certainty and stability. By pegging rate reductions or other tax reform measures to revenue targets, they allow a responsible phase-in of tax changes that tracks with, rather than getting ahead of, the state’s finances. They increase the viability of tax reform by addressing economic uncertainty. And, as part and parcel of that, sometimes they press the pause button because conditions aren’t yet ripe.
When a budget shortfall prevents a tax cut from going into effect, that’s a success—not a failure—of triggers, and should give other states confidence that triggers do what they’re intended to do.
This is also why it’s important that triggers are well designed. Oklahoma’s trigger worked this time, but earlier this year, we called out Oklahoma for some shortcomings in its trigger mechanism that undermine its reliability:
Most tax triggers rely on actual revenue, not projections. By relying exclusively on year-over-year general fund balance projections, triggers like those employed in Oklahoma have the potential to trigger tax cuts in a year when revenue declines unexpectedly. Conversely, by relying on fund balances, the Oklahoma triggers are susceptible to legislative gamesmanship, in which expenditures are pre-authorized or diverted to postpone an otherwise scheduled tax cut even in good years. Although the use of revenue forecasts can permit a more prospective approach, they introduce greater uncertainty, particularly where current projections are compared to past projections, and not to actual revenues.
By making sure that tax triggers set proper baselines and benchmarks (more on that here), policymakers can ensure that tax triggers do their jobs consistently, phasing in tax reductions when revenue growth allows and hitting “pause” when necessary. As more and more evidence accumulates of triggers working as intended, they are likely to become an even more ubiquitous feature of tax reform packages in coming years.
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