First Take on the Kicker Reform Bill

As an ardent supporter of kicker reform to support a permanent rainy-day fund I am following, with considerable interest the new proposed bill in the state legislature.

Here is a synopsis from the Corvallis Gazette Times [which is a lot better than the fairly incoherent one in the Oregonian which is linked above]:

Here’s how [the] plan would work: At the beginning of each biennial budget cycle, the Legislature would set aside the first 3 percent increase in general fund appropriations over the previous two-year budget (after accounting for inflation and population growth) to go into the rainy day fund.

Any general fund money left unspent at the end of the biennium — up to 1 percent of general fund appropriations — would also go into the rainy day fund.

The measure would also divert most of the money from the state’s kicker law into reserves. Currently, any time general fund revenues exceed projections by more than 2 percent, the excess is kicked back to taxpayers — both personal and corporate — in the form of a refund.

Under SJR 26, half of the personal kicker would still go back to taxpayers, with the remainder going into the rainy day fund.

All of the corporate kicker would go into the university stability fund. Once the fund reaches its maximum — 15 percent of the prior biennium’s higher education budget — additional deposits would flow into a subaccount set aside for maintenance and capital improvements.

The rainy day fund also has a cap, set at 12 percent of the previous biennium’s general fund revenues. Any deposits beyond that level would be refunded to taxpayers.

I have not had a chance to examine it carefully but here are my first thoughts:

1) It isn't nearly big enough. Most economists who study these things advocate for a reserve that is 5% of state GDP. In Oregon's case that would be about $8.25 billion. The bill call for the rainy day fund to top out at 12% of current biennium revenues which today would be in the $1.8 billion range. The current biennium is facing a 3.5 billion shortfall and the past biennium there was about a 3.8 billion shortfall.  Clearly the proposed size of the kicker is too small.

2) Diverting general fund revenue before the kicker is a bad idea for a state with underfunded services.  With a sufficient rainy-day fund this should not be necessary and will be especially damaging to K-12 education.  Just how bad are we willing to let K-12 get?  

2) Dedicating the entire corporate kicker to universities is great for me but not a good move overall.  I am not a big fan of dedicated revenues and would prefer more independence for state universities rather than dedicated funding streams.  I do think support should rise, but I think K-12 is probably as or more important as universities are able to deal with low support levels by more price discrimination, more out of state and international students, etc.

Now, political realities are what they are, but I don't see why, after the mess we have been through, the simpler keep all kickers until we have a 5% of GDP reserve.  The kicker still does it's job in restraining state spending but also provides for the other side of the equation - allows sustainable spending levels during recessions.  I await the citizen sponsored referendum!

And, in case you are interested, you can read what I have posted previously on rainy-day funds by clicking here.

Chile's Rainy-Day Fund

Reader Jacob Grier sent along this article from the Wall Street Journal which describes Chile's rainy-day fund and how useful it is at the moment. Here is an excerpt:

By MATT MOFFETT
SANTIAGO, Chile -- During the emerging economies' commodities boom a few years back, Chilean Finance Minister Andrés Velasco was a wet blanket at the fiesta. Chile, the world's largest copper producer, was reaping a bonanza from the quadrupling in the metal's price. Mr. Velasco insisted on squirreling away a large chunk in a rainy-day fund.

As the savings swelled above $20 billion -- more than 15% of Chile's economic output -- Mr. Velasco faced growing pressure to break open the piggy bank. In September, protesters barged into a presentation by Mr. Velasco, carrying an effigy of him and shouting, "The copper money is for the poor people."

The 48-year-old Mr. Velasco, wary that a flood of copper income could generate lending and consumption bubbles, stood his ground, even as the popularity of the center-left government withered. Latin American history, he cautioned, was full of "booms that had been mismanaged and ended badly."

Finance Minister Andrés Velasco built Chile's rainy-day fund. Today Mr. Velasco looks like a prophet. Since the onset of the global economic crisis, copper prices have fallen by 50%, in line with the sharp decline in other commodities. Emerging economies that got too giddy in the good years are now coping with nasty hangovers. Soybean-dependent Argentina is facing a possible debt default while oil-rich Russia has been stuck bailing out banks and companies that got in over their heads in debt.

Thanks to Mr. Velasco's caution, Chile is now in a position to try to bootstrap its own recovery from the global recession. Mr. Velasco's preemptive moves have kept Chile's government from having to spend a single peso on bank bailouts. Having paid down foreign debt during the fat years, Chile is now a net creditor nation, with a debt rating that was upgraded by Moody's Investors Service in March.

And now Chile is pouring some of its copper savings into a massive stimulus plan, consisting of job-creating public-works projects, tax breaks for business, investments to keep mines operating and other goodies. Chile's plan is one of the largest stimulus packages in the world relative to the size of its economy. The Chilean program is the equivalent of 2.8% of gross domestic product, versus 2% in the U.S.

As a result, economists expect the nation's annual economic output to decline a very slight 0.5% this year, compared with much steeper declines elsewhere.

.............

The moral of this story is, of course, you should always defer to the economists! (Velasco has a PhD in economics from Columbia). Such a fund would be pretty nice to have in Oregon right now, huh?

On Kicker Reform

The proposed ballot measure to essentially repeal the corporate kicker has been getting lots of attention.  In essence, any time the states revenues exceed the forecast by 2% or more both personal income and corporate revenues in excess of this 2% threshold (of the forecast - including the 2% buffer) are returned to taxpayers.  The ballot measure would take the corporate tax excess and return it to the general fund for K-12 education funding (though the wording on this is unclear - would it be tied to K-12 and even if so, you could just reduce the other money going to K-12 so that as far as I can tell this just increases the general fund).

I have been a strong proponent of kicker reform but my purpose in so doing is to try promote a plan that provides fiscal stability through the creation of a permanent rainy-day fund.  This ballot measure does no such thing but only increases general fund revenues during flush times.  I not only do not see the point I think passage of this measure would harm future efforts to do wholesale kicker reform and a permanent and substantial rainy day fund.

But then perhaps I am naive, after all I would have thought that we would have had kicker reform and a permanent rainy day fund by now.  The topic of conversation at all the kids soccer games, baseball games, band recitals, etc. is how deeply upset this latest round of cuts has made folks, why politicians cannot find the political will to try and do something about it is beyond me.  We can't fix the immediate problem but we can do a lot to ensure it doesn't happen again.  We are talking about something that doesn't raise tax rates (but does cancel a tax refund) and provides stability in state services that reduces a huge amount of waste.  If you can't sell the thing now, when?

Update: correction above - thanks Josh...

Fred Thompson: Stuffing Oregon's Kicker

Note: Another Dispatch from the desk of Fred Thompson:

There are 12 Christmas trees in Oregon for every person, more than in any other state. That’s one way we are special. Another is our system of state and local public finances, where, by many measures, Oregon is an outlier.  Generally, special also means better.

Nevertheless, Oregon’s system of state and local finance has one difference that isn’t particularly praiseworthy: the so-called kicker law,  which requires the state to return actual revenues in excess of the annual budget forecast to taxpayers. No other state in the country has anything quite like it. Oregon’s kicker was justified as a means of keeping the legislature from rolling over revenue windfalls to future budgets, thereby unsustainably increasing state spending. This was and is a reasonable concern, but the kicker was and is an ill-conceived fix to this particular problem. Rather, it is fundamentally inimical to the very worthwhile goal of smoothing out state and local spending, which calls for setting revenue growth in excess of long-term trends aside for a rainy day.

Oregon’s Total Revenue and Total Expenditure

 Oregon’s kicker law dates back to 1979. The voters overwhelmingly ratified the law in 1980, but the first actual kicker rebate didn't actually occur until 1985. During the 90s a surprisingly good economy generated kicker rebates nearly every biennium: 1995, 1997, 1999, and 2001. The only subsequent rebate occurred in 2007, a personal income tax rebate of $1 billion. That year the legislature diverted the business-tax kicker to the state’s rainy day fund and in 2012 Measure 85 assigned it to the public-school fund for keeps.

The dearth of personal-income-tax kicker rebates so far this century is not entirely due to a disappointing economy. That is the main reason, of course. But Oregon’s recovery has by most measures outstripped that of the nation as a whole, especially with respect to state revenue growth. Consequently, it appears that the state also highballed the official revenue forecast. In so doing, its actions were entirely consistent with the recommendations of the 2008-9 Legislative Task Force on Comprehensive Revenue Restructuring. The Task Force aimed at making Oregon's tax system more stable and adequate. It found that the secret to stability and adequacy lies in stabilizing spending growth at a sustainable rate and in using savings and short-term debt to smooth out revenue volatility. The Kulongoski administration put these findings into place via its so-called reset budget. Then, so long as the administration remains committed to the reset-budget’s long-term spending targets, funds are automatically generated for Oregon’s rainy-day fund and/or to pay down its debt (the measures also allowed for automatic borrowing if revenue fell short of the spending target).

This year it probably will not be possible to avoid a kicker rebate without legislative action. Despite the best efforts to avoid such an outcome, actual revenues look to be running ahead of the forecast. Not surprisingly kicker repeal is once again on the legislative agenda. (Of course, the legislature can always put off the distribution of a kicker rebate by an emergency vote, as it did in 1991 and 1993, without actually repealing the law.)

Moreover, some legislators are concerned with the current administration’s apparent inclination to discard the reset budget: reset principles are not highlighted in the 2015-17 budget proposal and the medium-term fiscal planning unit in the Department of Administrative Services that formulated the reset budget and put it into place has been dismantled. This is a potential threat to the state’s long-term fiscal stability and, perhaps, also underscores the ongoing need to enact the Task Force’s recommendations for improvements to Oregon’s fiscal system, including reform of Oregon's personal-income-tax kicker, into law.

Senator Ginny Burdick, Chair of the Senate Finance and Revenue Committee, is the key to these reforms. She served on the Task Force and has a longstanding commitment to both fiscal stability and kicker reform. Interestingly, California, Oregon’s neighbor to the South, recently voted Proposition 2 into law. Proposition 2 amends the California Constitution to require that the Governor make mid-term spending and revenue targets part of the state budget process, requires the state to set aside revenues each year – for 15 years – to pay down specified state liabilities, and substantially revises the rules governing the state’s rainy day fund. In other words, California’s legislature did pretty much what Oregon’s has, so far, not done with respect to kicker reform. They referred a measure aimed at making state and local spending sustainable to the citizenry. On November 4, 2014, 70 percent of Californians voted in its favor.

We need to go there too.

Taxes, Revenues, Spending and Oregon

Update: I have made a correction to an unfair criticism that I did not really intend. Sloppy writing on my part, sorry.

Mark Thoma on Sunday had an Op-Ed piece in the Oregonian treading over some old territory for this blog: suggesting a sales tax. I only wish Mark had done his due diligence emphasized spending stability rather than revenue stability. A while ago I wrote a series of posts in which I tried to find out what I could about the reality of sales tax and income tax volatility.

The conclusion: sales taxes are not much less volatile than income taxes and the two are highly correlated. They may add a tiny bit to stability but they won't solve the problem. We need only to look at our neighbors to the north to see that sales taxes are not then answer to volatility questions. Sales taxes cratered a bit before income taxes, but they will likely recover faster too.

While in the long term we may want to think about appropriate revenue levels it is important to remember that trying to tax our way out of a recession is only a recipe for prolonging the recession. We need to be very careful during this recession to be sure that any new temporary taxes are used to preserve only the most essential services and avoid the temptation to enact a host of new taxes to fill the budget gap.

The real problem looking to the future is not revenue instability but spending instability. Mark is right about this: a permanent rainy-day fund is an absolute necessity. A rainy day fund that is 5% of state GDP and filled by withholding kicker refunds until the fund is full. 5% of GDP is, admittedly, a lot and I'd settle for less (3%?), but 7-8 billion would come in pretty handy right now, wouldn't it? The fund can be invested conservatively and excess returns can be refunded to taxpayers as well. It is true that strict rules will have to be enacted to assure that the rainy day fund is not used in the sunshine. But such rules are relatively simple to write down and enact.

What is important now is to think about the appropriate level of revenues in the long term. I don't know the answer to this off hand, but I do know that Oregon is a relatively low-revenue state. According to the Tax Policy Center of the Urban Institute and the Brookings Institution we raise about $3,360 per person in Oregon which places us 35th in a ranking of states. Compare that to Washington which collects almost $4,000 per person and California, which collects more than $4,500 per person.

This leaves us with some serious issues, most notably the abysmal funding of K-12 education. From the Tax Policy Center's data on expenditures we can see that in a list of state expenditures on K-12 schools Oregon is 41st in the nation at $1,394 per person. However, overall expenditures on all services in Oregon is $6,866 per person which puts us in 22nd place which begs the question, why are we so low in school funding? By the way, the difference in the revenues and expenditure numbers is, I assume, mostly federal transfers for things like medicaid as well as timber payments and the like.

I am far from ready yet to say that revenues should increase, and we know we have no sales tax, but what about corporate taxes which have received so much attention? Are they really so low? Again, according to the Tax Policy Center a little less than 2% of all state revenues comes from corporate income taxes which places us 3oth among states. Per capita, according to the Tax Foundation, we are in 39th place with $109 raised in corporate income tax per person.


Finally two last points about sales and corporate taxes. We are one of the very highest income tax states, meaning that adding a sales tax would have to involve a lowering of the income tax without overburdening Oregon households. Also as companies have to compensate employees for high taxes to keep them from fleeing to other states, income taxes can be seen as an indirect tax on businesses. Food for thought.

This is intended to start a discussion and exploration into these issues and, as always, I welcome your thoughts, opinions, knowledge, etc.

Time to Sound the Drum for a Rainy Day Fund...and a Few Other Things

The latest Oregon budget forecast predicts a $473 million kicker refund to Oregon taxpayers.   This when Oregon's economy is going strong and we could finally start to address things like having the lowest high school graduation rate in the country:

This blog has sounded off about the kicker many times before, with both and Fred Thompson and I arguing for its demise, and in it's place a permanent and significant rainy day fund to stabilize state spending.  Doing so would allows us to better achieve things like protect and enhance our transportation infrastructure that at serious risk of significant deterioration.

If I were governor, this would be my agenda:

1.  A bill that would convert the kicker to a rainy day fund.

2. A bill that instituted a carbon tax for all carbon fuels, including gas, and used proceeds to fund transportation infrastructure with rebates for low-income households. Included in this bill would be a repeal of the ban on self-service gas to offset the increased price at the pump.

3. A budget that significantly increased funding for K-12 education dedicated to class size reduction and an increase in contact hours.

4. I would also increase funding for public research universities (conflict of interest alert!).

To me, these are the three pillars of a sound long-term state economy: solid transportation infrastructure, an talented and educated workforce, and an active and innovative research and development infrastructure.

Once More on the Kicker

Fred Thompson chimes in again on kicker reform:

Chuck Shekatoff of the Oregon Center for Public Policy reminds us of a very simple fact, one that probably ought to be obvious, but evidently isn’t: “revenue stability shouldn't be the goal...stability of the fiscal system should be the goal.” The things that government does for us, the services it provides have one fundamental attribute: they are all things we depend upon to get by – the legal system, incapacitating criminals and fire protection, education, a transportation network, a social safety net, clean water, etc. Moreover, deferring their delivery is prohibitively costly; these services must be provided in real time. That means their providers cannot be permitted to fail. If one were to formulate an objective function for most government programs it might look something like the following: maximize sustainability or reliability, subject to some minimum performance constraint. The essential requirement for meeting this service objective is stable funding.

The extreme measures taken by public officials to stabilize service delivery, together with persuasive evidence that spending volatility severely degrades service performance in government, attests to the critical importance of stable funding. For example, during New York’s fiscal crisis I observed that the City’s first response was to cut maintenance. From a purely financial perspective this make no sense. A properly maintained bridge wears out a rate of 1-2 percent a year; a bridge that isn’t maintained at all wears out at a rate of 15-20 percent a year. That’s a very costly source of cash. When one asked why, the answer usually went to the need to maintain services. Maintenance can be deferred, at a cost, operations can’t. Besides, what New York paid for cash by deferring maintenance is actually less than the price Oregon has often paid during past recessions, when the state borrowed from PERS at an implicit interest rate that exceeded twenty percent.

Instability can be attributed in part to the myopia of existing public-sector budget norms and rules, which tend to focus on balancing budgets one year at a time. Consequently, many students of budgeting want to put spending growth on a more stable path by basing it on long-term revenue growth rather than annual forecasts. Aaron Wildavsky, for example, proposed that the average rate of revenue growth should determine the permissible rate of expenditure growth. If cash outflows nevertheless continued to outstrip cash inflows, he further argued, a percentage or two ought be knocked off the planned (real) rate of expenditure growth until it looks like spending was back on a sustainable path.

The effectiveness of this general approach, both for controlling expenditure growth and for stabilizing programmatic support, is suggested by various case studies, most persuasively by the Chilean experience. The Chilean government has adopted a budget rule that allows a steady rate of spending growth adjusted for changes in its net worth. This system allowed Chile’s President, Michelle Bachelet, to resist intense pressure to boost spending earlier in her administration, when government revenues soared. Then, when the global recession came and revenue fell sharply, it allowed Chile to continue to grow spending at a sustainable rate, using assets that it had acquired during the boom. The upshot of this is that Bachelet is leaving office with the highest approval ratings of any President since the return of democracy to Chile.

It would be easy to make such a system work for Oregon. By basing our annual revenue forecast on the geometric mean of past revenue growth and balancing the budget against that forecast, we could put the state on a stable, sustainable spending path. Then, if revenues exceed the forecast by more than 2 percent, the excess would be placed in a rainy day fund and prudently invested by Oregon’s Treasurer. If revenues turned out to be less than the forecast by a similar amount, the Treasurer would go to the credit market to redress the cash shortfall. My own view is that kicker funds should never be returned to taxpayers except when the corpus of the rainy day fund exceeds the sum of the state’s general obligations debt plus a safety stock for emergencies – 30 percent of general fund outlays would be sufficient to cover shortfalls about seventy percent of the time assuming a three percent real growth rate in spending. Beyond that point, I have absolutely no reservations about returning any additional excess to taxpayers.

Under this proposal, the rainy day fund could only be depleted to make principal and interest payments on debt and those depletions would be automatic.

Kickers, Rainy-Days and Rising Seas

The news that $400 million will be returned by the State of Oregon to taxpayers has aroused me from my hibernating slumber.  Plus, it is going to be a rainy-day so it all just seems too perfect an opportunity to miss to moan about our ridiculous revenue policy in the state.  Fred Thompson and I have written in these pages extensively about the Kicker and its folly.

The kicker system is one-sided - in unexpectedly good revenue years the government has to shed excess revenue, but in unexpectedly bad revenue years the government has no way to make up of the lost revenue.  This system ensures the state will always have to endure painful and grossly inefficient cuts during lean times.  Which is just stupid.

Economies are cyclical, revenues are cyclical too (no matter how you rearrange the tax structure - sales taxes don't help).  What a good manager does (just like any household) is create a system where highly variable revenues don't cause highly variable spending.  A good analogy is a realtor who has an unexpectedly exceptional year - prudence requires stuffing some of that money in a savings account to have ready for those unexpectedly bad years.

So why doesn't Oregon behave the same way?  It is not a crazy thought - many states have rainy-day funds that are very effective in smoothing out fiscal spending.  The kicker should cause us to think about how we manage our budget as a state and our woeful performance on a vast number of metrics regarding public education as well as the condition of our roads should be enough to convince us that what we are doing is not working.

Conveniently, we are also seeing, quite dramatically the effects of a warmer planet.  It is too late to stop the immediate impacts like dramatically rising sea levels (something not inconsequential for a coastal state) but folly not to try and address the root cause.Similarly, we also need to repair and maintain our fragile transportation infrastructure.  Both of these facts seems to provide the perfect opportunity to sell a rainy-day fund and to sell a carbon tax by highlighting the good work that could be done with the revenues.

So I will restate a basic policy proposal I made a few months ago:

1. Convert the kicker into a permanent rainy-day fund for the state.

2. Institute a carbon tax with revenues dedicated to transportation infrastructure (including mass transit) and public education.

3. End the ban on self-service gas to lower the cost of retail gas and help offset the impact of the carbon tax.

Seems like a good referendum, eh?

Beyond Measures 66 & 67: What Do We Do Now?

[From Fred Thompson]

When the legislature convenes this week in emergency session, lawmakers are expected to address many of the taxing and spending issues raised during the campaign over Measures 66 & 67. Gov. Ted Kulongoski, for example, announced that if they don't do something about the kicker this session, he will order them back to Salem until they do. Lane Shetterly and Tony VanVliet, former Republican state representatives, in an editorial entitled “Where Oregon must go from here” argue that their main order of business ought to be fixing our “volatile revenue system that condemns us to repeat our long history of boom-and-bust budget cycles, spending on services in good times and making deep cuts when the economy turns sour.” The last Republican elected to state-wide office, former labor commissioner Jack Roberts writes that “the kind of fundamental tax and spending reform that the state badly needs” includes revising the kicker, addressing corporate and capital gains taxes, and removing the working poor from the tax rolls. Similarly, Chuck Shekatoff of the left-leaning Oregon Center for Public Policy Research offers a similar list: fixing the kicker, corporate-tax reform, and expanding “the Earned Income Tax Credit to help working families with children make ends meet.” Chuck’s rhetoric may be inflammatory and his facts slippery, but his policy agenda is eminently mainstream.

My point here is that a lot of people agree about what needs to be done, the real question is how? The surprising answer is that there is a fairly simple, cheap solution. By simple, I mean one that does not require extensive legislative or institutional change. By cheap I mean one that won’t cost Oregonians a lot of new money.

The first step is to take the sales tax off the table. There is just no point in talking about consumption taxes at this time. Not only are they a political non-starter, they are also probably a bad idea. My research shows that replacing the income tax with comprehensive goods and services tax like Australia’s or a value-added tax like Ontario’s (since we would be starting new, there is not much sense in talking about an old-fashioned retail sales tax like California’s or Washington’s), which was also as progressive as our existing income tax, would be equally volatile and probably nowhere near efficient enough to compensate us for the half-billion in additional personal income taxes we would have to send to Washington DC (state income tax payments can be deducted from income for federal tax purposes, but not sales taxes). The unavoidable fact is that, if one taxes flows (income or consumption) rather than stocks (wealth), revenue volatility is directly proportional to progressivity.

A revenue structure that depended 50/50 on taxing consumption and income (assuming marginal rates of about 5 percent on both), would be only slightly less efficient than a pure consumption tax and would generate a small portfolio effect – that is, it would reduce revenue volatility by about the same amount Measure 66 will increase it). I seriously doubt that this would represent sufficient advantage to justify sending roughly $250 million more a year to the IRS.

[See Thompson, Fred and Gates, Bruce, Betting on the Future with a Cloudy Crystal Ball: Revenue Forecasting, Financial Theory, and Budgets - An Expanded Treatment. Public Administration Review, Vol. 67, No. 5, pp. 48-66, September/October 2007. Available at SSRN: http://ssrn.com/abstract=1123736]

The second step is to take very seriously the proposal put forward by the Legislature's 2008 Task Force on Comprehensive Revenue Restructuring to achieve “virtual stability” by changing the way we forecast revenue and by amending our one-of-a-kind income tax kicker law. As Shetterly, who chaired the 2008 task force, and VanVliet explain, “[i]n May of every legislative session the state economist predicts how much revenue the state will collect over the coming biennium, and the Legislature pegs the state general fund budget to that number. If revenues come in more than 2 percent above the forecast, all of the excess revenue is ‘kicked’ back to taxpayers…. Predicting biennial state revenue within a 2 percent margin of error is nearly impossible. In fact, [the] task force determined that the actual range of accuracy over the past 20 years of personal income tax revenue forecasts has been more like 6 percent, above and below the forecast.”

Chile, which has the world’s most volatile revenue structure and like Oregon has a self-imposed ordinance requiring the enactment of a balanced budget, has found a way to deal with this conundrum. They have redefined the meaning of balance. Their solution is to balance the budget against a forecast based upon long-term revenue growth. The simple fact of the matter is that it is easier to forecast long-run revenue trends accurately than to forecast revenue growth one or two years into the future. Each year, economists in the Chilean Ministry of Finance calculate a sustainable rate of revenue growth based on the geometric mean of past revenue growth and Chile’s executive and legislative branches use that figure as the basis for expenditure planning (budgeting). If revenues come in above the long-term trend, they are kicked into a sinking fund, which can only be used to make up revenue shortfalls or to pay down the national debt.

In other words, Chile has a kicker that looks very much like ours, but theirs constrains the rate at which spending (including unsustainable tax cuts) can grow during booms and stabilizes spending during busts. It constrains spending during booms because the Chileans use a forecast that is consistent with long-run sustainability; ours isn’t. They can stabilize spending during busts, precisely because they put their excess revenues aside for a rainy day; we don’t. Moreover, because the money is safely locked up in a sinking fund, the government of the day cannot get its hands on it except when revenues fall below the forecast, and then only indirectly.

It would be fairly easy for Oregon to achieve the same kind of virtual stability. The legislature needs merely to amend the revenue forecast so that it grows at a sustainable rate and to stipulate that a rainy-day sinking fund would have first call on kicker funds. We don’t need to repeal the kicker; we just need to change what we do with the money.

This proposal goes farther than revenue task force’s, which also recommended changing where the money went, but only the first 6 percent above the forecast -- “Any excess revenue over the 6 percent cap would kick back to taxpayers just as it does today. And once the rainy-day fund has reached a limit of 10 percent of the general fund budget (which we determined would take about four years on average), kicker checks would once again be sent out just like they are now.” My concern is that 10 percent of the general fund budget is just not enough – it is, for example, less than half of the state’s current cash float.

My proposal also goes farther than the task forces in honoring what Shetterly and VanVliet call “the spirit of the kicker – to limit the Legislature's ability to spend every dollar during good times – while creating a viable fund that could be drawn on to help sustain crucial services during hard times. (This would also make tax increases during future downturns less necessary or likely.)” The task force proposal would allow bigger increases in spending during booms.

One point should be stressed here: the state would need to borrow to make up revenue shortfalls to make my version of “virtual stability” fully sustainable – the nature of sinking funds calls for withdrawals to be made gradually over time. I do not believe that it would be fiscally responsible to return the kicker to taxpayers if the sinking fund amounted to less than 100 percent of the state’s general obligation debt, plus a prudent surplus, perhaps10 percent of the general fund budget. Only when the rainy-day sinking fund is full, would returning the kicker to taxpayers be justified.

[See Dothan, Michael U. and Thompson, Fred, A Better Budget Rule (February 10, 2009). Journal of Policy Analysis and Management, Vol. 28, No. 3, pp. 463-478, Summer 2009. Available at SSRN: http://ssrn.com/abstract=1077555]

Is this legal; is it feasible? To answer these questions one has to think back to 2003 and measure 28.

Remember what the opponents of Measure 28 predicted would happen if it failed: nearly a billion dollars cut from the budget, a 100,000 people dropped from the Oregon Health Plan or more, tens of thousands of seniors and people with disabilities denied assistance; schools shut down all around Oregon, and thousands of dangerous criminals released from prison early, causing dramatic reductions in public safety and exploding crime rates.

Certainly, bad things happened when Measure 28 failed. The legislature cut $110 million from the DHS budget. As a result DHS made the following changes to the Standard Oregon Health Plan (OHP), affecting approximately 89,000 members:
• Added premiums of $6-$20 per month based on income.
• Expanded co-pays for office visits, labs, ED, prescriptions, hospitalization.
• Non-payment of premium resulted in 6 month “lock-out” from OHP.
• Eliminated coverage for dental, vision, outpatient mental health, substance abuse, and durable medical equipment.
• Temporarily (two weeks) eliminated prescription benefits.
Moreover, effective July 2004, OHP halted new enrollments; on August 1 it restored them.

According to DHS research about 45 percent of those affected by these policies dropped out of the program, 26 percent for over 5 months, compared with 13 percent and 3 percent of OHP members whose benefits were unchanged. This implies that 29-41 thousand members dropped out of OHP as a result of Measure 28, 20-24 thousand for 5 months or more.
• Those who lost coverage had higher unmet needs for medical care, urgent care, mental health care and prescription medications than those who remained members of OHP.
• Persons with chronic illness who lost coverage were more likely to report unmet health care needs than those who remained members of OHP.
http://www.omip.state.or.us/OHPPR/OHREC/Docs/Presentations/EARLYCohort03_04_ppt.pdf
http://www.oregon.gov/DHS/healthplan/data_pubs/ohpoverview0706.pdf

The Legislature also cut 10 percent of state school aid, causing 84 of the state's 198 districts to truncate the school year by 3 days or more. Six other districts cut days from the year, but not from the end. But it is also apparently true that In 2003-04, Oregon’s school districts accrued unrestricted general-fund balances of 15 percent of their annual revenues, or $526 million – nearly two times the cut in state aid.

Crime rates also increased. According to Oregon Benchmarks data total crimes were up 2 percent above the trend line in 2003 and 2004 and property crimes were up 4 percent;, although crimes against persons were down nearly one percent and behavioral crimes were unchanged.

These are serious consequences. But they are not the cataclysmic effects threatened by Measure 28’s advocates. Most of the devastating cuts to state programs that were predicted never happened. In the end, three-fourths of the spending cuts threatened did not eventuate.

Why? Because the state borrowed most of the tax shortfall that occurred when Measure 28 failed. The Oregon Constitution requires only that the governor present and the state legislature enact a balanced budget, which is what happened prior to 2003, taking into account the tax increases challenged by Measure 28. Since the legislature had enacted a balanced budget and a shortfall then nevertheless ensued, the state could legally borrow to make up the difference, which is precisely what happened. This kind of borrowing would be equally legal and feasible when Oregon experiences a revenue shortfall under a revised revenue forecasting process.

In at least one way, virtual stability would work better for Oregon than Chile. Funds obtained to meet shortfalls would be borrowed by the state at federally tax-exempt rates; the offsetting assets in the sinking fund would be invested at higher taxable rates.

The third step would be to do something about removing the working poor from the tax rolls. Oregon’s personal income tax is progressive. But Measure 66 gives us an opportunity to make it more so. Consider the following table:




What this table shows is that the average, effective state personal-income-tax rates for the bottom two quintiles of Oregon taxpayers is actually higher than their average effective federal personal-income-tax rates. This is because Oregon taxes the first $6,100 of taxable income for a couple filing jointly ($3,050 for a single filer) at a rate of 5 percent, the next $9,100 ($4,550) at a rate of 7 percent, and incomes over $15,200 and less than $250,000 ($7,600-$125,000) at a rate of 9 percent. When the top rate comes down from 11 percent to 10 percent, why don’t we also take that opportunity to index the top rate and eliminate the first two tax-brackets? We ought to be able to afford it.

The fourth step probably ought to include the creation of a special task force to take a look at local revenues.

Oregon is not a high tax state. It was a high tax state during the 1980s, when its combined state and local own-source revenue burden, measured as a proportion of personal income caused Oregon to rank between 3rd and 11th highest in the US.

But it isn’t a low tax state either, not at least when all forms of government revenue are considered. During the last decade its combined state and local own-source revenue burden ranked between the 20th and 29th highest in the country, on average right in the middle.

http://www.taxfoundation.org/taxdata/show/336.html

Oregon’s fall in the revenue league table is NOT due to the state’s failure to raise taxes in line with other states. During the 1980s Oregon consistently ranked near the top ten in terms of state government tax burdens; it still does (9th in 2008). One thing about volatile tax bases is that they are also income elastic, not merely in the short run (which causes revenue volatility) but also over the long run (trend). This means that the State of Oregon’s revenue tends to grow faster over the long run than in other states even without tax increases.

Oregon’s fall in the combined state and local own-source revenue league table is due entirely to reduced local property tax burdens. If one looks only at state and local “tax revenues,” because of Measure 5 and 47, Oregon now ranks in the bottom 10 (this is the basis for the claim that OR taxes are the 44th highest in the county). But Oregon’s local own-source revenue rank hasn’t dropped nearly as fast as its tax rank because local user charges and miscellaneous revenues have been growing faster here than in any other state since passage of Measure 5. Increases in local user charges and miscellaneous revenues have made up more than half of the local revenue lost as a result of retarded property-tax growth.

http://www.census.gov/govs/www/statetax.html
http://www.taxpolicycenter.org/briefing-book/state-local/revenues/index.cfm

The fifth step has to do with corporate and capital gains taxes. We aren’t ready for a task force to look at this issue, but Chuck Shekatoff proposes a reasonable starting point: “Oregon still needs corporate tax disclosure to figure out how to best reform the corporate tax system.” My own view is that we would be better off with a lower marginal tax rate and different system of apportionment, but we don’t really have the facts to judge. We could use more study, in order to more clearly understand potential outcomes of any proposed policy changes in this area. Meanwhile, we have enough to do dealing with the changes that clearly are needed without more study.

So till then, let’s leave well enough alone, and deal with what we know.

Fred Thompson, Director, Willamette University Center for Governance and Public Policy Research

Ka-boom!

Went the Oregon general fund.  The Office of Economic Analysis blog has a nice picture that does a good job describing the torpedo they good ship Oregon took to her hull.

This is net receipts from February though April for the last 14 years.  Note how Oregon is $400,000 in the red in 2010, meaning we refunded $400,000 more than we took in during that period, and this is with 66 and 67.

What is going on?

...preliminary numbers show that the biggest culprit was capital gains. Following a 60 percent decline in capital gains income from the 2007 tax year to the 2008 tax year, we were expecting an additional 10 percent decline for the 2009 tax year. This was in line with what many other states were projecting (5 percent to -20 percent) based on an informal survey conducted early last winter. Unfortunately, preliminary estimates show that capital gains income likely dropped at least another 50 percent for the 2009 tax year. Going forward we believe that we will see an uptick in capital gains income, but carry forward losses and low levels of business transactions will limit growth.

Sigh.

Which brings me to another topic. Polictical football is being made of the decision not to call a special session and institute a 9% across-the-board cut. But, of course, as OPBs Chris Lehman reported lots of agencies only rely partly on general fund monies.  In fact K-12 education makes up more than 40% of general fund spending thanks to Measure 5.  Higher ed. another 10%. Mandated Medicaid about another 12%.  After that the only other significant portion is corrections and we see what a 9% cut will do there.   Given the dire state of K-12 in particular it seems difficult to understand why we wouldn't want to try and protect it.  But the reality of the numbers is stark: there just isn't a way to protect K-12 without totally gutting other state programs.  So while I like the idea of being more nuanced about cuts, there just aren't many degrees of freedom here.

Which of course brings me back to kicker reform and a rainy-day fund.  Yes, it does not fix long run trends that Tim Duy has very clearly explained, but a substantial rainy-day fund would allow us to avoid these types of draconian cuts to basic services in recessions.

Kicker Reform and Rainy Day Funds

On my way to Corvallis this morning I listened to a podcast of OPBs Think Out Loud show on kicker reform. It was an especially good show, largely because guests Tom Potiowsky and Lane Shetterly did a very good job explaining how the kicker works and how the Task Force on Comprehensive Revenue Restructuring's proposed reform would work. I recommend the show very highly for those wanting to familiarize themselves with the issues.

Two things that were said stuck out to me however:

1. Tom Potiowsky made the claim, when asked about why our revenue volatility is so high, that not having a sales tax is partly to blame. But there is a very large body of evidence that sales taxes are not significantly more stable than income taxes - especially in the short-run. [Just look at the current revenue situation in Washington state] So I was astonished to hear him say this.

That said, the focus was on the fact that we have revenue instability and what to do with it and the solution of a rainy-day fund was emphasized. But I think it is important that people understand that a sales tax is not a solution to revenue instability.

2. Steve Buckstein, of the Cascade Police Institute, made another astonishing claim in saying that kicker reform as proposed would decrease state volatility at the cost of increasing individual volatility. Say what? State revenues that come in in excess of a forecast do so mainly because individual incomes were higher than expected. To not return a kicker to households would actually decrease volatility to both parties. On what basis he made this claim is simply beyond me.

Also, his preferred solution, cutting state spending so money can be diverted into a rainy-day fund without touching the kicker is a pretty weak solution for a state that has, for example, one of the worst systems of public education in the nation.

The Aftermath

Today is not a happy day in Oregon. I am pleased that we have passed Measures 66 & 67 because I feared for public education. But passing these measures does nothing to fix the fact that we have, by most meaningful metrics, one of the worst public education systems in the country.

The state must now, finally, undertake the hard work of designing a stable and sufficient revenue base to bolster education funding and to avoid more costly disruptions in support levels. Another reason I am pleased at the passage of Measures 66 & 67 is I think that it is actually more likely, with the passage of these measures, that this will now happen. Why? Because no one is happy that it had to come to this and conservatives now must realize that Oregonians value the public services that the government provides so we can't just cut spending to fix all our revenue problems.

I think there is a very broad consensus that a permanent rainy day fund is essential and this should be the top priority of lawmakers in February. A sales tax does very little to solve the volatility issue but it could help prevent us from being an outlier on the income tax front, but we can't replace one with the other. In the future then, we have to look at property, sales and income taxes together and forge a sensible government funding model. But this is secondary, a rainy-day fund is the order of the day now. Let's get it done.

[I am pleased that the editorial board of The Oregonian has essentially the same message this morning]

Rainy Day Fund Now!

Today the Governor and the State Treasurer testify in Salem in support of kicker reform for a permanent rainy day fund.  My stance is clear - fiscal volatility is damaging and costly and the state is simply shooting itself in the foot by not addressing it.  This is not a Republican v. Democrat issue, it is common sense.

Though I would prefer a slightly different version of the bill being discussed - particularly not dedicating funds to universities but to education in general and making the fund much bigger - I strongly support it compared to doing nothing at all.

The Oregon Budget Mess - Myths and Reality

In an otherwise very solid piece on the Oregon budget crisis by Harry Esteve in The Oregonian, there are a few high profile misfires.  I am most disappointed in this list which I think is misleading:

Eight reasons Oregon is in deep budget trouble
1. Recession: Unlike past economic troughs, this one was too deep, too vicious to muddle through with nips and tucks.
2. No sales tax: Our heavy dependence on income taxes to pay for schools and state programs leaves us vulnerable when jobs dry up.
3. Failure to apply spending brakes: Lawmakers went on a spree in 2007 that came back to bite them.
4. Dinky savings accounts: The state's first-ever rainy day fund, established in 2007, was all but depleted within two years.
5. Ballot measures approved by voters: Property tax limits, longer prison sentences, kicker rebates and mandatory parks spending leave little wiggle room when income stalls.
6. Public employee benefits: Most state employees get fully paid medical insurance. And the retirement system, despite rollbacks and changes for newer employees, still has old guaranteed returns and present retirement contributions that add up to soaring future costs.
7. Federal stimulus: It saved jobs for two years, but now it's going away and the economy did not recover fast enough to replace it.
8. The kicker: If the economy takes off faster than state officials anticipate, Oregon could be sending money back to individuals and corporations while cutting schools and services.

#1 is clearly correct, this is the worst recession since the great depression, there is no way to escape its downward pull.  But #2 is simply wrong.  As I have illustrated in this blog through a rather extensive bit of research, a sales tax would not solve anything as consumption and income are very highly correlated.  Sales taxes are almost as volatile as income taxes.  It is the shift away from property taxes that contributed most the the current volatility of state revenues - which is alluded to in #5.  [Though Ironically de-coupling property taxes from market values helped a tiny bit as the housing crisis hit] #6 is also misleading.  I don't know of a full accounting for all state employees, but the relatively generous benefits I get as a state employee are more than outweighed by the much lower salary I get relative to my peers.  I accepted a salary that was 25% below a competing offer when I moved back in 2006.  I had a very, very strong preference for living in Oregon, but we are at a competitive disadvantage amongst those without such preferences.

I do agree most strongly with #4 as you all well know.  In fact I think a good rainy-day fund built into the kicker would render the kicker question (#8) moot.   I think this is the #1 priority for the state legislature going into the next session.

Oregon's Fiscal Policy: Fred Thompson, Guest Blogger

Finals are around the corner and I have been busy so I have been lax in my bloggitorial duties, fortunately Fred Thompson is here to rescue me:

According to the Pew Center on the States, a part of the Pew Research Center at Harvard’s Kennedy School of Government, only eight states fared worse than Oregon in a study of government money management practices. They are about half right and pretty much all wrong. They are right that we haven’t faced up to one very big, long standing problem: the extreme volatility of state government’s revenue structure. They are wrong when they confuse policy advocacy with problem diagnosis.

What don’t they like about us? We don’t have a sales tax; our ‘rainy-day’ fund is insufficient; and we have the kicker. All true; but adopting a sales tax and eliminating the kicker would still leave us with a revenue volatility problem, which is the main concern driving the Pew Center’s assessment, and it is too late to build a big enough‘rainy-day’ fund to make a significant difference the next time revenues go south(probably, next fiscal year), even if that were a good idea, which it is not. Moreover, as my previous column noted, we can deal with the revenue volatility problem directly.The great things about Oregon’s revenue structure are that it is fair and adequate.

The Pew Center damns Oregon’s professional money managers with faint praise, saying thestate “employs an impressive number of talented individuals. Unfortunately for them, allthe good intentions in the world can't overcome the state's thoroughly unwieldy fiscalstructure.” Frankly, their accomplishments deserve better than that. Oregon’s Treasury functions (investment management, debt management, and cash management) are among the best in the nation (as judged by their treasury officers in other states and financial analysts in the private sector). Oregon’s budgeters and revenue forecasters are equally respected. The state’s accountants and internal auditors consistently produce the top-rated general-purpose financial statements and a squeaky-clean, government largely free of financial scandal. Much the same thing can be said of many of Oregon’s state agencies and departments, including the often-maligned Department of Human Services,which has recently made dramatic improvements in its money management practices.

Oregon’s fiscal structure is a lot of things, but unwieldy it’s not.

No Support for a Rainy-Day Fund?

OPB is reporting on a poll they commissioned showing a decided lack of support for kicker reform leading to a permanent rainy-day fund. Frustratingly, they do not appear to be releasing the poll itself so one cannot know the exact wording of the questions. It is surprising as other recent polls mentioned by Peter Courtney and others have shown 58% support (which they say is still too low for it too succeed). Polls are extremely sensitive to the wording and order of the questions and it frustrates me that a news organization is not transparent about theirs (and any poll they report on).

So what gives? Why won't they release the poll?

This is a complicated issue and the academic in me thinks that all it takes is a little educatin' to get folks on board - but not if it is really at 38% support.

Economist's Notebook: Taxes and the Rainy-Day Fund

A rather depressing sense of self-satisfaction seems to have consumed the state democrats after the passage of Measures 66 & 67. But celebrating their passage as a major political victory, and allowing their passage to become an excuse not to immediately address the revenue instability that necessitated the new taxes, is a serious mistake. The taxes were not a victory to celebrate but a disheartening sign of the disfunction of the state's revenue system. The fact that we had to pass them should be seen as a defeat, not a victory, and as a condemnation of our stewardship of the state's finances. To allow these new taxes to take our eyes off of real reform is to squander an opportunity to permanently fix what's wrong with the states revenues. Everyone is (or should be) upset, and motivated to fix what is wrong.

One of the main reasons for this lack of urgency, I believe, is the sense that these new taxes were carefully targeted, so that there is little real effect on most Oregonians - that we get a free lunch. But this ignores one of the most basic lessons in economics: TAXES DON'T STAY WHERE YOU PUT THEM.

Even a tax on the wealthiest households don't stay there. Research has shown that employer's pay is based on real wages net of taxes - so businesses will end up compensating highly paid employees for the new taxes - which increases their cost of doing business, which will end up in higher prices and lower share performance, both of which affect everyone. [This is the reason, by the way, why income taxes do not turn out to be very effective in addressing income inequality] New taxes on businesses will have the same effect, eventually making their way into higher prices and lower quantities which means - yes - jobs. The point is all Oregonians end up paying these new taxes in some small way and so we should all be upset that we got to this point in the first place.

I supported the new taxes and still do: they were necessary in my opinion and the net effect should be minimal. But there will be effects, make no mistake. I would have preferred them to be entirely temporary because of this.

So it is time for the state legislature to stop wallowing in self-satisfied complacency and get a permanent rainy-day fund passed this year. I have been very critical of the Governor in the past, but he is spot on this time in trying to get this moving now. Because whether you voted for or against Measures 66 & 67 you shouldn't be happy - you should be motivated for real reform.

A Permanent Rainy-Day Fund?

The Oregonian is reporting on a plan coming out of the state legislature to put in front of voters a plan to create a permanent rainy day fund. Friend of the blog Fred Thompson and co-authors have looked at this problem in the midst of the last round of budget woes (only a few years ago) and their analysis is interesting and raises some questions:

• Why not also relax fiscal rules and allow borrowing during economic downturns?
• Is $1.5 billion enough? Thompson, et. al., suggest it is in the right ballpark, but given the current revenue gap which might easily eclipse $4 billion over the next two and a half years, it might need to be bigger.
• Why build something on top of this ridiculous rule that depends on an economic forecast (as Paul Krugman says economic forecasting is slightly less respectable than witchcraft)? We are fortunate to have a talented and professional state economist in Tom Potiowsky, but I am sure even Tom would tell you that forecasting is simply very educated guesswork. Why not come up with something new and better?

Still, I am very, very supportive of this initiative, it is the right idea and needs to happen. I think that this puts the emphasis in the right place: spending stability rather than revenue stability (which is unachievable).

Tax Reform in Oregon

I am following with some interest the latest foray in to state 'tax reform' by the governor.  I think it is a good time to repeat what I have said and documented in these pages many times: A sales tax will not provide revenue stability in any significant way.  This is not hard to see, just look across the Columbia and you will see a sales tax dependent state that is struggling with revenues as much or more than is Oregon.  No surprise this as income and consumption are very highly correlated.

What Oregon needs is fiscal stability not revenue stability.  Revenues will never be stable, but our budget can be stabilized through a sensible rainy-day fund.  Other states have them and benefit from them why can't we?  The answer is that whenever we talk about taxes both those that want taxes higher and those that want them lower start jumping in and saying they will withhold support of a rainy-day fund unless they demands are met.  This is stupid and destructive.  

But since still we are talking about tax reform, let's at least talk sensibly.  I don't know what to make of the tortured logic of the Oregonian editorial board this morning: 

But Oregon is much less tax friendly to small business. The gap arises in large part because of the way small businesses are structured and the way Oregon taxes the two most common types of corporate structure.

Traditional corporations pay corporate income or excise taxes. Those rates top out at 7.6 percent. Many small businesses are structured as what the Internal Revenue Service calls S corporations. These businesses do not pay corporate tax, but owners, whether a sole proprietor or shareholders, pay taxes at the personal income tax rate. Owners of sole proprietorships and partnerships also pay at the individual rate. In Oregon that rate tops out at 9.9 percent.

Um, what? If I am a small businessperson and my income comes from the revenues of my business, why should that income be taxed at a lower rate than someone who works for a third party? They say earlier that:

The amount of taxes paid by businesses varies widely, according to circumstances. For example, Oregon's lack of a sales tax improves its score in tax rankings, but sales taxes are a relatively small expense for many businesses.

But this is nonsense - if I am a small businessperson, I pay an income tax on the income I earn from my business, just like everyone else, but then I don't have to pay a consumption tax so my overall tax burden is quite modest, just like everyone else. Comparing the individual income tax rates to those of C class corporations makes little sense. Those corporations pay lower taxes, but their employees pay income taxes.

Which is really all to say that don't fall into the trap of thinking of a sales tax as that much different from an income tax, you have to think of these two together when thinking of the overall tax burden on individuals.

A Final Treatise on Sales Taxes

In previous posts I have examined a number of aspects of sales taxes and looked for evidence that would shed light on the actual experience of sales taxes and different tax mixes. Unfortunately, the empirical evidence is scant and not terribly informative. This is not too much of a surprise as it is a very challenging research problem, you have to control for all of the things other than taxes that might affect state revenues, investment, employment, etc. and doing so is virtually impossible. It is frustrating, however, but as an economist I have a fall back: economic theory which can give some insight into expected affects of tax structure changes. I am now in a position to summarize what I have learned and what I now think about sales a sales tax for Oregon and why.

Before that, however, I have a few loose ends to fill in. The first is what George Zodrow of Rice University (who very generously sent me a copy of his book, “State Sales and Income Taxes: An Economic Analysis”) calls the "exportability" of a tax system: how well a state can export its revenue burden to residents of other states. Income taxes, as I said before have the nice feature of being deductible on federal tax returns (sales taxes have been added too in the past as a temporary measure, but you have to choose one or the other, so if we are talking about adding a sales tax along with income taxes, we loose a bit of the exportability). Deducting income taxes on federal returns shifts the burden a bit to residents of other states. But a lingering question is whether sales taxes can be good in the exportability criterion from the fact that non-residents spend money in Oregon.

I think Zodrow says it best:

The sales tax on consumer goods can be exported to the extent that such goods are purchased by out-of-state residents – primarily tourists and business visitors. This is not likely to be an important source of revenue for most states. In any case, if opportunities for tax exporting in this area are deemed to be significant, they can be exploited through the use of special taxes on hotel/motel occupancy, car rentals, and, to a much lesser extent on entertainment and admission to amusements.

To this I would add that a gas tax is also a big area in which we exploit these opportunities to export our taxes. Dean Runyan Associates does the Oregon State Travel Impacts studies for the state and I looked at their estimates. First, they report that many locales charge an occupancy tax for hotel/motel rooms – though these are local taxes, not state. They also report that food and retail spending together make up less than 40% of visitor spending. But in 2006 they estimate a total in excess of $7 billion spent in Oregon by out of state visitors – so perhaps there is room for some more specific taxes if not a sales tax in general, though we must be mindful that we are very dependant on tourism in this state and we would not want to impact it too much.

This brings me to another point, if sales taxes are enacted; will it hurt the tourism and retail sectors hard? I feel pretty strongly that they would not. I think the price elasticities would be low due to the fact that we would probably have a sales tax on the low end in the national spectrum, so we would not be abnormally expensive.

On the other hand, abnormally high tax incidences do worry me for the very same reason. So Oregon’s income tax rate, essentially the highest in the nation, worries me a lot. I have tried to
find evidence of the impacts and I have seen estimates of lower investment, job losses and increased expense for employers who have to compensate for the tax difference but overall impact on the economy is, in my mind, difficult to assess and I remain unconvinced by the evidence. But I am pretty strongly influenced by economic theory, however, which suggests that this should matter in investment and employment decisions.

Volatility is, as I said at length before, not reason enough to support a sales tax, as not much is necessarily gained by such a tax. The only real answer to volatility is either a rainy day fund, or (as was pointed out to me by Fred Thompson) allowing the government to engage in deficit spending during bad periods. The latter strategy has the appeal of not over saving which is inefficient. Equity is a concern, but income taxes have been shown to be a poor way to achieve redistributive goals (and may in fact be impossible because labor markets adjust). It is through ex-post transfers that equity gains are made in general, but we would have to be ready to devote a good portion of any sales tax to such an end if we are to avoid making our tax system more regressive.

So in the end, where do I stand? Well I would like to see a sales tax to lower the income tax incidence in Oregon. I would support it only if there were adequate exemptions and transfers that could assure we do not add regressively into the tax system. I would also like to see some type of permanent rainy day fund or the allowing of deficit spending. I think we could stand to gain much as a state in terms of investment and job creation from the lowering of the income tax and that boom and bust cycles in state spending are very inefficient. Any exportability we get from a sales tax will be countered by the loss in exportability from the lower income tax, and I don’t expect much in terms of volatility reduction except perhaps in extended downturns. I do think that, all else equal, diversification of revenue streams is a decent goal, but, more importantly, I think we should avoid being an outlier in any one tax dimension in the US.