Policy Matters Blog
The benefits of a graduated income tax
July 20th, 2015
The Ohio General Assembly has taught us a lesson about the benefits of the graduated income tax.
Earlier this month, The Plain Dealer reported that many business owners would wind up paying higher income taxes for 2015 despite a provision in the state budget bill that significantly expands a tax break for this same group. A spokesperson for the Ohio Department of Taxation called it one of the inevitable “anomalous impacts” that happen when there are changes in the tax code.
But while the policy might have been inadvertent, its results were exactly what you would expect when you replace a graduated tax with a flat one: People with low incomes pay more.
Here’s how it works in this case: For 2015, the tax break will allow owners to deduct the first 75 percent of their first $250,000 in business income. They will pay a 3 percent flat rate on the other 25 percent, and any income over that total.
Last year, by contrast, while there was a similar deduction of 75 percent of the first $250,000, the remaining income was taxed according to Ohio’s graduated tax. That tax has nine brackets, beginning at just 0.528 percent on the first $5,200, and increasing on additional income as it grows.
So a business owner with $60,000 in income would deduct $45,000 in either year and pay tax only on the remaining $15,000. However, for 2014, she would have been liable for just $133, assuming she had one personal exemption. By contrast, for 2015, the 3 percent flat tax, figured with the same exemption, amounts to $384, or more than $250 more.
This is true only for one year. After that, the deduction covers all earnings up to $250,000.
Subsequent news reports indicate that legislators will probably “fix” the problem. Presumably, that means scrapping the flat tax for 2015, and going back to the graduated rates that tax Ohioans based on their ability to pay. That will be interesting to watch, since the same budget bill also requires a committee to come up with recommendations to transition to a flat state income tax for everyone in 2018. While they’re at it, legislators should also scratch the flat tax idea. As this snafu demonstrates, it would hurt poor Ohioans.
Zach is Policy Matters research director.