Budget & Tax

Volatile revenue sources make budgeting difficult

November 9, 2018

Curtis Shelton

Not all taxes are created equal. The goal of tax policy should be to provide a fair, stable revenue base with minimal drag on economic growth. Predictability is crucial for a tax structure since the state budget is based on estimates of future revenue. This is why the term “budget shortfall” can be misleading. A budget shortfall does not mean the state has less money than before, but that revenue has come in below the estimate. Last fiscal year gave an example of this as revenue exceed the previous year’s total, but a budget shortfall occurred because the state had predicted even higher revenues.

Revenue coming in over the estimate can also be a problem. During massive swings in cyclical industries like oil and gas, state revenues can soar. This excess can create an incentive to expand programs beyond what is sustainable when the economy, and revenues, return to normal levels. The state’s Rainy Day Fund was created to help stabilize the state budget during these swings, but the fund’s efficacy has come into question.

Because of the importance of predictability in Oklahoma’s tax structure, OCPA has analyzed volatility in the state’s major revenue sources, when adjusted for inflation. By using the standard deviation as the measure for volatility, we can show which taxes have had the greatest variance since fiscal year 2000.

Comparing the variance in each of these tax sources to the variance in the overall economy can paint a picture of whether a specific tax has a greater variance than that of the “normal” variance of the state’s economy as a whole. The variance in Oklahoma’s total personal income and gross domestic product both hover near 5 percent.

The table below shows the standard deviation for each of Oklahoma’s major revenue sources. A larger standard deviation means that revenue source fluctuates more year-to-year on average.

According to the data provided by the Oklahoma Tax Commission, the corporate income tax shows the greatest volatility among the major revenue sources for Oklahoma. Motor fuel taxes, which include taxes on gasoline, diesel, and natural gas, were found to be the least volatile of the tax sources analyzed.  It must be noted that while the sales tax and corporate income tax rates have remained unchanged, that has not been the case for the other taxes.

There are two outliers in fiscal years 2005 and 2006 when the tax rate on cigarettes grew by 350 percent, from 23 cents a pack to $1.03 a pack. The year-over-year change in revenue was measured over 70 percent for these two fiscal years. To put those two years in perspective, no other years saw a year-over-year change over 8 percent. There was no other year-over-year change in tax rates that resembled that drastic increase.

The individual income tax saw the most changes in rates, moving from 6.75 percent in fiscal year 2000 to 5 percent in fiscal year 2018. I have shown previously how income tax rates are not the only driver of income tax revenue. As income taxes only show a slightly higher variance than the overall economy, these tax rate changes have not had a significant impact on the tax’s volatility.

Every tax source other than motor fuel taxes has a greater variance than both broad economic indicators. This means that these tax sources are more elastic and are thus susceptible to change due to specific industry and business cycles that can be harder to predict than the economy as a whole.

Just as an investment portfolio benefits from diversification, so too does a tax benefit from a broad base. Levying taxes with a narrow tax base or offering a plethora of exemptions can make a revenue source more volatile. An overreliance on volatile revenue sources can make predicting revenue, and therefore crafting the state budget, difficult. Deciding how to spend tax dollars is already hard enough. Adding in the uncertainty of how much there is to spend makes the job that much more difficult.