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‘Mild’ downturn will cut taxes for next state budget

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State economists make projection for late 2023 or early 2024, though money continues to flow into coffers.

By PETER WONG

Oregon Capital Bureau

Oregon’s unemployment rate remains near record lows, income taxes continue to flow into state coffers, and a record $3.5 billion is likely headed back to taxpayers in 2024.

But state economists also hoisted warning flags during their quarterly forecast to lawmakers on Wednesday.

Their latest projection is the likelihood of a “mild” economic downturn, late in 2023 or early in 2024, that would reduce tax collections by $1.2 billion or more for the next two-year budget that lawmakers will start working on in January.

“This is a relatively mild recession compared with what we could face or have faced in the past,” Mark McMullen, Oregon’s state economist, told members of the House and Senate revenue committees.

The latest forecast by McMullen and senior economist Josh Lehner still projects $600 million more in state coffers in the current budget cycle, which ends in June 2023, but a recession that starts afterward would reduce future tax collections in the next cycle.

“It’s not much of a story in terms of the overall resources here,” McMullen said.

The Office of Economic Analysis is still forecasting a record $3.5 billion to offset personal income taxes owed in April 2024 — a “kicker” occurs when actual collections exceed projections at the start of a two-year state budget cycle by 2% or more — and $1.1 billion in excess corporate income taxes. The latter money automatically goes into the state school fund.

Those numbers won’t be final until the economic forecast a year from now, after the end of the 2021-23 budget cycle. The most recent kicker in 2021 was $1.9 billion.

McMullen said much depends on the outcome of the Federal Reserve’s raising interest rates effort to curb inflation, which has been at a 40-year high. When the Fed did so back then, the U.S. economy went into a downturn that took seven years to recover from.

McMullen is not forecasting that deep a downturn, unlike those in 1980 and 2007, each of which took Oregon seven years to recover from. The 2007 downturn was prompted by the speculation in housing, including mortgages at subprime rates that owners could not repay.

No recession now

“It’s hard to see that we are in a recession today,” he said.

“Households are still spending money, and businesses still want to hire and expand. As long as that is the case, we are not in a recession. A recession is when everyone pulls back on that at the same time.”

But he also said Oregon is at an “unsustainably low” unemployment rate. The July rate was 3.5%, where it has been for a few months, and is just above the pre-pandemic rate of 3.4% for the four months preceding the onset of the pandemic in March 2020.

Withholding taxes from paychecks — the way most wage earners pay income taxes — is still up by 5% from the previous year. “Most states would kill for that amount,” McMullen said, but the rate is down from earlier.

Also, he said there have been record amounts of taxes collected on sources of income other than wages, such as capital gains, which are profits from the sale of assets like stocks. In 2020, capital gains accounted for $10 billion — and McMullen said it tops $8.5 billion so far this year as some people meet an October deadline for filing their extended returns. (Oregon does not offer a state tax break for capital gains, which are taxed as ordinary income; the highest rate is 9.9%.)

He said some of those capital gains were prompted by the possibility of increased federal taxes on higher-income households, which typically have more capital gains and income other than wages.

Recently passed legislation by Congress will impose a new minimum tax on large corporations that exceed $1 billion in annual earnings — averaged over three years — and an excise tax on stock buybacks by corporations. Some other proposals, which did not pass, would have raised tax rates on higher-income earners or reduced tax breaks on non-wage income.

“There will be less of these unrealized gains to realize going forward,” McMullen said. “This is where we’ve had so much volatility in the state budget.”

Such a drop-off in Oregon tax collections back in 2001 and 2002 helped account for a 20% reduction in the tax-supported general fund and a record five special sessions of the Oregon Legislature to balance the state budget in 2002.

But there were no state reserves then.

Voters created the conversion of an existing education fund into a reserve that year. Lawmakers created a general-purpose reserve fund in 2007, when they used excess corporate income taxes scheduled to go back to businesses.

According to the latest report by the Legislative Revenue Office, the education reserve will have about $700 million — lawmakers used $400 million during the pandemic in 2020 to balance the budget — the general-purpose reserve will have $1.3 billion, and the unspent ending balance from the 2021-23 budget is projected at $3.7 billion at the end of the budget cycle in mid-2023.

More stability now

The current two-year budget from the tax-supported general fund and lottery proceeds — the most flexible sources of spending — is about $27 billion. The overall budget contains $86 billion more in federal grants and other funds, but each has spending restrictions.

Oregon also has new sources of consumption taxes, though not a general sales tax, as all but five states have. Marijuana was taxed after voters legalized its possession and licensed sales in 2014 — the current state tax is 17% — and the 2019 Legislature approved a new corporate activity tax that took effect in 2020. (Lehner did say that a record 2021 harvest depressed marijuana prices, and is likely to result in 4% less in state tax collections than previously projected. Similar taxes in Washington, Colorado and Nevada show similar trends.)

“Consumption taxes do diversify the tax base, and they are much less volatile than income taxes,” McMullen said. “So we will probably be more stable than in past recessions.”

While inflation is boosting the amount of taxes going into state coffers, it also drives up the prices of goods and services that state agencies must buy. Inflation also is affecting construction costs, which will affect state projects funded by the American Rescue Plan Act and the Infrastructure Investment and Jobs Act.

“We are going to have to have some hard conversations,” said Rep. Greg Smith, R-Heppner, given the number of public projects underway.

The next budget will be prepared under outgoing Gov. Kate Brown. Whoever is elected governor Nov. 8 will have until Feb. 1 to propose changes to lawmakers, who have the final say.

Brown, who is barred by term limits from seeking a third consecutive term, said this:

“Thanks to the fiscally responsible decisions the State of Oregon has made over the last several years, we are well positioned with significant reserves to weather any economic challenges that lie ahead. Now, we must continue to make investments to benefit Oregon’s working families, so that all Oregonians can feel the benefits of our strong economic recovery.

“With rising costs of living continuing to impact Oregon families and businesses, the Legislature can, in the budget for the next biennium, build on the investments we made in the last session — particularly in housing, workforce development, behavioral health, and child care.

“And, thanks to the work of Oregon’s congressional delegation and the Biden-Harris administration to pass the Inflation Reduction Act and the Bipartisan Infrastructure Law, we can continue to invest federal dollars to lower costs and create jobs for working families.”

 

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