TaxBreakOregon

The Register-Guard http://www.registerguard.com/

GUEST VIEWPOINT:

The tax-break trap

If Oregon had kept tax ‘loopholes’ in check,

state would be in the black

By Steve Robinson

For The Register-Guard

Published: Sunday, Jun 12, 2011 02:21PM

Over the past decade, the state of Oregon has had to make massive budget cuts on a regular basis. The main cause?

Not greedy unions. Not public employee salaries and benefits. Not even the escalating cost of health care.

The main cause: tax breaks.

The data show clearly that the persistent deficits and budget cuts in Oregon could have been avoided except for the steady increase in the state’s “income tax expenditures.” This is the official term; depending on your point of view, you may call them tax loopholes, giveaways, incentives or the more neutral term I’ll use: tax breaks.

I have done a historical analysis combining data from Oregon’s Tax Expenditure Report with tax data from the Internal Revenue Service and the Oregon Department of Revenue, official budget and expenditure data, and economic analyses by various sources. I used data for each biennium from 1999-2001 through the projections for 2011-13, adjusted by the growth in total statewide personal income (58 percent since 2000) to make each biennium comparable to all the others.

The state’s discretionary spending is mostly funded by income taxes and net lottery proceeds. Without tax breaks, these sources would have produced a very steady stream of revenues, at about $26 billion per biennium.

But tax breaks, which now eat up 46 percent of the potential revenue, have been growing at the rate of $230 million each year, leading directly to similar decreases in discretionary spending that have how totaled $2.7 billion.

My conclusion: If we had kept tax breaks from growing as they did, we would not have a budget deficit now.

What exactly are these tax breaks?

The Tax Expenditure Report, available on the Department of Revenue’s website, lists 217 income tax breaks with a total revenue impact of $12.1 billion for 2011-13. Most of these — both numbers and dollars — are in the federal tax code. The rest are under state law (subtractions, credits and others). Some examples:

Federal law exempts from taxation many employee benefits, Medicare, Social Security, some capital gains and special breaks for corporations. Retirement plan contributions and earnings are not taxed until withdrawn. Taxpayers who itemize can deduct home mortgage interest, property taxes, charitable contributions and some medical expenses.

Oregon law grants the Business Energy Tax Credit, limited exclusion of federal income taxes paid, a more generous deduction of medical expenses for taxpayers older than 62 and many other corporate and personal tax breaks.

The Tax Expenditure Report also lists 123 property tax expenditures and 38 in other categories (credits against taxes on fuel, tobacco products, beer and wine, etc.), but I’m focusing on the income tax variety.

Let’s review recent history. Since 1999-2001, as the graph shows, Oregon’s budget has gone through three distinct periods: a loss of 10 percent through 2005, expansion of 7 percent through 2009, and another loss of 11 percent projected through 2013, for a total loss of 14 percent. During those same periods, tax breaks expanded each time, a total of 31 percent.

Adding up the damage from this growth in tax breaks, the total comes to $11 billion for the 12 years. Combined with the loss of federal matching funds in human services and health care, this growth has reduced resources available for program spending by some $15 billion.

During this period, cuts have been made in rough proportion to program allocations in the budget. Restoring these cuts would have provided about $6 billion for education, $7 billion for human services and health care, and $2 billion for public safety and other services.

As well as avoiding these damaging cuts to our public infrastructure and safety net, we would certainly have dodged the divisive campaign over Measures 66 and 67 a year ago, and Oregon’s top income tax rates would have stayed where they were.

Who benefits from income tax expenditures?

Nearly all taxpayers benefit to some extent; however, the benefits are extremely concentrated at the top. The Tax Expenditure Report contains distribution tables for 25 of the 217 tax breaks. Extrapolating from this sample, I estimate that over half — about $6 billion — of the $11 billion in tax breaks has gone into the pockets of the top-earning 20 percent of taxpayers, who in 2009 averaged $143,000 in adjusted gross income.

The largest single beneficiary of this trend, however, isn’t anyone who lives in Oregon. It is the U.S. Treasury. Not only has Oregon left $4 billion in federal matching funds on the table, Oregon taxpayers have paid another $3 billion to $4 billion in federal income taxes as a result of reduced state income tax deductions. That’s $7 billion to $8 billion gained by the federal government, and lost to Oregon, as a result of the growth in tax breaks over the past 12 years. These added funds would have also stimulated additional economic activity and reduced unemployment in Oregon.

Why are tax breaks growing so fast? The data show that much of the answer to the growth question emanates from the federal tax code, how it has changed since 1999-2001, and its interactions with broader economic trends.

The George W. Bush-era tax cuts contained provisions that were especially generous to upper income earners. High earners are more likely to benefit from powerful tax-cutting benefits such as health insurance, retirement plans and others. These folks make full use of itemized deductions such as home mortgage interest, property taxes and charitable contributions, while those in lower brackets tend to use the standard deduction instead. Nothing wrong with that; that’s our system.

The political dynamics in Salem contribute to the problem. Suppose we are talking about a bill to establish a new tax break or extend an existing one, with a revenue impact of $140 million a biennium. That’s only 1 percent of the general fund, so no single program is getting hit too hard if the tax break is adopted.

On the other hand, the proponents — those who will receive the $140 million in benefits — are extremely motivated. They are hiring lobbyists, making campaign contributions and flying in experts from around the country, talking about how this tax break will create jobs and grow our economy.

In short, the debate about tax breaks has been unbalanced, resulting in the massive accumulation of 217 such measures on the books.

A related issue is oversight. The Legislature’s Joint Ways & Means Committee scrutinizes each general fund program in great detail, with the assistance of the budget office in the executive branch as well as the Legislative Fiscal Office.

Tax breaks have not been subjected to the same degree of scrutiny. We have seen some progress in recent years with the establishment of the Joint Tax Credit Committee; this session, Ways & Means has even set up a “budget” for the committee to work within. But the federal tax breaks are still not included in even this moderately improved oversight process.

In 1996, Oregon voters passed a constitutional amendment requiring that revenue-raising bills receive a three-fifths vote in both chambers of the Legislature. Whether this should apply to bills that simply cut back on tax expenditures is a matter for debate, and has yet to be determined by the attorney general. As of now, however, legislative counsel says it does, so we have a ratcheting effect that tends to make tax breaks grow over time.

It takes only a simple majority to pass a tax break, but if we discover shortly thereafter that the costs of it are ballooning out of control, as happened with the Business Energy Tax Credit, it takes a three-fifths majority even to scale it back — and that’s a hard nut to crack.

What can we do to fix this problem?

If we do nothing, tax breaks may well continue to eat into the state budget at the rate of $230 million a year, with serious consequences for education, health care and other services. Looking back, if we had found a way to freeze tax breaks at the level of 1999-2001, we would have an extra $4 billion (including federal matching funds) available next biennium to spend on education, health care, public safety and other vital services.

The Legislature has already taken some steps in the right direction by increasing the number of Oregon tax credits scheduled to sunset on a six-year cycle, establishing the Joint Tax Credit Committee, and passing House Bill 2825, sponsored by Reps. Phil Barnhart, D-Eugene, and Kim Thatcher, R-Salem, to increase transparency and accountability of existing tax credits. But stronger action is required.

The Legislature should develop a longer menu of federal exclusions and deductions subject to frequent review without the three-fifths majority rule creating additional barriers to control. That means ending the automatic “rolling reconnect” to the federal code, which causes federal tax breaks to automatically become part of the state income tax system, and making good decisions about which of these items — with their large and growing cost to state government — to connect to on a case-by-case basis.

We should also encourage our representatives to refrain from causing any further damage to revenues, such as by enacting new tax breaks or extending those that will otherwise sunset. They should take a hard look at existing provisions that provide a disproportionate benefit to upper-income taxpayers to little apparent purpose.

The first places I would look would be wherever Oregon has tacked a credit or deduction onto a federal one. In such cases, since it is much smaller than the federal tax break, the Oregon version is unlikely to effect a desired change in behavior (such as new investment or promoting green energy).

If we can move our system over time toward providing better data, more transparency and greater accountability, we have a chance to gain control over the income tax breaks that are sucking the life blood out of Oregon’s general fund. It will take a lot of political courage to actually roll back some of the more popular tax breaks that upper-income people have gotten used to, but there are techniques available, such as capping and means-testing, in case such courage develops in response to popular demand.