Wouldn’t it be nice not to have to pay state income taxes? In North Dakota, lawmakers are considering just such a proposal, hearing testimony next week from a conservative group about the long-term benefits of abolishing the state income tax. North Dakota already has some of the lowest tax rates in the country. Its highest tax rate, for incomes above $424,950, is only 2.9 percent, still lower than the lowest tax brackets in many states. The proposal would replace these tax revenues largely with taxes on the oil industry. The proposal is garnering unusual pushback from the right, though, out of fears that abolishing the state income tax would put all the its fiscal eggs in one basket.
While at first blush abolishing the state income tax seems like a proposal that would garner support from small-government conservatives, some are cautioning that the proposal risks leaving the state vulnerable to boom and bust revenue cycles.
“As a practical matter, however, we shouldn’t lose sight of the importance of keeping our tax base broad. Eliminating the income tax would narrow the state’s revenue streams significantly. That’s not good policy,” writes columnist and radio host Rob Port.
“We’re better off keeping taxes low and broad. Not only does this make state revenues more stable, and more predictable, but it ensures that the electorate keeps some skin in the game when it comes to paying for our government,” he said.
Port makes an important point. Income taxes are one of the more stable sources of state revenues. Taxes on energy production, meanwhile, are some of the most variable.
According a study by the Pew Charitable Trusts, states whose economies were heavily reliant on energy markets saw much higher rates of volatility in their revenue collections. North Dakota and Wyoming in particular saw the highest swings in revenue, driven by shifts in their severance tax collections. Severance taxes are charged on the extraction of non-renewable resources–including ore and fossil fuels–for consumption and sale outside of the state.
These taxes are one of the most volatile sources of revenue for states, since they are tied to global energy markets, including the price of oil. The more that a state relies on severance taxes for its revenues, the more uncertain its financial future may be.
“The three states with the highest overall scores—energy-rich Alaska, North Dakota, and Wyoming—collected the greatest share of their tax dollars over the past 10 years from highly volatile severance taxes. Yet Texas, the largest oil producer in the nation, ranked close to the middle of states for overall revenue volatility even though its severance tax revenue was more volatile than any but Alaska’s,” wrote Mary Murphy and Barb Rosewicz, project directors studying state fiscal health for Pew.
“The crucial difference is that severance tax accounted for less than 10 percent of Texas’ total tax collections over the past decade, compared with 67.3 percent of tax revenue in Alaska, 42.3 percent in North Dakota, and 37.6 percent in Wyoming.”
Volatility in state revenues makes it harder for lawmakers to effectively budget, since periods of unexpectedly high revenues can easily be followed by periods of unexpectedly low revenues.
North Dakota has already seen the damage that falling oil prices can do to state revenues. When the price of oil fell in 2015, the state government cut its budget in half. That meant less money for schools, law enforcement and other government services. More recently, at the start of 2017, the legislature adjusted industry forecasts down by more than $1 billion, believing that it was better to err on the side of caution. Meanwhile, in 2018, tax revenues collected from the industry are 22.8 percent higher than forecasted totals.
These swings are significant for a state where the oil and natural gas industries provide 45 percent of state revenues. Were North Dakota to remove its income tax, that percentage would only grow. They may also learn a lesson from the situation in Oklahoma, where slower growth in the energy sector left the state’s schools dangerously underfunded.