Oklahoma’s Tax Reform Journey: Progress Made, More to Do 214

 in News / Tax Guide  tagged Oklahoma's Tax Reform / Tax by (updated 29 days ago)

Oklahoma continues its impressive stride towards a more competitive tax environment. Recent legislative action has further refined the state’s individual income tax by lowering the top marginal rate to 4.5 percent, streamlining its six brackets into three, and introducing a clever system of fiscal safeguards for future triggered rate reductions.

While these are significant wins, the work isn’t over. Oklahoma has opportunities to further enhance its economic competitiveness through strategic reforms to both corporate and individual income taxes. However, it’s crucial for lawmakers to steer clear of policies that could inadvertently harm the economy, such as a complete overhaul of the property tax system.

A Decade of Pro-Growth Reforms

Oklahoma lawmakers have consistently prioritized tax competitiveness since 2021. This focus has paid off handsomely. In 2022, the Sooner State ranked 31st in the State Tax Competitiveness Index. Today, thanks to a series of impactful reforms—including reductions in corporate and individual income tax rates, the abolition of the state’s capital stock tax (franchise tax), and the repeal of the marriage penalty—Oklahoma has climbed to an impressive 21st overall. The state was also a trailblazer, adopting permanent full expensing even as the federal provision was phasing down, a competitive edge that may now be somewhat diminished with the full restoration of federal policy. Currently, Oklahoma stands more tax competitive than all its neighbors, with the notable exceptions of Texas (7th) and Missouri (13th).

Latest Individual Income Tax Changes

Building on this momentum, Governor Kevin Stitt (R) unveiled a bold plan in his 2025 State of the State address to reduce, and eventually eliminate, the individual income tax. The legislature ultimately reached a compromise, signed into law in May 2025, through HB 2764. This legislation will reduce Oklahoma’s top marginal rate from 4.75 percent to 4.5 percent for the 2026 tax year. Additionally, the state’s six individual income tax brackets will be consolidated into a simpler structure of three.

Smart Safeguards for Future Reductions

HB 2764 also established triggered rate reductions of 0.25 percent each, contingent on revenue availability. Lawmakers thoughtfully included fiscal safeguards, requiring the state Board of Equalization to certify that specific benchmarks have been met. These triggered reductions will take effect after a two-year waiting period, providing the state ample time for necessary budget adjustments. Crucially, if a revenue shortfall is declared during this intervening period, a scheduled rate reduction is automatically nullified, preventing undue fiscal strain.

Impact on Competitiveness

Had HB 2764 been in effect during the last Index assessment, Oklahoma’s overall rank could have improved to 20th, and its individual income tax component ranking could have jumped from 28th to 24th, with further improvements anticipated as rates continue to phase down. Beyond the numbers, these changes clearly demonstrate a competitive and sound tax policy direction. As we’ve emphasized, lower rates and simplified tax structures are effective strategies for attracting and retaining residents, while simultaneously easing the burdens of tax administration.

Remaining Opportunities for Tax Reform

While the reforms to date are commendable, there’s still more work to be done. Oklahoma lawmakers have demonstrated prudence in considering the costs of reforms and future revenue needs. Given the uncertainties surrounding state finance following the passage of the federal One Big Beautiful Bill Act, lawmakers might consider focusing on low-cost options to achieve greater tax competitiveness. A recent update to a 2021 study outlined several reform options, ranging from bold, comprehensive approaches to standalone policy updates. All these options would ultimately benefit Oklahoma taxpayers, both individuals and businesses, regardless of the prevailing economic environment.

Here are some areas where Oklahoma can continue to improve its tax code:

Individual Income Tax: Address Bracket Creep

A persistent flaw in Oklahoma’s individual income tax code, which HB 2764 did not address, is the lack of inflation indexing. This oversight leads to bracket creep, a phenomenon where taxpayers are pushed into higher tax brackets due to nominal income increases, even when their real income remains stagnant or declines due to inflation. This essentially subjects Oklahomans to unlegislated tax increases based on economic conditions, making the system less competitive. This is an easily resolvable issue.

Corporate Tax: Enhance Neutrality and Simplicity

For corporate taxpayers, Oklahoma’s tax code contains several nonneutral corporate incentives. Prioritizing certain taxpayers over others complicates efforts to lower the single corporate rate for all businesses. Additionally, Oklahoma does not conform to federal depletion provisions, which are akin to depreciation rules but apply to natural resources. Conforming to the federal code in this area would significantly enhance simplicity.

The Senate Appropriations Committee has commendably proposed eliminating the state’s throwback rule. This rule attributes “nowhere income” back to Oklahoma when a seller lacks sufficient nexus to be taxed on income from sales in a separate, destination state. This results in taxation in the wrong state and at the wrong rate. Repealing this provision would be a competitive reform that simplifies Oklahoma’s tax code.

Business Property Tax: Eliminate Inventory Taxes

Although Oklahoma has successfully eliminated its capital stock tax, its code still taxes business inventory. These taxes are levied irrespective of profitability, are nonneutral, and disproportionately affect businesses with larger inventories. This can lead to inefficient timing and location decisions for taxpayers. Repealing this tax would be a highly competitive and pro-growth reform.

Avoiding Economically Harmful Policies: The Property Tax Debate

As lawmakers consolidate the gains of recent years, it’s crucial to avoid pursuing economically harmful policies. A prime example is the discussion around eliminating the property tax entirely. While Oklahoma’s property taxes are relatively low (per U.S. Census data, only Arkansas and Alabama collect less state and local property taxes per capita), some lawmakers have called for an interim study to explore eliminating the tax altogether, joining several other states considering similar measures.

The Critical Role of Property Taxes

Nationwide, over 70 percent of local funding is derived from the property tax. In Oklahoma, this tax accounts for 56 percent of local tax revenue and 21 percent of all state and local revenue. Eliminating it would necessitate compromising the local services that Oklahomans rely on daily, or shifting to far more economically damaging forms of taxation. Replacing property tax revenue—whether through state-level levies distributed to localities or through new local taxes—presents significant challenges in geographic distribution. No alternative local tax will generate adequate replacement revenue in all jurisdictions, and state distribution formulas often create perverse incentives for localities.

A study conducted in Indiana on replacing the property tax with an income or sales tax concluded that shifting to an income tax would cause gross state product to fall by 2.8 percent, and by 2.7 percent if replaced by a sales tax. Despite its unpopularity, the property tax is relatively efficient. Shifting to other forms of taxation to compensate for revenue loss would cause economic harm and ultimately leave Oklahomans worse off. In contrast, Texans pay significantly more per capita in property taxes, yet Texas remains a top 10 state for net in-migration (slightly outpacing Oklahoma), largely due to its competitive overall tax code.

A Better Approach to Property Tax Relief

If lawmakers aim to provide property tax relief, a more neutral and stable approach is to enact strong levy limits. These limits constrain overall revenue growth by adjusting for inflation and population growth. This method ensures adequate funding for local services while preventing local governments from benefiting excessively during periods of surging property valuations. Levy limits are far less distortive than other relief options.

Conclusion: Seizing the Moment for Continued Growth

In recent years, Oklahoma has demonstrated a strong commitment to competitiveness, making concerted efforts to embed principles of sound tax policy—simplicity, transparency, neutrality, and stability—into its tax code. Lawmakers and the administration should be proud of the significant gains the state has achieved and strive to build on these successes.

Despite ongoing economic uncertainties, Oklahoma has clear avenues for further improvement. Failing to seize this moment could see the Sooner State lose ground to regional powerhouses like Texas. Now is not the time to become complacent with past reforms or to consider economically harmful policies that could set the state back for years. Instead, lawmakers should continue to channel their energy into reforms that genuinely benefit the state and its residents.

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