Fiscal Policy Shake-up Comes to Energy States

The sharp decline in oil prices since summer 2014 has allowed consumers to save hundreds of dollars annually at the pump, but it also has left some energy producing states clamoring to come up with policy ideas to make up for lost revenue.

Before the recent precipitous decline in oil and other fuel prices, states that rely on the energy sector for revenue enjoyed years of fiscal bliss thanks to the high price of natural resources. Rarely fretting about ways to pay for public services, many of these states found themselves so flush with funds that they began cutting taxes and offering corporate giveaways. With energy revenues flowing, lawmakers failed to make the tough, long-term decisions needed to ensure their states had a diverse portfolio of broad-based taxes.

Now that oil prices have remained comparatively low for the last two years, and the price and demand for coal, natural gas, and other energy commodities also have taken a hit, there is no way to know for sure when the fortunes of the energy industry may rebound. This reality imposes a revenue challenge for states with budgets that are heavily dependent on energy markets.

Many of the most consequential tax debates taking place right now are in states with a significant energy sector presence. States such as Alaska, Louisiana, New Mexico, North Dakota, Oklahoma, Texas, West Virginia, and Wyoming have been forced to find ways to fill budget holes in the past year, which in some cases has necessitated rethinking the very structure of their state tax systems.

How Did We Get Here?

To be sure, these states are reeling in part because of low-energy prices. But that is not the whole story. Most energy-reliant states celebrated “boom” times with ill-advised tax cuts and corporate giveaways. The most egregious example is Alaska’s elimination of its personal income tax some 35 years ago (Alaska is the only state to ever repeal a personal income tax). With near complete reliance on the energy sector, Alaska has no personal income tax or state sales tax to turn to in times of crisis.

Other states did not go as far as to repeal personal income taxes, but many made ill-advised tax cuts when they were awash in energy revenue. Louisiana’s decision to eliminate the “Stelly Plan” in 2008, for example, significantly reduced tax rates for the wealthy. This politically charged policy change cost the state an estimated $800 million a year. Over that same period, Gov. Bobby Jindal handed out lavish credits and rebates for corporations. As a result, this year alone the state has paid $200 million more in tax breaks than it has collected in corporate income and franchise taxes.

New Mexico lawmakers’ phased in cuts to the state’s top personal income tax rate, costing  an estimated $500 million in revenue per year. The damage done in the early 2000s continues to play out as the state struggles with year after year of budget challenges. Oklahoma’s shortfall was driven in large part by generous tax breaks and unaffordable, repeated cuts to the state’s income tax over the past decade. The most recent income tax rate reduction had the poorest timing of all, triggered this January despite an official “revenue failure.” Today this series of cuts comes with an annual price tag in excess of $1 billion in lost revenue.

North Dakota lawmakers slashed income tax rates for years, pushing to lower or even eliminate them as energy prices slumped. 2015 legislation alone reduced both individual and corporate income taxes across the board by 10 percent and 5 percent, respectively. While near the peak of its oil boom in 2011, voters concerned about service cuts overwhelmingly rejected a referendum to eliminate the state’s property tax.

Business tax cuts are a major contributing factor to West Virginia’s fiscal problems. The state’s elimination of its business franchise tax took full effect last year, and over the last several years the corporate income tax has been reduced as well.

State Actions This Year

Booms are followed by inevitable busts. Cutting taxes while flush with revenue is not advisable for energy-dependent states. Particularly for states with narrow tax portfolios that are highly reliant on the success of the energy sector.

To date, the tax policy changes enacted in energy states have been limited largely to regressive tax hikes, though there are indications that more meaningful tax reforms could be on the horizon.

Tax Increases

Lawmakers in traditionally conservative states such as Louisiana, Oklahoma, and West Virginia all approved tax increases in 2016 to help address significant revenue shortfalls. Legislators in Louisiana raised $1.3 billion in new revenue through a 1-cent sales tax increase, the elimination of certain exemptions from the state sales tax base, and tax increases on beer, alcohol, wine, and tobacco. Lawmakers tried, but failed, to enact long-term personal income tax changes. A task force is now exploring comprehensive reform options for 2017.

Tobacco tax debates were a common theme in energy states this year—West Virginia lawmakers also opted to raise tobacco taxes and Oklahoma lawmakers came close to doing the same.

While a cigarette tax increase was not ultimately enacted in Oklahoma, lawmakers did raise revenue by repealing the state’s “double deduction,” a nonsensical law that allowed Oklahomans to deduct their state income taxes from their state income taxes. In addition, they voted to change the state portion of the Earned Income Tax Credit (EITC) from refundable to non-refundable, a move that disproportionately affects low-income taxpayers by denying the credit to families that earn too little to owe state income taxes.

In New Mexico, Gov. Susana Martinez has reiterated her “no tax increase” pledge despite the state’s projected $600 million shortfall. Given the breadth of the revenue gap, state legislators have urged her to reconsider her position.

While major tax increases have yet to come to The Last Frontier, the significant fiscal debates that took place in Alaska this year are also worth mentioning. There, lawmakers discussed a range of options to remedy the state’s multi-billion-dollar deficit during the state’s regular legislative session and two special sessions called by Gov. Bill Walker.

Spending Cuts

In 2016, virtually every energy-reliant state cut vital public services. North Dakota saw cuts exceeding 4 percent earlier this year. That was followed by a May announcement for a total of 10 percent across-the-board cuts for the coming biennium. And the problem persists—Gov. Jack Dalrymple called a special session to address yet another shortfall.

Similarly, New Mexico lawmakers passed budget amendments early this year to cut spending across state agencies. New revenue gaps have since appeared, leading lawmakers to request that Gov. Susana Martinez call a special session. In Wyoming, Gov. Matt Mead recently announced another round of cuts, this time nearing $250 million. Those cuts and the associated loss of federal funds are expected to result in massive layoffs across the state.

Alaska, Louisiana, Oklahoma, and West Virginia accompanied their tax increases (or in Alaska’s case, proposals for tax increases) with cuts to state spending. And many additional cuts are anticipated for the coming years. For example, Texas lawmakers have asked most state agencies to lower funding requestsfor the coming biennium, with a call for 4 percent nearly-across-the-board cuts to many programs that are already underfunded.

Short-Term Fixes

While all of these states have made progress in closing their current budget gaps, there remains a need for revenue and structural reforms in the long run. One-time revenues were used heavily in both Oklahoma and West Virginia. In Oklahoma, 60 to 80 percent of the budget hole was filled with non-recurring revenuesuch as one-time bond issues and cash transfers. West Virginia filled its gap with a range of one-time funds, including a $70 million withdrawal from the state’s Rainy Day Fund.

Similarly, Louisiana’s solution was primarily dependent upon temporary tax measures. Changes to the state’s inventory tax credit and corporate franchise tax come with expiration dates attached.

And in Alaska, legislative inaction forced Gov. Bill Walker to veto large swaths of the state’s spending plan. In doing so, the governor capped next year’s Permanent Fund dividend, a flat dollar payment that most Alaskans receive each year, at $1,000. This is down more than 50 percent from the state’s 2015 dividend payout of $2,072. A restructuring of the state’s dividend program will likely be revisited next year.

Some Progress, But More Reforms Are Needed

While lawmakers in energy-sector states have taken steps to close their revenue shortfalls, not nearly enough is being done to address the structural inadequacies driving the problem. Inaction or short-term fixes were too often a theme for energy-reliant states in 2016. While partly driven by hope that energy prices will rebound, this tendency for delay is not a long-term solution. Rather than watching desperately for signs of improvement in energy markets, lawmakers should take matters into their own hands by reconsidering past tax cuts that have drained state coffers and by fundamentally rethinking the makeup of tax structures that have become over-reliant on energy revenues.

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