Tax policy

March 28, 2013
   
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One of the biggest stories of this proposed budget is a billion dollars in tax cuts, and with those cuts an increase in regressivity of state and local taxes. These tax changes include:

  • A broadening of the state sales tax to more services, with defined “essential” services (medical, housing, education) exempted. Services would routinely be subject to the sales tax, with a need for special exemption to be removed rather than specific legislative action to add them to the tax code;
  • A reduction of the sales tax to 5 percent from 5.5 percent; 
  • Control by the state and reduction of local sales taxes that piggy-back on the state tax for three years, with a minimum revenue-growth rate guarantee (a floor, not a ceiling);  
  • Application of a new form of severance tax to horizontally drilled oil and gas;
  • The rainy day fund will be filled to its 5 percent of GRF limit and overflow into the Income Tax Relief Fund, which will fund a 4 percent across-the-board cut in the personal income tax for one year at the cost of $415 million. (This tax provision is not really attributable to revenues in the next biennium, but would occur in the course of the coming fiscal year).
  • A permanent, across-the-board personal income tax cut of 20 percent, similar to the 21 percent cut of 2005, this would be taken over the next three years;
  • The exclusion of half of business income up to $750,000 from the income taxes of owners of partnerships, S Corporations, sole proprietorships and other businesses organized as “passthrough entities,” because their owners are taxed on the business income through the personal income tax;
  • The elimination of a handful of the 129 tax exemptions, credits and deductions that together add up to more than $7 billion in annual foregone state revenue.   

The proposed changes in tax policy mean that the state will rely less on Ohio’s wealthiest and more on Ohio’s middle- and low-income families for revenues. These families already spend a larger share of their income on state and local taxes than the wealthy do. In Ohio, non-elderly taxpayers at the lowest end of the earning scale, that fifth making less than $17,000 in 2010, on average spend 6.7 percent of their income on sales and excise taxes, while those in the top earning 1 percent, making more than $324,000, spend only 1 percent. By contrast, a progressive income tax works the opposite way:  the higher one’s income, the more personal income tax one pays.[27] Under current tax policy, the wealthiest pay almost a third less in state and local taxes than the poor as a share of income. 

Revenues from the severance tax and the sales tax will be used in the proposed budget to pay for cuts to the personal income tax. A Policy Matters analysis found that while the wealthiest of Ohioans would see, on average, an annual tax cut of $10,369, the bottom 20 percent of earners would see an actual tax hike of $63 per year. Those of middle income would see a tiny increase as well.[28]  The sales tax needs to be broadened to cover more services, to provide adequate revenue and to make the tax fit with today’s economy. However, the regressive impact of expanding the sales tax for those at the bottom of the income scale highlights the need for tax credits to protect household income at these levels. We recommend a sales tax credit and an earned income tax credit to make up for the tax shift to low and middle-income families.[29]

Although cuts in income tax make the overall state and local tax system less fair, proponents claim  that they will stimulate job creation. This has not worked in Ohio. In 2005, Ohio’s legislature lowered personal income tax rates by 21 percent, eventually phased in over seven years, and overhauled the business tax system. Now fully implemented, the tax code changes eliminate $2.5 billion in revenue every year.[30]  Yet Ohio’s economy lost 4 percent of its employment base since those tax changes were signed into law in June of 2005, while the nation’s employment grew by 1 percent. Tax cuts have not worked in the past to boost Ohio’s economy and there is little reason to expect that they will work in the future.[31]     

Ohio’s state and local taxes as a share of state personal income in fiscal year 2010 were 10.8 percent, almost identical to the national average of 10.7 percent and close to that of our neighbors: Indiana (10.9 percent), Michigan (10.9 percent), Kentucky (10.0 percent), West Virginia (11.3 percent) and Pennsylvania (10.6 percent).[32] A significant body of research finds that state and local reductions do not increase job growth.[33] 

The 20 percent personal income tax cut proposed by the Kasich administration would be in addition to a proposed tax cut on business income. Independent contractors and business owners could exclude from state taxes income of up to $750,000 – effectively cutting state taxes in half on business income up to that level. Wealthy Ohioans could see substantial tax cuts as a result. The example contained in the Appendix to the Budget Reforms document that accompanied the release of the executive budget used an example of a limited liability corporation in which each owner reported $500,000 in business earnings.[34] Each one would see a tax cut of $11,820 as a result of this break.  The theory is that this will boost hiring, but in practice, businesses hire based on product demand, not based on a tax break that is smaller than a new staffer’s salary would be.[35] A substantial amount of this new tax break would go to those with such small business income that it is unlikely to lead to meaningful job creation; according to the taxation department, the median amount business owners expected to qualify for this tax break will be able to exclude is just $3,103.[36] Meanwhile, attorneys at big Ohio law firms and others who are unlikely to be engines of job creation would be able to exclude half the compensation from their firms, up to the cap. This tax change also increases the regressivity of Ohio’s state tax system: 53 percent of the value of this tax break goes to the top 1 percent of earners, and another 26 percent to the next 4 percent.[37]

In sum, the income tax cuts are expensive, but will not improve the economy of the state. The proposed broadening of the sales tax base makes the tax more effective and stable, but even with a lower rate, it has a negative impact on households of modest income. A sales tax credit and an earned income tax credit could help offset this impact. The severance tax, exported to out-of-state consumers, is a good move, although the rate could be substantially higher and the front-end loopholes eliminated.

Other sections:
Executive summary
Introduction
Expenditures
Medicaid expansion
Other health and human services
K-12 education
Higher education
Local government
Conclusion 
 

[27] Policy Matters Ohio, “Ohio’s state and local taxes hit poor and middle class much harder than wealthy,” Jan. 30, 2013, at http://www.policymattersohio.org/income-tax-jan2013.

[28] Zach Schiller, “Kasich tax proposal would further tilt tax system in favor of the affluent,” Policy Matters Ohio, February 2013 at http://www.policymattersohio.org/tax-policy-feb2013.

[29] David Rothstein, “Small Investment, Big Difference:  How an Ohio Earned Income Tax Credit would help working families,” Policy Matters Ohio, March 2013, at http://www.policymattersohio.org/eitc-mar2013 

[30] Testimony of Deputy Tax Commissioner Frederick Church, Legislative Study Committee on Ohio’s Tax Structure, Aug. 24, 2011, p. 21.

[31] Zach Schiller, “Kasich tax proposal would further tilt tax system in favor of the affluent,” op. cit.

[32] Federation of  Tax Administrators, using data from the Census and from the Bureau of Economic Analysis, at http://www.taxadmin.org/fta/rate/10stl_pi.html.

[33] For example, see a recent report by the Center on Budget and Policy Priorities, examining the economic record of states that had approved personal income-tax tax cuts and the economic literature. “State Personal Income Tax Cuts:  A Poor Strategy for Economic Growth,” by Michael Leachman, Michael Mazerov, Vincent Palacios and Chris Mai, March 21, 2013, at http://www.cbpp.org/cms/index.cfm?fa=view&id=3936.

[34] Ohio Jobs Budget 2.0, “Reforms Book,” Table 3 – Example of Tax Savings from Small Business Deduction, p.43

[35] See Michael Mazerov, “Cutting State Personal Income Taxes Won’t Help Small Businesses Create Jobs and May Harm State Economies,” Center on Budget and Policy Priorities, Feb. 19, 2013, at http://bit.ly/YDQrTw.   

[36] Email from Gary Gudmundson, Ohio Department of Taxation, to Zach Schiller, Policy Matters Ohio, March 1, 2013. Based on 2009 data,

[37] Zach Schiler, “Kasich tax proposal would further tilt tax system in favor of the affluent,” Policy Matters Ohio, February 13, 2013 at http://www.policymattersohio.org/tax-policy-feb2013

 

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