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Oregon Supplemental Report

Tax Environment

Oregon is by far the state that is the most dependent on the income tax, which has left it vulnerable to major swings in revenue. This vulnerability has become more pronounced in the last decade. The state has no sales tax and its citizens are as antagonistic to the implementation of a sales tax as Tennesseans and Washingtonians are repelled by the idea of an income tax. Initiatives to create a sales tax have been placed on the ballot for citizen approval nine times and each time they’ve been soundly defeated.

The fact that Oregon is one of the most active initiative and referendum states has a profound impact on the tax environment. In 1906, Oregon’s ballot had the first statewide tax initiatives in the U.S., according to “A Brief Analysis of Voter Behavior Regarding Tax Initiatives, from 1978 to 1999”, Bill Piper, Initiative and Referendum Institute. In 1978, Oregonians rejected an initiative similar to Proposition 13 in California, but in 1990, property tax reduction Measure 5 succeeded, setting limits on the amount of tax that can be paid on each property to support schools and local government. In the mid-1990s, Bill Sizemore, the head of Oregon Taxpayers United, rose to the forefront of the anti-tax movement. In 1996, Measure 47, which was heavily sponsored by anti-tax groups outside of the state of Oregon, attempted to cut property taxes a second time, but was poorly written. It was repealed and replaced the following year by Measure 50, which had similar aims. This rolled back assessed values, set permanent tax rates and held the growth of taxable value to 3 percent a year, except for new construction. Despite significant growth in property values, all property tax revenue dropped 3 percent from FY91 to FY98, and the money raised from local property taxes for education dropped 35 percent during that period.

Sizemore’s success appeared to wane in 2000 when two extreme anti-tax initiatives failed at the polls, though two other milder ones, which were submitted by the legislature, passed. That year, the Oregon Education Association and the American Federation of Teachers’ state chapter sued Oregon Taxpayers United for election fraud and racketeering. In fall, 2002, a civil jury ordered Oregon Taxpayers United to pay $840,000 to the unions — an amount, which was then tripled, based on Oregon’s racketeering laws. The Oregon Justice Department joined the lawsuit seeking dissolution of Oregon Taxpayers United and the judge granted the department’s motion for dissolution. Sizemore has said he plans to appeal.

In addition to the direct effect that initiatives and referenda have on the tax environment, they also raise the level of uncertainty and the potential for sudden change. In any case, the total state and local tax burden for Oregon’s citizens has dropped considerably. Measured as a percentage of personal income, Oregon’s tax burden was 13th at the beginning of the 1990s. It is now 39th, according to 2003 Oregon Public Finance Basic Facts.

Recent Tax Developments

• In 2000, voters approved a legislative referral that reduced taxes by increasing the federal income tax deduction allowed on state income taxes. This is now being phased in over four years instead of the one year originally intended.

• Voters approved a 60-cent-per-pack cigarette tax hike in a special election on September 17, which made Oregon’s cigarette tax of $1.28 the sixth-highest tax nationwide. They also gave their stamp of approval to turning an Education Endowment Fund into a rainy day fund for schools and colleges. (This included the immediate use of $150 million from the fund to avoid immediate public education cuts.)

• A revised budget, approved by the legislature in September 2002 included a referral to the voters of a three-year tax increase. The suggested temporary increase, which was to raise the top personal income tax rate from 9 percent to 9.5 percent and the corporate tax rate from 6.6 percent to 6.93 percent, was scheduled for a January 28 vote. It was designed to raise $313 million in the current budget year and $411 million through the whole 03-05 period. This referendum was defeated with 54 percent of voters opposed and 46 percent in favor of it.

Budget Information

FY2002 ended with a disastrous last quarter, when April to June revenues showed a 24.1 percent decline from the previous year. Of the other 49 states, only California looked worse with a 24.7% decline.

In all, revenues declined about $2 billion from original projections for the FY2001-2003 biennium, with the legislature meeting some five times in 2002 to re-balance the budget. After repeatedly plugging the hole with spending cuts and one-time revenues, the legislature faced a new $480 million gap in September. One month before, Moody’s Investor Services changed the outlook for the state from neutral to negative. Fitch Ratings downgraded the state to A-plus from its previous AA rating for general obligation bonds.

The threat of mammoth cuts — including the layoff of state troopers and the shutdown of juvenile detention facilities, the release of felons from prison, and the layoff of 2500 teachers — was put off until January 28 when voters were to accept or reject a temporary income tax hike. They resoundingly rejected it. The defeat of the income tax hike put into effect an automatic cut of $310 million that had been signed into law by former Gov. Kitzhaber in October. This, of course, went beyond cuts already enacted through calendar year 2002.

The impact of cuts has been significant. The Center for the Study of Education Policy, at Illinois State University, put out a study in December that showed Oregon, with a 11 percent cut in higher education funding for 2002-2003, had the steepest higher education cuts of any state. http://www.coe.ilstu.edu/grapevine/50state.htm. Other impacts in the state include dramatic reductions to the state’s health care programs, layoffs by law enforcement agencies, and a shortening of the school year. Meanwhile, more weight continued to fall on fees. In June 2003, for example, the House was considering raising auto registration fees, freight truck fees and vehicle title fees to support a $1.9 billion bridge and road bond package.

Adequacy

Oregon’s tax system is about as unbalanced as they come. It is the state that is the most dependent on the income tax. With restrictions on property tax at the local level and no sales tax at all, the state sinks or swims based on its volatile income tax revenues. Currently, it’s sinking. As the state’s director of revenue points out, the current level of services and the level of funding for schools cannot be maintained with the current tax structure. The state’s revenues were boosted for years due to capital gains money that flowed through the mid to late 1990s, buoyed by tremendous stock market growth. While Oregon officials knew this situation couldn’t last forever, no one predicted the extent of the drop-off. In fact, capital gains income sank 51 percent from 2000 to 2001. Additional weakness in the income tax came from the state’s relatively high unemployment rate compared with other states and the growing importance of the hard-hit technology industry in its economy.

The vulnerability of Oregon’s system is no secret. Five years ago, when revenues were gushing in to the state, a tax review technical advisory committee pinpointed the issue of stability as the key policy issue for the tax system.

The severity of the tax structure problem is clear to experts who have compared the revenue problem today with that faced in the early 1980s. The shortfalls were roughly proportional. But unemployment twenty years ago was in double digits, whereas unemployment in Oregon at the end of 2002 was around 7 percent. The increased volatility of an already unstable tax system has largely been due to a shift in funding of education to the income tax, instead of local property taxes.

Despite its erratic flow of revenue, Oregon was one of a handful of states that didn’t put money aside in a rainy day fund during the 1990s. Its revenue kicker law, which was passed in 1979 and put into the Constitution in 2000, requires that if revenues exceed forecast revenues by 2 percent or more over the two-year budget cycle, the excess is returned to taxpayers. Although proponents of this policy believe that it helps to dampen budgetary growth, it also makes it difficult for the state to deal with inevitable economic cycles. Among legislators, the idea of getting rid of this unusual budget mechanism is growing in appeal, but any change would need to be approved by voters, which is a tough sell.

There are other issues that are hurting Oregon’s revenues. The state tax system is linked to the federal government, so bonus depreciation, enacted last spring at the federal level, reduced Oregon’s revenues.

In addition to leading to higher fees, the pressure on tax revenues has led to substantial pressure to increase the revenues from state-sponsored gambling.

Fairness

The great shift that increased the state and local government’s dependence on the income tax and decreased its dependence on property taxes had the plus of making the tax system less regressive. The state has a nearly proportional tax system, with lower income individuals paying slightly over 9 percent of their income in taxes and higher income individuals paying between 8.8 and 9 percent. This gap is far less than in most states. The lack of a sales tax, the earned income tax credit, as well as the indexing of tax brackets and exemptions are cited as progressive features by the Institute on Taxation & Economic Policy in its well-known study, “Who Pays? A Distributional Analysis of the Tax System in All 50 states.” The study notes however, that the system has become somewhat more regressive in recent years due to increases in excise tax burdens. (The high cigarette tax is considered regressive, for example.) http://www.itepnet.org/whopays.htm

One potential issue relating to property valuation: Measure 50 locked in property tax values that were in place in 1995-1996 (less 10 percent) — including any inequities that existed at the time. Now that base can’t be changed. With the limit on value growth that was put in place, the base gets further and further away from market growth on the property. This has not yet materialized as a problem in the short run, but it is possible it will materialize as a problem in the future.

Management

The state’s dependence on the income tax causes a number of severe problems. But it does simplify the management task faced by Oregon’s Department of Revenue and enables officials to focus their attention.

To provide electronic filing options for its citizens, Oregon participates in the Federal/State Electronic Filing Program. In 2002, more than 30 percent of Oregon’s returns electronically. Although businesses do not yet have the ability to file or make payments over the web in general, they do have the ability to pay estimated payments, withholding and transit district taxes electronically.

Oregon has had an integrated tax system since 1993, so that revenue staff can look at information for an individual or business and can get a holistic view of its taxes through a variety of data. In several areas, Oregon’s technology appears to lag, however. It does not have imaging technology and still requires manual data entry for its paper returns, but it is expanding the use of 2d bar codes to its full-year resident returns and plans to expand 2d barcodes to corporation filings in tax year 2004. Given the shortage in funds, the ability to invest in innovative technology is very limited currently

A Governing analysis of revenue department websites in Fall 2003 put the state in the third of five tiers. Oregon has been using the web increasingly to communicate information to taxpayers and to tailor information to subgroups of taxpayers. A reviewer found the site comprehensive, but complained that the organization of the material (with different topics lumped in long lists under very general headings) made it difficult to find specific information.

According to the Center for Enterprise Development, the state has good tax policy accountability. A biennial tax expenditure report, which totes up the loss of revenues due to tax breaks, has been published since 1995 and is available on the website, http://www.dor.state.or.us/statistical/ExpR0305/TOCexp.html. This report is one of the best in the country, according to Bob Zahradnik from the Center on Budget and Policy Priorities. The state also does a good job of analyzing the impact of tax changes on different income levels. http://sadrc.cfed.org/states/or.php

The Department of Revenue has put a good deal of effort into taxpayer outreach and customer service efforts. The idea is to put resources up front to make sure the forms are easy to use, to provide assistance to taxpayers that need it, and do outreach to new taxpayers, “so they get the habit and get it right,” as the revenue director says. To make filing and payment easier for businesses, the Department of Revenue and other Oregon agencies that deal with business merged their filing and payment requirements in the 1990s, so that instead of dealing with five payments and their associated forms, businesses now have to deal with only one of each and can file them through email (though not yet on the web.)

Local Issues

With its limitations on local property taxes in the 1990s, Oregon took on much more responsibility as a state for funding school operating expenses. In FY92, 34 percent of school operating funds came from the state. By FY96, 66 percent was state funded.

But those property tax limitations also spelled trouble for local governments. A 2002 report, “”Diminishing Returns: Oregon Cities’ Struggle to Afford Basic Services,” by consultants with Barney and Worth, Inc., predicts plenty of financial pressure for cities over the next decade. http://www.barneyandworth.com/images/diminishingreturns.pdf The report contends that cities — particularly those that are not in a growth mode — suffered financially during the 1990s, despite a strong economy. The report also expresses concern that the future of utility franchise fees, which helped offset property tax losses in the last decade, are “clouded by litigation.” As the state budget struggles with major revenue shortfalls, state-shared revenues look increasingly precarious, as well.

Oregon’s local governments do have some other revenue options. About one third of Oregon’s cities and close to half of its counties have a local lodging tax. About half of the 100 cities that responded to a Barney and Worth survey noted that they were dealing with revenue problems by raising fees and charges. In May, voters in Multnomah County passed a local income tax, making it the first county in Oregon to do so, while voters in Beaverton and Joseph, passed property tax increases for schools.

Noteworthy Programs

• Property tax deferral. Oregon (as well as Illinois and Virginia) has a property tax deferral program for eligible low income seniors. Eligible individuals are allowed to postpone the payment of all or a portion of their property taxes until the sale of their property or the death of the homeowner. There is also an elderly low income rental assistance program.

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