Ohio’s Local Income 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.
es: Complex and in Need of Reform
Economist, Tax Foundation
Hearing of the Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S.
The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others.
of the Ohio House of Representatives
May 7, 2013
Chairman Beck, Ranking Member Letson, Members of the Committee:
My name is Scott Drenkard, and I’m an economist at the Tax Foundation. For those unfamiliar with the Tax Foundation, we are a non-partisan, non-profit organization that has monitored fiscal policy at all levels of government since 1937. We have produced the Facts & Figures handbook since 1941, we calculate Tax Freedom Day each year, and have a wealth of data, rankings, and other information at our website, www.TaxFoundation.org. We are guided by the principles of sound tax policy: simplicity, neutrality, transparency and stability.
I’m pleased to have the opportunity to speak today with regard to H.B. 5, a bill to reform elements of Ohio’s municipal tax system. While we take no position on the bill, I hope to give some perspective based on our research.
In 2011, we wrote a paper on city- and county-level income taxes, and found that of the 17 states that rely on local income taxes, Ohio has among the highest rates. In 2010, local income tax collections as a percentage of state personal income were 1.06 percent. The only state with higher effective rates is Maryland.
However, sound tax policy is not just about how much money is collected. It is about collecting revenue for necessary government services in the most efficient way possible. Ohio’s municipal tax system is far from that ideal. H.B. 5 does a great deal to remove some of the complexity built into Ohio’s municipal tax system. I’m hoping it represents a start to a movement by lawmakers to make the code more sensible and user-friendly.
Simplifying Income Tax Filing
Today, I’d like to do something I normally don’t get the chance to do, and that is say something nice about Maryland’s tax system. Maryland is similar to Ohio in that the state leans heavily on local income taxes to fund government, but it does so in a way that generally minimizes taxpayer headache. If you look at their state income tax form, the entirety of the compliance with the local income tax is handled on just a few lines of the form. Taxpayers simply multiply their taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. from line 21 (their taxable income) by the percentage corresponding with their locality, which is conveniently located in the instructions, then subtract out two credits for low income individuals. H.B. 5 does not get Ohio to this standard quite yet, but this just illustrates that local income taxes can and should be just that easy.
Figure 1: Maryland Local Income Taxes on the State Form
By contrast, Ohio law makes individuals fill out additional forms detailing their local income tax liability. Sometimes individuals fill out multiple forms, and businesses often do. Frustratingly, these tax bills are often trivial, meaning that municipalities are contributing a great deal to compliance costs, which economists will tell you are just a tax burden that doesn’t even collect any revenue.
What’s worse is that each of these jurisdictions has what we call local “base autonomy.” That means that each locality is permitted to come up with their own calculation of taxable income and their own collection requirements. This is especially problematic if the localities don’t treat credits for taxes paid to other jurisdictions in the same way. In Ohio, it’s entirely possible to pay local income taxes on the same dollar to more than one jurisdiction. This is an affront to the time-honored principle of avoiding double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. .
There are nine states that have local base autonomy for their 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. es, and we track that variable and it counts against those states in our annual calculation of the State Business Tax Climate Index. We actually don’t even track base autonomy in local income taxes, and truthfully, that’s because we didn’t even know that any state had competing local income tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. s until I was asked to testify here today. H.B. 5 doesn’t move to an entirely uniform base for local income tax collections, but it is a start.
Net Operating Loss CarryforwardA Net Operating Loss (NOL) Carryforward allows businesses suffering losses in one year to deduct them from future years’ profits. Businesses thus are taxed on average profitability, making the tax code more neutral. In the U.S., a net operating loss can be carried forward indefinitely but are limited to 80 percent of taxable income. s
One of the elements of uniformity that the bill would bring is in the treatment of net operating loss carryforwards. NOL carryforwards are an important element of any tax code because they promote neutrality between businesses and individuals that have different income flow patterns.
The fact that taxes are collected once a year is just a tool to help with budgeting; but not all businesses operate on a 365 day income model, and it’s important to adjust for this fact of economics. Some entrepreneurs take years building up start-up capital and sustaining little profit with hopes of obtaining larger profits in the future. NOL carryforwards help smooth this income inconsistency so we don’t harm new innovative enterprises. H.B. 5 ensures that carryforwards are at least offered for five years.
The Casual Entrant Exemption
One of the other components of this bill that deserves praise is the reform of the “casual entrant” exemption, which is necessary to bring tax complexity under control. Currently, businesses are forced to withhold income taxes in multiple jurisdictions even when their employees spend just a few days working there. I’ve heard horror stories of service professionals in Ohio that end up with over 20 W-2s at the end of the year.
My intuition tells me that many businesses simply don’t bother with going through the trouble of withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. in all the jurisdictions their employees might visit and instead just hope their books don’t get auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. ed. This is a great example of tax law that undermines voluntary compliance. Businesses want to pay all the taxes that are due, but simply find that too difficult.
H.B. 5 extends this casual entrant exemption to 20 days, alleviating some of this pressure. However, I think the measure could go somewhat further. In Pennsylvania, localities simply tax non-residents based on their primary place of employment, and this cuts down on a tremendous amount of additional paperwork. I think that is a viable model for states that have local income taxes, and one that Ohio should take under strong consideration.
In closing, while I’ll be the first to admit that administrative tax changes like those in H.B. 5 are not the most scintillating discussion topic, I’m pleased to see this committee taking a serious look at making the local income tax structure in the Buckeye State more sensible. It will reap huge benefits. Thank you for your time and consideration; I look forward to your questions.Share