Policy Documents

Research & Commentary: Tax Reform in Ohio

July 10, 2013

The Ohio General Assembly has considered several major tax reform proposals during the current legislative session. The proposal currently being considered contains several positive tax reforms, but it would not achieve the comprehensive reform Ohio needs.

The first part of the proposal mirrors efforts underway in other states, shifting the state’s tax revenue away from income taxes and toward sales taxes. The proposal would increase the statewide sales tax from 5.5 percent to 5.75 percent and expand it to digital products such as music downloads.

The second part of the plan would reduce income tax rates across the board by 10 percent over three years. The Buckeye Institute estimates that would allow nearly $3.2 billion more to remain in Ohio taxpayers’ pockets. The bill also allows pass-through entities (such as LLCs and S-corps) to deduct their income below $250,000 by 50 percent, creates a new earned income tax credit, and tightens the homestead exemption. In all, the income tax changes could result in more than $4.8 billion in tax cuts.

The third component of the plan, expansion of Ohio’s gross receipts tax, is receiving the most criticism from tax reform and free-market groups. The exemption on the state’s gross receipts tax, known as the Commercial Activities Tax (CAT), would be reduced from $1 million to $500,000, subjecting many more businesses to the tax. The Tax Foundation has argued the CAT is the single worst part of Ohio’s tax code.

The CAT already increases the cost of consumer goods, and lowering the exemption would make a bad situation even worse, slowing economic growth while hitting small businesses especially hard. Unlike corporate income taxes and sales taxes, gross receipts taxes apply to all transactions, including intermediate business-to-business purchases of supplies, raw materials, and equipment, regardless of the firm’s profits or losses. A key problem of the CAT is its lack of transparency: it makes it impossible for consumers to know how much tax they are paying.

Ohio consumers and the economy are likely to be made worse off by the tax bill. The haphazardly constructed plan seems to contradict itself in several ways. The income tax changes would leave more money in taxpayers’ pockets, but the CAT increases the cost of goods and thus limits the tax cut’s effect. And although the pass-through deduction is designed to help small businesses grow, the plan increases the number of small businesses affected by the CAT.

The following literature examines Ohio’s tax reform proposals from multiple perspectives.

Ten Principles of State Fiscal Policy
http://heartland.org/policy-documents/ten-principles-state-fiscal-policy
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”  

Rich States, Poor States
http://www.alec.org/publications/rich-states-poor-states/
The sixth edition of this publication from the American Legislative Exchange Council and authors Laffer, Moore, and Williams offers both individual-state and comparative accounts of the negative effects of income taxes.  

Budget Tax Plan: Steps in Right Direction, but More Cuts Necessary to Make Ohio Competitive
http://buckeyeinstitute.org/the-liberty-wall/2013/06/24/budget-tax-plan-steps-in-right-direction-but-more-cuts-necessary-to-make-ohio-competitive/
Greg Lawson of the Buckeye Institute says Ohio’s new tax proposal is a decidedly mixed bag. Lawson says there are several very positive provisions that represent movement toward a better tax system overall—changes that have the salutary effect of leaving more money in the pockets of Ohio’s taxpayers. However, he concludes, more is needed to make Ohio competitive: “Without further major income tax reductions, the revenue enhancement in the proposal could subject Ohio to the worst of all worlds: relatively high income and sales tax rates.” 

Ohio Tax Reform Package Keeps Getting Worse
http://taxfoundation.org/blog/ohio-tax-reform-package-keeps-getting-worse
Scott Drenkard of the Tax Foundation discusses the tax proposal currently under consideration in Ohio and argues that even though it cuts revenues by $2.6 billion over three years, it really cannot be called tax reform; it is just a mishmash of tax changes with no central theme. Drenkard focuses on the proposed expansion of the state’s Commercial Activities Tax, which he calls the most damaging part of Ohio’s tax code. 

Concerns Voiced For, Against Ohio GOP Tax Reforms
http://www.the-review.com/dix%20statehouse/2013/06/22/concerns-voiced-for-against-ohio-gop-tax-reforms
Marc Kovac of The Review speaks with supporters and detractors of the Ohio tax reform plan: “Business groups and owners, advocates for the needy and a conservative economist voiced their support Friday afternoon for a Republican-backed tax reform package that would lower state income tax rates, boost the state sales tax rate and close loopholes in state tax code. But school officials, magazine publishers and one liberal think tank voiced concerns about the proposal, which is expected to be folded into the state’s $61.7 billion biennial budget bill and signed into law before the end of the month.” 

Ohio Republican Lawmakers Unveil Income Tax Cut, Sales Tax Hike Days before Budget is Due
http://www.cleveland.com/open/index.ssf/2013/06/ohio_legislature_introduces_br.html#incart_river
Brandon Blackwell of the Cleveland Plain Dealer discusses the plan proposed by Republican leaders of the Ohio House and Senate, a major tax overhaul that would be included as part of the state’s two-year budget.

Research & Commentary: Ohio Municipal Income Tax Reform
http://heartland.org/policy-documents/research-commentary-ohio-municipal-income-tax-reform
In this Research & Commentary, Heartland Institute Senior Policy Analyst Matthew Glans examines another, more positive tax reform being considered in Ohio: municipal income tax reform. Glans points out, “Although critics of the reforms express concern the new system would shortchange communities that rely on local income tax revenue, the bill does not prohibit local governments from changing their tax rates. The ideal reform would be to eliminate or at least lower income tax rates, but the proposed reforms would be a significant step toward simplifying Ohio’s tax system and making the state more economically competitive.” 

Institute Brief—No Income Tax: The Key to Economic Growth
http://heartland.org/policy-documents/institute-brief-no-income-tax-key-economic-growth
The Public Interest Institute examines how states with no income tax are doing compared to those with income taxes: “Studies show that states without an income tax have greater economic growth rates than states with an income tax, including greater rates of income growth, population growth, and job growth, and are more attractive to businesses looking for locations to build or expand.”  

State Income Taxes and Economic Growth
http://heartland.org/policy-documents/state-income-taxes-and-economic-growth-0
Barry W. Poulson and Jules Gordon Kaplan explore the impact of tax policy on states’ economic growth within the framework of an endogenous growth model. Regression analysis is used to estimate the impact of taxes on economic growth in the states from 1964 to 2004. The analysis reveals higher marginal tax rates inflict significant damage on economic growth.  

Research & Commentary: Gross Receipts Taxes
http://www.heartland.org/policybot/results/20724/
This Heartland Institute Research & Commentary examines the effects of gross receipts taxes on businesses and shows their regressive effect on consumers. 

Tax Pyramiding: The Economic Consequences of Gross Receipts Taxes
http://www.taxfoundation.org/research/show/2061.html
The Tax Foundation explains why gross receipts taxes are poor tax policy, noting GRTs lead to harmful “tax pyramiding,” distort companies’ structures, and damage state and local economies. 

New Mexico's Harmful Gross Receipts Tax: A Warning to Other States
http://www.heartland.org/policybot/results/20655/
Paul J. Gessing and Harry Messenheimer of the Rio Grande Foundation discuss New Mexico’s experience with gross receipts taxes, using it as a cautionary tale for other states.

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News Web site at http://news.heartland.org/fiscal, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or mglans@heartland.org.