Budget & Tax, Agriculture

Unleashing Rural Opportunity in Oklahoma

April 8, 2015

Steve Anderson

State finances are a complicated morass of federal, state, and local revenues and expenditures interacting in ways that almost no journalists understand and very few political leaders can explain. In my tenure while serving two governors (Oklahoma’s Frank Keating and Kansas’s Sam Brownback) and consulting with many more, I have found that decision-makers and the citizens who elect them need to be provided a clear view of those interactions. Citizens deserve to understand the relationship between the actions (or inaction) of government and the outcomes.

In Oklahoma, the most glaring example of a lack of understanding is the view from the state capitol building of the rural areas of our state. This understanding gap has resulted in government policies which have not been successful in helping rural Oklahoma maintain its infrastructure, much less stanch the flow of people and resources from those rural counties.

When I first met Sam Brownback, we had a conversation that could be repeated almost verbatim if we were talking about Oklahoma instead of Kansas. I told him when you look at the state’s assets as a balance sheet, and look at people and resources as the primary assets on that balance sheet, the rural areas are the most undervalued and hence low-performing.

The key part of that statement is “undervalued.” The statistics for Kansas and Oklahoma are fairly similar. Who would think that, when looking at revenue from crops, Oklahoma would be 30th in dollar value of crops produced—trailing states like North Dakota (11th), Minnesota (6th), or Idaho (20th)? Oklahoma does better on livestock production, but at 12th it still lags behind Kansas (5th), Arkansas (9th), Wisconsin (8th), and California (2nd).

On top of those discouraging statistics is a steady reduction in population in many rural counties and the resulting reduction in services available locally. Large-ticket sales items had already mostly been transferred to metro areas, and the Internet has continued that movement of sales-tax dollars out of the local communities.

The trend in modern agriculture has been mechanization and economies of scale. Nowhere is that effect more pronounced than in the bulk crops like wheat, corn, and cotton that dominate Oklahoma’s crop output. Of Oklahoma’s 77 counties, 23 lost population in the first decade of this century, continuing a pattern that has left some counties with constantly declining revenue bases for county and city services.

Oklahoma policymakers have struggled with how to help rural Oklahoma replace those lost revenues that support basic infrastructure. Programs like the Rural Economic Action Plan (REAP) and Community Development Block Grants (CDBG) have attempted to replace some of those lost revenues from sales and property tax receipts. While these policies have no doubt helped on some level with maintaining infrastructure, they have not changed the dynamics that created the need for them.

When Governor Brownback and I looked at these very similar issues in Kansas, we knew the status quo was unacceptable. Changing the course was not going to be done by any typical government program, nor was it going to happen without a viable short-term and long-term approach. In the short term, we looked at empowering locals and their economic development directors by creating Rural Opportunity Zones (ROZ). These initially applied to counties who had lost population over the prior decade, but we soon discovered the idea was so popular that additional rural counties were added in successive legislative sessions.

The base of the plan from the state’s perspective was to make any individuals who moved to those counties from out of state free from individual income tax for five years.

What was key in the design of the ROZ was that sole proprietorships, limited liability companies (LLCs), partnerships, and other entities taxed as “pass through” were also by definition tax-free.

I will explain below why this is so important to the long-term strategy. The immediate impact of the tax-free zones was felt primarily by individuals who were recruited by existing businesses. As in any reduction or elimination of tax rates, the higher the income the greater the impact on the recipient. It helped hospitals, such as the one in tiny Ashland, Kansas (population 855), to include the additional income the doctor would keep in his or her pocket in the package they used to successfully recruit.

We also saw that those economic development directors who understood the ROZ used it as an effective tool in their kit for recruiting businesses. Norton City/County Economic Development executive director Scott Sproul was a great example of how you can use the ROZ to bring businesses to your town. Sproul cast a nationwide net, letting business owners know that if they were a pass-through taxed entity both they and their employees they brought with them were tax-free. He also journeyed a short distance to the north to directly recruit businesses just across the border in Nebraska. I would encourage those who doubt the short-term impact of the ROZ to talk to the hospital administration in Ashland or to Mr. Sproul to get real stories of success.

Maybe even a better indicator was that in every session since the first ROZ legislators have added counties to the program.

The long-term goal was to bring higher-value crops and livestock production to the Kansas rural areas, along with the processing of rural products in the areas that produce them. Not only do these sorts of agricultural endeavors bring more dollars to rural areas, they also tend to require more employees even without the processing plants. The few opponents who decried even the small estimated impact of the ROZ on state coffers—original fiscal impact was estimated at $2.2 million—failed to understand that every out-of-state resident or business that moved to a ROZ county may not be paying income taxes to the state but they are paying property taxes and sales taxes. Even more importantly, the increased population is needed for the rural areas to sustain the critical mass to continue to support schools, hospitals, city/county services, and infrastructure needs.

Passing the ROZ gave our rural areas a head start on using the advantage of the zero income tax to solicit businesses. We followed the next year by announcing and then passing the “March to Zero,” which began the elimination of the income tax for all citizens and immediately eliminated the tax on pass-through businesses. This sent a clear signal that if you came for the ROZ you were going to see those benefits extended as we eliminated the tax for everyone. All the pass-through businesses that came for the ROZ benefited from the removal of the income tax permanently.

However, because of the huge fiscal impact that reducing the taxes on wages had on state revenues (the original estimated impact of the first-year reduction from 6.45% to 4.9% was in excess of $800 million), we could only reduce the rate to what is now 4.6% from the 6.45% as we marched toward zero. That left the tax on wages as an additional incentive for businesses to recruit or bring with them employees from out of state. Those out-of-state wage earners who became residents will have five years with no income tax and then join the rest of Kansas residents in watching what will already be a low tax rate in five years completely disappear.

But the long-term thought process also includes a more regional approach to changing rural areas and addressing the issue with the Kansas “balance sheet” in a way that could benefit the entire Midwest.

In the central part of the country, Texas and South Dakota were already no-income-tax states, and Oklahoma was giving us mixed signals on their direction. The biggest play in our strategy for taking advantage of the multiple zero-tax areas (including the Kansas ROZ and the March to Zero) was to try to bring the high-value processors out of California and other areas with longer growing seasons to the Midwest. We can do this by creating a north-to-south zone in which they could move up or down as the weather changed with the seasons, giving the processors 12-month growing seasons while maintaining a similar tax and regulatory consistency throughout. These processors would provide a local purchaser who has access to the retail market for farmers. The current lack of a purchaser or access to market has prevented many farmers from moving even a small part of their acreages from the conventional bulk crops to higher-value crops. The ability of farm families to keep more of their children on the farm by increasing the potential returns per acre was very much in our minds.

It needs to be remembered that the ROZ did not merely help bring new businesses but gave existing businesses opportunities to recruit from out of state. In the case of McCarty Family Farms, it also helped with moving their sons from Pennsylvania so they could expand their operations. McCarty Family Farms is a family-owned LLC which brought a number of employees with them with the milking cows from their sons’ operations. To make their operations more profitable—which just happened to be timed in conjunction with the elimination of the income tax on LLCs—they expanded to processing their own milk. Today if you buy Dannon yogurt there is a good chance the condensate came from the McCartys’ condensation plant.

How big of a deal is one dairy operation to a rural community? McCarty Family Farms now employs 125 people and they have refurbished and provided 77 houses to employees. Just building the condensation plant required more than 50,000 man-hours of compensated time that poured funds in to local contractors and the rest of the rural community. This is all largely in the small community of Rexford, Kansas—which was well on its way to becoming just another ghost town in western Kansas.

These sorts of stories are exactly why a Rural Opportunity Zone plan is needed for rural Oklahoma. It is not a comprehensive fix for what ails rural Oklahoma, but it’s a great tool that can help empower locals to take charge of their future without having to come to Oklahoma City to beg for state revenues.

In the long term, to maximize the economic-development impact of the ROZ and to establish the north-south corridor of processors, Oklahoma should continue to pursue a methodical, responsible phase-out of its income tax.

Steve Anderson (MBA, University of Central Oklahoma) is an OCPA research fellow. A Certified Public Accountant with more than 30 years of experience in private practice, he is currently a partner at Anderson, Reichert & Anderson LLC. Anderson spent two years as a budget analyst in the Oklahoma Office of State Finance, and most recently served as budget director for the State of Kansas. At one time he held 17 state teaching certifications ranging from mathematics to physics to business.