A rosy revenue outlook has allowed Ohio to join eight other states (Arizona, Idaho, Iowa, Louisiana, Montana, Nebraska, New Hampshire, and Oklahoma) in providing taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. relief this legislative session. The legislature agreed on a two-year budget ahead of today’s deadline, and the budget is now awaiting Gov. Mike DeWine’s (R) signature. It includes individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. cuts worth $1.7 billion and offers tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. s for taxpayers who, in 2021, paid municipal income taxes to jurisdictions that collected taxes from commuters even though they weren’t commuting during the pandemic.
The tax cuts in dollar amounts agreed upon are larger than both the House and Senate proposals from earlier this year. The Ohio Senate had proposed income tax cuts of 5 percent and the Ohio House had proposed income tax cuts of 2 percent. After the two chambers’ deliberations, they agreed on changes to the income brackets along with 3 percent cuts (except for the new top bracket, which is reduced by over 9 percent).
The change to the income tax decreases rates for all income brackets and eliminates the top bracket. Moreover, the lowest bracket level is increased to $25,000, which will exempt anyone making less than $25,000 per year from any state income tax liability. According to the Legislative Budget Office, the reductions will decrease collections by $915.8 million in fiscal year (FY) 2022 and $784.5 million in FY 2023.
|Old Individual Income Brackets||Old Rate||New Individual Income Brackets||New Rate|
Sources: Katherine Loughead, “State Individual Income Tax Rates and Brackets for 2021,” Tax Foundation, Feb. 17, 2021, https://www.taxfoundation.org/state-income-tax-rates-2021/; and Ohio House Bill 110,
The income tax changes are retroactive to January 1, 2021, and the budget suspends inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. adjustment of the brackets for tax year 2021. Although Ohio has moved from nine brackets to four in just six years, lawmakers have yet to address the marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. , as the above rates and brackets apply to both single filers and to married filers. Under a progressive, graduated-rate income tax system, tax rates increase as a taxpayer’s marginal income increases. A marriage penalty exists when a state’s income brackets for married taxpayers filing jointly are less than double the bracket widths that apply to single filers.
The American Rescue Plan Act prohibits Fiscal Recovery Funds—Ohio is receiving $5.68 billion at the state level—from being used to facilitate net tax cuts, either directly or indirectly, but the U.S. Department of the Treasury has made clear that states are still free to cut taxes out of their own revenue growth without fear that any Recovery Funds would be recouped. In other words, Ohio must show that it can finance the tax cut without relying on federal aid.
To determine whether a tax cut is funded out of growth, Treasury plans to use Fiscal Year (FY) 2019—the last full fiscal year before the pandemic—as a baseline, looking at inflation-adjusted revenue growth since then. Even with a general fund revenue decline of nearly $900 million in FY 2020, Ohio’s revenue outlook is rosy, with projections from earlier this year showing aggregate revenue growth of $4.7 billion between FYs 2020 and 2023, for an average of $1.18 billion per year, and almost $4.3 billion in nominal revenue growth above FY 2019 levels in the two years of tax cuts within the covered period (FYs 2022 and 2023). The income tax cuts would return around 36 percent of the projected revenue growth since FY 2019 (slightly higher in inflation-adjusted terms).
The budget also provides an option for a refund for Ohioans who paid municipal income taxes to jurisdictions although they didn’t commute into those jurisdictions during the pandemic. While the majority of these taxes were paid in 2020, the budget only offers the option for a refund for tax year 2021.
In Ohio, municipalities levy income taxes on nonresidents’ income earned within their jurisdiction. It is not uncommon for localities to levy income taxes on nonresidents for work performed within their borders as a way to recover the cost of the local services utilized by commuting nonresidents. However, during the pandemic, many people worked from home, which severed the fiscal relationship between the taxing jurisdiction and income generated by commuters. Nonetheless, Ohio passed HB 197, which allowed jurisdictions to continue collecting taxes from nonresidents who had been commuting before the pandemic. The Budget would reverse that policy, incorporating the policy outlined in HB 157.
Remote work is likely here to stay, and cities and states will have to grapple with the revenue implications and may find it necessary to adopt policies to better compete with outlying areas. As the Ohio Senate proposal acknowledges, taxing people in places in which they no longer work is not a solution.
There are several positives in the budget—cutting income taxes and rectifying the problematic taxation of nonresidents during the pandemic in particular. Yet, some issues with the income tax remain, particularly the marriage penalty. The state’s nonneutral treatment of pass-through income is less than ideal as well, though in considering modifications, policymakers must bear the additional impact of the Commercial Activity Tax (CAT) in mind.
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe