The Task Force recommends that the Legislature itself adopt these changes as a whole or, as an alternative, send them to a vote of the people as a complete package. The various changes phase in over a three-year period beginning January 1, 2004, in order to minimize the displacement caused by expanding the sales tax to certain services.

The cumulative effect of the above recommended tax changes is to shift certain taxes, through imposing the sales tax on certain services, to business from individuals. Again, the Task Force believes that this shift is acceptable to achieve the recommended tax reductions. Another way to look at this is that the tax base is being broadened by including certain services in the sales tax base. Many economists point to the fact that the services component of our economy is growing substantially faster than the goods sector and leaving services out of the sales tax base puts more pressure on other tax sources.

Importantly most of the resulting tax relief goes to reduce the income tax substantially, cut the capital gains rate by two thirds, and reduce estate taxes. These changes will encourage retirees and business owners to remain in Oklahoma and keep their assets and capital here for the benefit of our people and our economy. Also, by adopting an income tax based on federal "taxable income" rather than federal "adjusted gross income", as is the case with our current income tax, the standard deduction and personal exemptions are raised significantly-more than tripled for most households. This change will make our income tax more progressive, with the lion's share of the tax relief being provided to our poorest citizens. The plan also includes tax credits targeted to low income families to increase the credit for sales taxes paid on groceries by these individuals and to ameliorate the impact on them of the sales tax on selected services.

The effect of these changes and the targeted sales tax credits for low-income individuals results in a reduction in the tax burden for the average household in every income bracket, as the following example illustrates

(Appendix C provides a more complete breakdown of benefits):

INTRODUCTION
On April 10, 2001, Senate President Pro Tempore Stratton Taylor, Speaker of the House Larry Adair and Governor Frank Keating requested that the Economics Departments of the University of Oklahoma and Oklahoma State University analyze the tax system of those states that have no income tax and report to the Governor and the Legislature on how Oklahoma could move to such a system in a revenue neutral manner. The report of the economists was received in June, 2001. While providing significant analysis of alternative tax systems, the report, in essence, recommended three possible avenues for Oklahoma to replace lost revenue that would result from the elimination of its income tax, as follows: 1) statewide property tax; 2) gross receipts tax; and/or 3) broadening of the sales tax base or a separate sales tax on services.

Governor Frank Keating, at the request of legislative leadership, took the lead in analyzing the various alternatives to develop a proposal that would eliminate the state income tax. While there was general agreement among the legislative leadership that the income tax, particularly as it affects investment decisions and capital movement, was a significant hindrance to Oklahoma's growth¾especially when competing in the economic development arena with our most prominent competitor, Texas, which has no income tax¾there was concern about the impact of the necessary tax increases or new taxes to replace the revenues that would be lost from eliminating the income tax. As part of that concern, the Governor and legislative leadership immediately rejected the option of resorting to a property tax on a statewide basis.

After significant analysis and discussion with citizens and businesses throughout the State of Oklahoma and numerous conversations and meetings with representatives of taxing authorities and businesses in other states, in late 2001 the Governor unveiled a proposal to eliminate the state income tax, eliminate the franchise tax, eliminate the state sales tax on groceries and become a pick up state for estate tax purposes and replace the lost revenues with a 5.9% tax on a broad array of services, excluding medical and health services, agricultural services and mining services, plus a few other specific exemptions. As a result of the ensuing debate, on February 19, 2002, the legislative leadership and the Governor created the Legislator and Citizen Task Force on Tax Reform and constituted members as follows: Don Davis - Co-Chair, Lawton; Howard Barnett - Co-Chair, Tulsa; Bob Anderson, Enid; Representative Debbie Blackburn, Oklahoma City; Representative Forrest Claunch, Midwest City; Carolyn Crowder, Oklahoma City; Richard Dowell, Norman; Ford Drummond, Pawhuska; Carl Edwards, Oklahoma City; Rose Ham, Tulsa; Jimmy Harrel, Elk City; David Henneke, Enid; Representative Todd Hiett, Kellyville; Senator Cal Hobson, Lexington; Senator Mike Johnson, Kingfisher; Dee Ketchum, Bartlesville; Barbara Ley, Oklahoma City; John Massey, Durant; Don McCorkell, Tulsa; Larry Mocha, Tulsa; Mark Monroe, Edmond; Senator Angela Monson, Oklahoma City; Jody Parker, Tulsa; Russell Perry, Oklahoma City; Representative Clay Pope, Loyal; Jack Riley, Ardmore; Don Rodolph, Clinton; Judy Stidham, Norman; Donald Story, Bartlesville; Dwight Watson, Tulsa; Senator Jim Williamson, Tulsa; and Sharilyn Young, Oklahoma City.

The Task Force held weekly public meeting for four hours at a time on successive weeks beginning February 21, 2002. Staff support was provided by the Oklahoma Tax Commission, State Senate staff and the Office of State Finance. Numerous alternatives and proposals were discussed and debated and significant input was received from businesses and citizens from throughout the State of Oklahoma. The membership of the Task Force was viewed as providing sufficient diversity of business interests such that the Task Force itself could knowledgeably debate the impact of tax changes on people, business and the general economy of the State of Oklahoma. At its first meeting, a letter was delivered from Speaker Adair, Senate President Pro Tempore Taylor and Governor Keating outlining the mission of the Task Force as follows:

" . . . your task is to determine whether or not the state's tax policy can be modified in such a way that would stimulate economic growth while still maintaining the current level of revenues, and if so, to recommend specific modifications that would accomplish that goal."

In addition to the expertise of the Task Force members and informal presentation and comments from the public, presentations and information were provided by the following parties: 1) Governor Keating on his plan and Speaker Adair and Senator Cal Hobson, representing Senate President Pro Tempore Taylor, on their goals for the Task Force; 2) Larkin Warner and Lex Holmes representing the economists that prepared original report from June, 2001, on that report and the economics of tax policy; 3) Office of State Finance on statistical information about Oklahoma taxes, the Oklahoma economy and the Governor's plan; 4) the Lumberman's Association on the effect of a service tax on that industry; 5) Representative Clay Pope on HB 2041; 6) Senate staff on various matters; 7) various analyses from the Oklahoma Tax Commission; 8) Tax Commissioner Johnson on national efforts to streamline sales taxes; 9) Senator Jim Dunlap and Martin Garber on Retiree Flight - Bartlesville/Phillips Perspective; 10) Representative Forrest Claunch and Senator Brad Henry on issues surrounding a lottery; 11) David Blatt, from Tulsa Community Action Project, on the effect of various taxes on the poor; 12) representatives of the trucking industry on the effects of a gasoline/diesel tax increase on that industry; 13) representatives of the Oklahoma Press Association, the construction industry and realtors on the effect of a sales tax on their industries; and 14) letters from an attorney and Sabre Systems on the effect of the sales tax on them and their customers.

In addition, at each meeting substantial information, as requested by members of the Task Force, was provided by the Tax Commission, the Senate staff and the Office of State Finance.

FINDINGS OF THE TASK FORCE
Based on the above-described information received and the knowledge and expertise of the Task Force members, the following conclusions were reached:

1. There is significant anecdotal evidence to conclude that the existence of Oklahoma's high marginal income tax rate causes a significant number of retirees and wealthy individuals, particularly at a wealth-realizing event such as the sale of a business, to leave the state. The state, through its support of such entities as the Oklahoma Capital Investment Board and The Oklahoma Center for the Advancement of Science and Technology, has continually shown its recognition that capital is in short supply in Oklahoma and its existence is absolutely essential for the growth of business and the start up of new businesses. Unquestionably, the retention of more capital in the State of Oklahoma would have a long-term positive impact on the state's economic well being.

2. Several large employers have also said that our high marginal income tax rate results in it being more difficult to recruit highly talented and, thus, highly compensated individuals to the state. Several employers reported having to pay a differential when moving an employee from Texas to Oklahoma to compensate for the effect of the Oklahoma income tax.

3. Oklahoma's income tax is unduly burdensome to the lowest income individuals in our state. Our top marginal rate is imposed on incomes of slightly more than $10,000 for a single individual and just more than $21,000 for a married couple. This, combined with the fact that our state's personal exemptions have not been increased to recognize inflation over the years, makes the income tax burden on our poorest individuals a significant problem.

4. The services component of the United States economy has been for years the fastest growing sector of the economy and is projected to be so for the foreseeable future. Yet, this fast growing segment of our economy is not subject to the state sales tax to the same extent as is the goods sector, which is growing at a slower rate. This increases the pressure to maintain or even increase other sources of revenue for government, such as income taxes.

5. The franchise tax raises only a small amount of money yet is a significant nuisance to small business since the cost to have the forms prepared is often more than the tax to be paid.

6. Labeling is important. Texas touts that it does not have a corporate income tax. However, its "franchise tax" operates in effectively the same manner as an income tax.

7. Oklahoma's estate tax is a burden on the ability of family businesses and farms to be maintained within the family. Also, Oklahoma's failure to be a "pick up" state puts us at a competitive disadvantage as all surrounding states have adopted such status. There is therefore an incentive for people who can-particularly if a person only has so called collateral heirs (which results in even higher estate taxes in Oklahoma)-to move to another state and take their assets with them.

8. Generally speaking, consumption taxes, with appropriate rebates or credits for low-income individuals, are better for future economic growth than taxes on income and capital.

9. Oklahoma's tax on gasoline and diesel fuel is one of the lowest in the region. In part because of this, Oklahoma is not doing a good job in maintaining existing highways, while at the same time general revenue is being required to be expended to cover the payments on outstanding road bonds. This exacerbates the long-term ability of the Oklahoma Department of Transportation to begin to catch up on its maintenance needs.

10. While many things go into making an economy successful, it is undeniable that Oklahoma has grown more slowly in the last decade than the rest of the nation (See Appendix A). There is no doubt that tax policy has a place in the development of a modern, growing economy. It is the conclusion of the majority of the Task Force that Oklahoma's tax policy can be changed in such a way as to provide a more favorable environment in which those other factors can operate to make Oklahoma a more prosperous place to live and work.

TAX PROPOSALS
Based on these findings, the Task Force's consensus, with a few dissents on specific taxes, was to lower the income tax rates as much as possible, eliminate the franchise tax, reduce or eliminate the estate tax and, in particular, focus on reducing those taxes that would have a negative impact on the retention of capital in the state.

Eliminating or reducing taxes is the easy part. Finding and agreeing upon new taxes to impose or old taxes to increase is, of course, the difficult part. In addition, the Task Force recognized that, in the same way that a different tax code can have a beneficial impact on economic development by encouraging certain types of businesses and activities to grow or locate in the state, the existing tax code no doubt has contributed to the kinds of businesses and jobs that have prospered here. Any move from the current tax system¾in which existing business have learned to survive¾to a new tax system must be done with a mind toward minimizing the inevitable displacement that will occur.

Taxes To Be Reduced or Eliminated
Franchise Tax/Corporate Income Tax
It is the recommendation of the Task Force that the corporate income tax, as such, be eliminated in its entirety and that the current Franchise Tax be eliminated and a new Oklahoma Franchise Tax put in place by readopting, without making any substantive changes, the current corporate income tax, separate and removed from the individual income tax, as the Oklahoma Franchise Tax. Thus, Oklahoma, like Texas, will have no corporate income tax and will have a Franchise Tax which will work like a corporate income tax .

Individual Income Tax
The individual income tax as currently constituted is recommended to be changed as follows:

1. The federal standard deductions and exemptions would be adopted by applying the Oklahoma tax to "federal taxable income" rather than "federal adjusted gross income." This will have the effect of substantially reducing the tax burden of our lowest earning families.Oklahoma's current maximum income tax standard deduction is $1,000 for singles and $2,000 for married people filing jointly. The federal standard deduction is $4,550 for singles and $7,600 for couples filing jointly. The Oklahoma personal exemption is $1,000 per person in the household. The federal exemption is $2,900 for an individual and $2,900 per person for a married couple filing jointly. The federal exemption is reduced at income levels over $139,950 for a single person and $199,450 for a couple filing jointly.

2. A flat rate of 4.5% would be charged on "federal taxable income" less net taxable capital gains. As part of this move to a flat tax, many official Oklahoma income tax deductions and exemptions would be eliminated. However, to ensure that retirees are encouraged to stay and to come, the Task Force recommends retaining the current deduction for social security income and the existing exemptions for certain private pension benefits. These changes would be phased in as described below.

This flat tax would replace both Method I and Method II under our existing income tax system.

Capital Gains
The income tax on net capital gains would be reduced to 2.35%, phased in as described below.

Estate Taxes
It is recommended that Oklahoma become a pick up state effective for deaths occurring after December 31, 2003. If the federal estate tax law eliminates "pick up" status, the law should provide that thereafter there is no Oklahoma estate tax.

New Taxes to be Imposed or Raised
Cigarette Tax
The Task Force recommends that the cigarette tax be increased from $0.23 per pack to $0.60 per pack. While the Task Force understands the issue that raising this tax could drive more people to Indian smoke shops, the Task Force believes that an increase of this size is sustainable. The Task Force also understands that opportunities may exist for modifying the cigarette compacts with many of the tribes to ensure the State's revenue from these agreements.

Sales and Use Tax on Selected Services
The Task Force recommends a sales tax in the amount of 4.5% be imposed on a variety of services . This sales tax would exempt exported services and government purchased services and a use tax would be imposed on imported services of the type covered by the sales tax.

Remove Sales Tax Exemptions
The Task Force recommends eliminating the sales tax exemptions on the sale of magazines and periodicals.

Low Income Credit-Sales Tax
The Task Forces recommends an increase in the credit against the sales tax for low income individuals, intended to offset the sales tax on groceries, to $60 a year and an increase in the qualifications to make it available to those earnings less than $50,000 (which was the case in 2001 before a "trigger" which occurred for 2002 reduced the qualifying income level to $30,000). Also, the Task Force recommends a new credit of $40 per individual earning less than $10,000 annually to help offset the new sales tax on services. This new credit would be administered as is the credit for grocery sales taxes.

Insurance Premium Tax
The Task Force initially voted to extend the services sales tax to insurance commissions. However, instead the Task Force recommends an increase in the existing insurance premium tax from 2.25% to 3%. This raises approximately the same revenue as the sales tax on commissions and, as it is an existing tax, it will be simpler to implement and collect.

Gasoline and Diesel Tax
The Task Force recommends that the gasoline tax and the diesel tax be increased to 18¢ per gallon. This is an increase of 1¢ per gallon for gasoline and 4¢ per gallon for diesel fuel. The Task Force further recommends that this tax increase be dedicated solely to roads, with the $51 million this tax increase is estimated to raise to be dedicated first to offsetting the $57 million of general revenue currently appropriated each year to the Oklahoma Department of Transportation to pay principle and interest on outstanding road bonds. This will free up $51 million of general revenue which is necessary to make the overall tax proposal from the Task Force revenue neutral. After the bonds are repaid, this dedicated revenue will be available for highway construction and maintenance.

EFFECT OF TAX CHANGES
The net effect of the above changes in the tax codes can be summarized as follows:

1. Capital gains will be subject to a tax equivalent to only one-third of the current state tax, thus encouraging the retention and attraction of capital.

2. Income, including distributions and withdrawals from retirement plans, will be subject to only a 4.5% income tax. This is a substantial reduction from the current 7% marginal rate.

3. The adoption of the Federal standard deductions and exemptions will make the Oklahoma income tax substantially fairer and result in a lower percentage of those taxes being collected from lower income individuals and families. Also, these deductions and exemptions will increase with inflation, unlike the current Oklahoma ones.

4. The services chosen to be subject to the sales tax were, for the most part, chosen because they are more often consumed by higher income individuals, are received in connection with the sale of goods already subjected to sales tax (such as car repairs and construction), or were primarily business consumed services which were deemed appropriate to tax. In addition, for many of the services which individuals buy, people have a choice on the timing of those purchases or even to not pay for the service and do the job themselves. The Legislature and Tax Commission are urged to be precise in defining the services to be taxed to ensure that an intended exempted service is not inadvertently included with one to be subject to tax. This can occur when multiple services are bundled together for sale.

5. Oklahoma estate tax laws will be brought into line with neighboring states, removing this incentive to relocate as part of estate planning.

6. The Oklahoma corporate income tax is repealed and is readopted, separate from the individual income tax, as the new Oklahoma Franchise Tax . The current franchise tax is eliminated. This makes our franchise tax one that is based on corporate income, along the lines of our largest competitive neighbor, Texas.

7. While there is a shift of $506 million in taxes from individuals to business, it is intended that the combination of individuals' increasing their spending because of their reduced taxes, the benefit for business of having the spending power of their employees increased and the likely retention of more capital in the state will more than offset this burden and make it acceptable and a long-term positive for business.

8. The following is a breakdown of the taxes that are being removed or reduced and the revenues to be raised by the new taxes, showing that this tax plan is effectively revenue neutral.