What does `revenue-neutral' really mean?

Journal Record, The (Oklahoma City), Jul 16, 2001 by William O. Pitts

An underlying principle of tax reform in Oklahoma has been that whatever changes are made in the tax system the result must be revenue-neutral.

The term came into vogue several years ago when voters approved a constitutional amendment essentially barring the Legislature from passing revenue-raising measures without a vote of the people. The Legislature came up with the idea this restriction could be evaded by simply raising one tax while lowering another in the same estimated amount, thus creating "revenue neutrality."

It was the subject of discussion of a tax reform report at last week's meeting of the House Revenue and Taxation Committee. The presentation was made by its authors -- economics professors Robert C. Dauffenbach, OU, Alexander Holmes, OU, Kent Olson, OSU, David Penn, OU and Larkin Warner, OSU.

Since Senate President Pro Tempore Stratton Taylor's instigated the tax reform study in late April, revenue and neutral have become basic buzz words. Even the report is entitled the "Revenue Neutral Tax Reform for Oklahoma-Final Report." That was the professors' directive and to an extent it was their focus. According to them, revenue-neutral "is a constant ratio of taxes to total personal income over a 10-year period." Exactly how a constant ratio of taxes to personal income over a 10-year period is pertinent to revenue- neutral tax reform this year seems nebulous at best.

Not being an economist, that seems difficult to understand. I thought the term meant if you lose a certain amount of revenue from one source next year, but regain it from another you have revenue neutrality for that year. What difference would such a plan make if you have to wait 10 years to find out whether it was neutral or not? Even if it weren't, trying to accurately determine that ratio 10 years in advance would be virtually impossible.

Don't be fooled. Virtually every individual, businesses or corporate taxpayer is likely to pay more or less taxes under a new system than under the present one, regardless of how it may be structured. It's simple. When you change tax bases you change tax burdens.

Use the current tax reform proposal as an example. It suggests eliminating the state income tax, the sales tax on groceries and changing the estate tax to make Oklahoma a "pick up" state with the federal estate tax. Estimated cost, $2.6 billion. To replace these the report offers several proposals, none of which seemed to be particularly satisfactory or adequate to the authors. They include:

* Tripling the property tax by creating a state levy with its own rates in lieu of or in addition to the present local ad valorem taxes.

* Imposing a gross receipts tax on the sale of all products and services at all levels of exchange.

* Increasing the sales tax rate along with broadening its base to include all services.

* Two different combinations of the others.

Simple theory

The revenue-neutral concept is simple in theory. If you reduce or eliminate tax A by $100 million and increase or add tax B that brings in $100 million, you have revenue neutrality.

In practice, it becomes much more complex because it is based on future revenues estimated by the Oklahoma Tax Commission. These may or may not be accurate. Any two or more tax sources may be determined to be revenue-neutral through estimations, but the actual revenues produced from those sources likely won't be.

Suppose for example they estimate that next year old tax A would produce $105 million and new tax B $105 million. Since tax A is gone there is no way to determine what it would have produced. At the same time in that first year tax B produces $110 million. Or suppose tax B only produces $95 million. Either way there is no real revenue neutrality.

The whole idea becomes even more complicated the more different kinds of taxes are involved. No matter how sophisticated computer models are available, determining which one or combination of these plans would provide the actual amount of revenue in the coming year is virtually impossible.

Obviously the tax commission has had difficulty with it. The immediate past fiscal year is clear evidence. The official tax collections for the fiscal year ended June 30 were 8.3 percent, or $360 million, above the previous year. More importantly they were 2.5 percent, or $258 million, higher than estimates. This is not an anomaly. It occurs virtually every year to a greater or lesser degree.

Trying to achieve a revenue-neutral tax involving several existing taxes by increasing others or imposing new ones quickly becomes a quagmire of suppositions. The entire concept of revenue neutrality is founded on Jell-O composed of adjustable guesses and qualified estimates. One of the professors suggested "revenue estimates are subject to wide confidence intervals."

On the premise of using estimates only, neutrality can be easily manipulated to be whatever the commission and legislative leaders want. It is a safe bet they will err on the side of ensuring more revenue will be produced rather than less.