Fixing Oklahoma’s Sales and Use Tax System

by Geoffrey Long

Abstract

In an ideal world a tax system has a broad base giving the largest tax burden to those with the greatest ability to pay. Income taxes are developed more progressively where high earners pay a larger share of their earned income as taxes because they have the ability to pay more. This system is designed to ease the tax burden on people who don’t have the economic capacity to pay a large portion of their income as tax. In reality the tax system is not entirely fair for all taxpayers. This is especially true for most sales tax systems.

Sales taxes are inherently regressive. First, sales taxes are generally blind to the taxpayers’ income level. Individuals who earn the least amount of income pay the same sales tax rate as those who make the most. Second, far fewer services are taxed than consumer products. If we assume that high earners purchase a far greater amount of services than low earners we can see how regressive a tax break on services is. For example, an individual earning ten thousand dollars a year spends far less on professional services and business services than someone earning ten thousand dollars a month.

Like all legislation, sales tax codes are also susceptible to special interest lobbying. In many sales tax statutes you will find a section devoted to exemptions. Some of these exemptions are admittedly legitimate; however, many make little sense in an ideal and fair tax system.

These issues are especially prevalent in the State of Oklahoma. Compared to many states Oklahoma is quite regressive, taxing few services and adding unnecessary exemptions regularly. This is costly for the State of Oklahoma and its residents. Oklahoma is losing potential revenue and making all Oklahomans pay a higher sales tax rate than they should with a fairer system.

If an inherently regressive sales tax system must be implemented it should be as fair as possible. Oklahoma could generate more revenue in a fairer way by increasing sales tax on a broader range of services, repealing unnecessary exemptions, and further promotion of the Streamlined Sales Tax project to collect a larger portion of use tax. These changes to the Oklahoma sales tax system would provide a broader tax base that could be taxed at a lower overall sales tax rate. This reform would shift the sales tax burden on low income families who spend a large portion of their annual income on consumer products to higher earners who can afford to pay a sales tax on services. In addition, this would spread the sales tax burden back onto individuals who have taken advantage of unfair exemptions.

Sales tax reform in Oklahoma would provide a significant benefit to the state and all Oklahomans. Low income families would have more disposable income from a lower sales tax rate, and Oklahoma would generate more revenue from a broader tax base.

Table of Contents

Introduction 2

Sales and Use Tax Basics 3

Improvements to Oklahoma’s Sales and Use Tax System 4

Revenue Stability 5

Economic Efficiency 6

Equity 6

Increase Sales Tax on Services 8

The Opposing View 10

Benefits of a Service Tax 12

Repeal Unnecessary Exemptions 14

Improve the Use Tax System 19

History of the Use Tax 20

State Constitutional Issues 23

Conclusion 24

Introduction

The State of Oklahoma’s sales and use tax system is in need of modernization to promote a multitude of state interests. Oklahoma taxes too few services and provides too many unnecessary sales tax exemptions. Sales tax reform is necessary in the State of Oklahoma to promote revenue stability, reduce regressivity in the current system, and allow for economic growth.

Oklahoma can accomplish these worthy goals by broadening the range of services subject to the sales tax, repealing unnecessary sales tax exemptions, and promoting the Streamlined Sales Tax Project with other states to simplify use tax collection and increase the amount of use tax collected. These changes are not overwhelmingly complex and could be implemented over time to ease into the change.

Any improvement in the state’s sales tax system could go great lengths to promoting the overall welfare of the State of Oklahoma. Increasing revenue could allow the state to implement and fund a greater number of state programs or lower the overall sales tax rate. Making Oklahoma more progressive with a broad-based sales tax system should be a priority for the state legislature; however, problems will arise with the feasibility of implementing tax reform. Regardless of what hurdles may arise in the process to fix Oklahoma’s sales and use tax system, change is necessary to promote economic growth and fairness.

This paper will outline some of the benefits associated with expanding the sales tax to a broader range of services, repealing many of the unnecessary sales tax exemptions, and further expansion and cooperation with the Streamlined Sales Tax Project.

Sales and Use Tax Basics

Sales taxes are tracked and imposed by state and local administrators, of which total more than 40,000.[1] Vendors and merchants charge the customer a sales tax which combines the state tax rate (4.5% in Oklahoma) and the sales tax rate for the locality the purchase is made in.[2] In order to be under the jurisdiction of a state for sales tax purposes the seller must have a sufficient “nexus” with the state, basically a substantial physical presence.[3]

When a purchase is made from an out-of-state vendor and the goods are shipped back into the state, the purchaser is subject to a use tax, or a tax on the use, storage, or consumption of goods within the state.[4] Use taxes can be easily ignored by individuals, but are still subject to reporting and taxation.[5]

Not all products are subject to the sales and use tax, and states have many differences on what is taxed and what exemptions are allowed.[6] In many states, sales taxes generally reach tangible goods, exempting or excluding many services.[7]

Essentially, sales and use taxes are a tax based on the consumption of goods and some services within a state’s jurisdiction.

Improvements to Oklahoma’s Sales and Use Tax System

Like many states, Oklahoma’s sales and use tax system is less than ideal. There are many changes that could, and should, be made to the Oklahoma tax structure to create a fairer system with a broader tax base. Simple changes could be made that would increase the revenue for the State of Oklahoma and lower the tax burden on individuals and families that need a break. Looking solely at the sales and use tax system, Oklahoma is missing out on valuable sources of income and is comparatively more regressive than other states. New revenue sources would improve the tax system by achieving greater revenue stability, increasing economic efficiency, and improving equity.[8]

Revenue Stability

Fluctuations in the business cycle directly effect tax collections.[9] Changing the tax system to increase revenue stability would alleviate stress from these cyclical variations on the state’s financial needs. Revenue stability facilitates predictable and consistent implementation of government programs.[10]

Recessions slow economic activity and reduce state tax revenue growth, creating funding difficulties for existing state programs.[11] In addition, the demand for state expenditures tends to increase in times of recession.[12] Anybody who follows the financial media has seen many analysts and experts discuss the potential recession that we may currently be entering. Even if a recession is not looming it is nearly inevitable that at some point we will find ourselves in a period of economic downturn affecting not just Oklahoma but all states.

Because of problems with revenue stability states tend to find themselves in a fiscal crisis during every recessionary period.[13] Relying on a broad selection of taxes helps protect a state from fiscal crisis during recessions, and ensures that all sectors of the economy share the government funding burden.[14] Oklahoma hedges shortfalls in tax collections from cyclical downturns with its Rainy Day Fund.[15] This fund is essentially a savings account where the state sets aside surplus revenue during good economic times in order to prepare for difficult fiscal times of recessions and economic downturns.[16] Although this fund is helpful, it is doubtful that we want to place the entire burden of unstable revenues during a recession on the state rainy day fund when we have the option of creating a tax system that shares some of this burden.[17]

Economic Efficiency

Taxes tend to reduce economic efficiency by changing some of the decisions individuals would make if there were no tax.[18] For instance, state tax systems may distort the location choices of individuals and businesses, reduce household savings and investments, reduce work effort, and distort household purchasing decisions.[19] In addition, taxes that discourage individuals and businesses from moving into the state will reduce growth.[20] Taxes that reduce savings or work effort will also reduce the state’s economic growth.[21]

Equity

Equity in a tax system means a fair distribution of the tax burden.[22] An ideal tax system taxes a broad range of people at a low rate. One predominant view of fairness is distributing the tax burden based on ability to pay.[23] Ability to pay is typically measured by income – current or permanent.[24] This raises one of the prime problems with a sales tax system.

Since sales taxes are generally shifted forward to consumers at the ultimate point of purchase or consumption they are often criticized as being regressive, meaning they constitute a larger proportion of the income of low-income families than of high-income families.[25] A sales tax is a tax on consumption or purchases. Therefore, those who spend a larger portion of their income pay a larger portion of their income on sales tax. Data from the Consumer Expenditure Survey shows that families earning under $30,000 spend nearly all of their income while families with incomes exceeding $200,000 spend less than 40 percent of their income.[26]

Equity is an especially important factor when looking at expenditures for necessities such as food, housing, and clothing. For example, a household with income in the range of $20,000 to $30,000 spends 54% of their income on necessities and total expenditures are 104% of their income.[27] In contrast, a household with income over $200,000 spends only 16% of income on necessities with total expenditures reaching only 37% of income.[28]

These factors are very important for the State of Oklahoma in considering any change to the tax system. Consideration must be given to the effect that a change has in terms of revenue stability, efficiency, and equity. A given tax change may increase the revenue of the state but may cost low-income families a great deal. Additionally, economic growth in Oklahoma must be promoted to entice new businesses and families to move to the state. This is only a fraction of the problems associated with the incredibly difficult task of managing and fixing state and local taxes.

Increase Sales Tax on Services

Implementing sales taxes on services has a long and controversial history.[29] Many states have extended their sales tax to a varying number of services, but these expansions have not been comprehensive and typically face great adversity.[30] In fact, no state has attempted a broad-based expansion of sales taxes to services since Florida in 1987 and Massachusetts in 1990, both of which were later repealed.[31]

Services Subject to Sales Tax in Oklahoma by Industry
Utilities / Personal Services / Business Services / Computer Services / Admissions/Amusements / Other / Total
8 / 3 / 4 / 2 / 10 / 5 / 32
Source: Federation of Tax Administrators, Sales Taxation of Services, 2004.

The number of services taxed from state to state varies to a great degree. Oklahoma tends to tax fewer services than many states. Oklahoma taxes a total of 32 services.[32] The services taxed in Oklahoma include 8 utilities, 3 personal services, 4 business services, and 2 computer services among others.[33] Six states tax over 100 services, with Hawaii and Washington being among the highest at 160 and 157 respectively.[34] Many states fall into a range of 55 to 75 services taxed.[35]

While there are many states that tax fewer services than Oklahoma it is clear that a broader range is available to be taxed and could provide a more stable and fair tax system. In addition, broadening the tax base to include more services could allow the state to lower the overall sales tax rate. Oklahoma’s Sales and Use Taxes in fiscal year 2004-2005 totaled $1,700,683,678.09.[36] State sales tax alone accounted for over $1.5 billion, sales being taxed at a rate of 4.5% on the state level.[37] Sales taxes are an extremely important revenue source for the State of Oklahoma making up 24% of the total tax revenue as the second largest source of revenue behind individual income tax.[38] The vast majority of this money goes towards the General Revenue Fund; however, it is also used for the Education Reform Revenue Fund and the Teachers Retirement Fund.[39] Additionally, sales tax revenue tends to grow with the state economy over time raising a little over $100 million in 1971-72 to over $1.5 billion in 2004-05.[40] States should rely on income taxes and make them as progressive as possible, but sales taxes should not be neglected.[41] Sales taxes should be modernized to include services and goods.[42]

Over time, there has been a gradual increase of sales taxes on select services.[43] Some states have been much more proactive than Oklahoma in expanding the sales tax to services. This expansion has covered services such as repair of personal and real property, data processing and information services, and cleaning services in addition to utilities, entertainment, and hotel services.[44] Taxing these services offers a great opportunity to increase and stabilize revenue. Generally, states have not implemented the sales tax on services that could generate the highest amount of revenues such as construction, professional services, and health care.[45]