This post originally appeared as an op-ed on Forbes here.
Last week, Ohio House leadership introduced a substitute bill to Governor Kasich’s proposed budget that would make many notable improvements to the tax plan. This is good news, because the proposed 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. plan that came from the Kasich administration was deeply in conflict with itself.
The central element of the governor’s proposal was to reduce the 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. , which Kasich argues has “sucked the vitality out of this state.” The internal conflict, however, came from the revenue offsets the governor chose, which would have placed greater hindrances on, well, economic vitality. When first details emerged, I wrote on Forbes that the governor’s plan may be a tax cut overall, but that doesn’t make it good policy.
The governor’s proposed hikes included an increase in the state’s unique Commercial Activity Tax (arguably the most distortive tax in Ohio’s code), a hike to cigarette taxes, new taxes on electronic vapor cigarettes, hikes in the severance tax, and a hike to the sales tax. When done correctly, tax swaps can reduce highly harmful taxes while offsetting revenue losses by leaning on less distortive taxes. The Kasich proposal, by contrast, leaned on economically distortive, nontransparent taxes to make the ledger balance.
The new House proposal fixes a lot of this. The individual income tax would be cut by about 6 percent across the board (there are nine brackets), reducing the top rate from 5.333 percent to 4.99 percent. The Commercial Activity Tax would stay at its current rate, the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. would remain constant, cigarette taxes would not be increased to prohibition-style levels, and severance taxes would be maintained at their current levels. The Columbus-based Buckeye Institute calls these moves a “big step forward.”
One final sticking point to mention as the House substitute bill makes it’s way to the Senate is the contentious small business income tax carve-out that would allow pass-through entities (S-corps, LLCs, and sole proprietors) to deduct hefty portions of their income.
Current policy in Ohio temporarily allows businesses to deduct 75 percent of their income up to $250,000; and the Kasich budget would have expanded that deduction to 100 percent of all pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. income up to $2 million, a provision I warned in January would introduce opportunities for tax avoidance, as wage earners could reclassify themselves as small businesses to get big tax savings. The House substitute bill would make the temporary 75 percent deduction permanent, but not expand this carve-out any larger.
This provision is still flawed, but the House proposal is admittedly a marked improvement.
All in all, the Ohio House deserves a lot of credit for coming up with workable solutions to the problems with the Kasich budget. Upon introduction of the substitute bill, House Speaker Cliff Rosenberger released a statement saying, “The testimony we have heard during the committee process has helped us to build on the governor’s proposal.” As someone who gave testimony to the House last month, I thank them for listening.
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