Oklahoma cut taxes. Now a squeeze on public services forces a rethink.

Oklahoma’s Republican-dominated legislature is looking at ways to close a revenue gap that’s affecting schools and health care. But one attempt just faltered.

As past president of the Oklahoma Independent Petroleum Association, an industry body that his father helped to create, Dewey Bartlett Jr. is a familiar voice in policy debates.

So when he began calling this year for higher state taxes on oil producers to help fund cash-strapped public services, Oklahomans sat up and listened. “I came out of the closet,” jokes Mr. Bartlett, a two-time Republican mayor of this city, once called the Oil Capital of the World.

Many of Bartlett’s oil-industry peers didn’t like what they heard. Soon Bartlett was facing calls to stick to the group’s talking points – keep taxes low to encourage oil exploration – or resign from its board of directors. So far he’s done neither, insisting that he has a right to speak out.

Now, as Oklahoma stumbles through a budget crisis after years of steep tax cuts, his call for higher taxes on his own industry and a rethink of what makes a state’s economy viable has struck a chord here.

On Wednesday, the Republican-dominated legislature failed to muster the supermajority needed to pass an interim bill to fund essential health services, deepening a political impasse. But many Republican legislators agree with Bartlett that what's needed is to put Oklahoma’s finances in order so that it can afford to pay teachers more and invest in social programs and infrastructure.

“We can’t cut our state government to the bone and expect our state to do well,” Bartlett says.

Echoes of Kansas

As in Kansas, where tax cuts in 2012 led not to supersized economic growth but to a fiscal cliff, Oklahoma may serve as a cautionary tale in the national debate over the efficacy of cutting personal and business taxes in order to spur spending and investment.

Like Kansas’s Republican governor, Sam Brownback, Oklahoma’s Mary Fallin was elected in 2010’s “Tea Party” wave election that gave her Republican party a free hand at fiscal experimentation. Governor Fallin vowed to eliminate state income taxes and make Oklahoma more attractive to business, in part by shrinking the state government.

Fallin’s tax cuts were less drastic than those in Kansas, which saw an immediate drop in revenues. But the global crash in oil prices in 2014 laid bare Oklahoma’s fiscal vulnerabilities. Yet the state failed to roll back generous tax breaks for oil and gas producers and other powerful industries, even as budget deficits piled up, year by year.

Mike Mazzei, a former state senator, says oil and gas is a vital industry in Oklahoma, but argues that lawmakers “went overboard” in granting special incentives. They “went way beyond what we could afford if we wanted to maintain some prudent financial management,” says Mr. Mazzei, a Republican, who left the Senate last year due to term limits.

A recent stress test by Moody’s Analytics of states’ ability to weather another recession ranked Oklahoma 48 out of 50 states based on the gap between its actual reserves and what it would need. The report found that 14 other states were similarly unprepared, and only 16 states currently had enough in reserves to withstand a moderate recession.

‘Communities are feeling it’

In the past few years, as Oklahoma’s state agencies, from prisons to schools to hospitals, struggled to cope with steep budget cuts, Fallin has recanted. The governor has urged a Republican-dominated legislature to mobilize the three-fourths majority required to raise taxes and restore funding. Deep cuts in K-12 spending have led dozens of districts to adopt four-day school weeks to save money.

“We’re seeing Republicans who recognize they can’t cut any further, that they cut taxes too much and that we need revenues,” says David Blatt, who runs the Oklahoma Policy Institute, a left-leaning think tank in Tulsa. “Tax cuts have consequences.”

Mr. Blatt, a former fiscal expert in the state Senate, says “Oklahoma has always been a low-tax state that underfunds public services…. Communities are feeling it.”

In May, lawmakers narrowly passed a $6.8 billion budget that, as in previous budgets, relied heavily on nonrecurring sources to close a $748 million deficit. Three months later, the state Supreme Court ruled a cigarette tax designed to fund health services unconstitutional, forcing a special session to convene since last month.

The bill unveiled Monday by Republicans would have raised taxes on cigarettes, fuel, and beer to make up the shortfall. It also set aside money for higher salaries for teachers and other public officials amid widespread concerns about staff recruitment and retention. But the bill spared tax breaks for oil producers, to the frustration of Democrats and some Republicans.

Should lawmakers fail to plug the gap, health officials have said they would slash staff and programs, including virtually all outpatient services for mental health. A spokesman for Oklahoma’s Association of Chiefs of Police said on Wednesday that the criminal justice system couldn’t cope with any further cuts.

“If we don't act immediately, we will be killing Oklahomans on a daily basis because we are not providing them the necessary mental health treatment,” Brandon Clabes, a police chief, told a press conference in Oklahoma City.

Effects on growth?

Unlike the federal government, most states have to balance their budgets, which makes them an inexact analog for federal tax policy. A 2015 study by the nonpartisan Tax Policy Center found little evidence that state tax cuts had a positive or negative effect on economic growth, contrary to the claims of free-market think tanks influential in Republican circles.

Defenders of Kansas and other tax-cutting states argue that lawmakers gave up too quickly on their fiscal experiments. In June, moderate Republicans and Democrats in Kansas voted to raise taxes, overturning Governor Brownback’s veto. Still, Kris Kobach, a Brownback ally who is vying to replace him when his term ends next year, stood firm. “Kansas does not have a revenue problem. Kansas has a spending problem,” he said.

In Oklahoma, Mazzei says similar arguments are losing steam because many voters are seeing the results of government cutbacks, particularly at local schools. “Your typical Republican in this state now understands we’re behind the curve, and we can’t fix the problem with more cuts,” he says.

A debate over oil incentives

Bartlett, on the board of the oil industry trade group, opposes one particular tax break: a 2 percent rate on oil production from new horizontal wells, which are drilled into shale beds, typically by larger companies. The tax break was first introduced in 1994 to incentivize what was then a new and risky technique. Traditional vertical wells, which Bartlett’s family firm operates, are subject to a 7 percent tax.

Today the majority of wells in Oklahoma are horizontal, and Bartlett says the tax break is no longer needed. “In my view, we should say hurrah, it was a success,” he says.

Tim Wigley, the trade group’s president, says he sympathizes with legislators trying to balance their budget and points to other oil-related tax breaks that have already been phased out. “We’re in this situation not because the oil and gas industry doesn’t pay enough tax,” he says.

He argues that the 2 percent rate, which covers the first three years of output, is paying off because more companies are drilling in Oklahoma rather than in rival states like North Dakota and Texas, and that means more jobs and tax revenues. “We’ve become the No. 1 target of outside investment in oil and gas,” he says.

Bartlett is still on the board of the industry group, and there has been no formal attempt to remove him, says Mr. Wigley. “He has a difference of opinion with the vast majority of our board members,” he says.

“They’re not quite as friendly to me as they used to be, which is too bad,” says Bartlett.