Posted by: Josh Lehner | February 27, 2015

Tax Structure and Volatility

During each of the past two recessions, Oregon’s general fund revenues dropped twice as much as in the typical state. In fact only Alaska and its reliance on oil (see: oil prices) saw considerably larger losses each time. Similar states to Oregon in terms of its economy and/or tax structure, like California, Connecticut, Idaho and Massachusetts, likewise see large revenue swings along with the business cycle. No other states have seen similar or worse revenue swings than these.

So it came as a surprise when a recent Pew report on state revenues found that Oregon’s tax system is not, in fact, that much more volatile than the typical state. However, past experiences have shown that both Oregon’s economy and tax system are indeed volatile. The differences arise at least partially in the methodology and calculations. For example, Pew examines each revenue source individually instead of comparing state general funds. Here, one can see a very large issue in that Oregon’s personal income tax really is not that much more volatile than the typical state, however our reliance on the tax makes our overall general fund volatile. More on this below. Making accurate state comparisons is always challenging since each one taxes certain items or activities at different rates and the like. However, similar to a previous Pew report, the specifics of the analysis do impact the interpretation for Oregon.CensusGFgrowth

As shown above, Oregon’s overall tax structure (using the same data over the same time period as Pew) is more volatile than the typical state. The one surprising finding in the Pew report that does turn out to be true however, is that Oregon’s personal income tax revenue is not much more volatile than the typical state. Initially I thought that would not be the case, particularly given the state’s economy is more volatile. However, it is true. So how then is Oregon’s overall volatility higher? It has to do with our reliance on the income tax; no other state comes close. Additionally, many of the states that have higher revenue volatility overall rely on severance taxes and/or are energy producers.CensusGFVolatilityPITSo this means Oregon needs to institute a sales tax, right? Well, maybe. If you want to shift the tax burden from income to consumption, then yes. Or if the primary goal is revenue stability, then yes. Work from the Legislative Revenue Office has shown that diversifying the tax base (i.e. put in a sales tax, lower income taxes) does result in more stable year-to-year fluctuations. While our office has no official position on the tax system (we are tasked with forecasting revenues), we do try to provide some broader points for discussion.

First is the issue of risk versus return. Previously we dove deep into comparing Oregon’s income tax with Washington’s sales tax. Those results still stand. In the typical year, income taxes generate more revenue than do sales taxes. (Of course some see this as a drawback, not a benefit.) However with a greater return does come more volatility and year-to-year fluctuations. This creates challenges not only for forecasters, but more importantly it creates management issues for the Governor and Legislature trying to draft budgets and provide services.

Second there is the broader issue of an eroding tax base, something our office previously discussed as well. With an aging demography and with a larger share of purchases shifting from goods to services (which are not generally taxed to the same degree) both income and sales tax effectiveness is and will continue to erode. Grandma has less current income in retirement than during her working years, which generates less income tax revenue. So she spends less overall (lower sales taxes) and what she does spend money on is largely not taxed (e.g. food and medical care.) Even as both major tax instruments face pressure over the extended horizon, sales taxes began eroding first due to the shift in consumption from goods to services and online sales, and sales taxes have certainly eroded further in the past decade.

CensusPITSalesCompNone of this is to say that instituting a sales tax is bad policy by itself. There are some really big benefits as well, such as exporting the tax to visitors. Rather, our office tries to bring a broader discussion to light and for individuals and interest groups to realize some of the trade-offs that would occur.


Responses

  1. Josh, nice discussion. Do you have a recent estimate of the amount of out-of-state tourist expenditures would be subject to a sales tax? Many years ago the estimate was that tourists would cover the administrative costs of a sales tax and not much more.

    • Hi Scott,

      I don’t have a good answer for you, unfortunately. However given a state like Oregon, which does have a good amount of tourism, I would guess that it’s larger than just administrative costs, depending upon how large those costs are too. For a very rough gauge, if you look at retail sales per capita and adjust for personal income levels across the country, Oregon is 16% above the national average. A lot of that has to do with the border tax effect and Clark County, as you know. However not all, and not all of that border tax impact would go away either.

  2. […] state has come to expect during bad economies. State funding is notoriously volatile because of Oregon's extreme reliance on personal income taxes, which can fall sharply in bad economic times. As the Great Recession set in a decade ago, the […]


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Categories

%d bloggers like this: