A Proposal to Simplify Ohio’s Local Income Tax Compliance
February 23, 2017
A few weeks ago, we covered Ohio Governor John Kasich’s budget proposal here. One provision that deserves additional attention is his plan to simplify municipal income tax collection, because the proposal is a thoughtful attempt to reduce compliance costs in Ohio’s worst-structured tax.
Municipal income taxes are not necessarily unique to Ohio; however, the collection of local income taxes in Ohio is a serious headache compared to what is done in other states, particularly for businesses. In Ohio, businesses must withhold income taxes in every jurisdiction that an employee works in. More than 600 cities and villages also tax a business’s net profits in the state as well.
In some cases, the cost of compliance of these two taxes is significantly larger than the actual tax burden for employers. As we explained in 2013:
This complexity creates an extraordinary compliance burden, as employers, especially contractors of varying stripes, must track their employees’ location by hour, by jurisdiction to properly comply with the differing tax codes of all the localities in which they conduct business. A northeast Ohio electrical contractor once filed 221 W-2s for 19 employees, along with 39 business returns, most having a tax due of $5 or less.
Governor Kasich (R) has proposed one statewide, unified filing system for all businesses to file their net profits tax returns. The net profits system would build on the state’s current Ohio Business Gateway and allow businesses to complete only one return under one set of rules. Municipalities would still set tax rates and credits. Localities would still be in charge of collecting municipal income taxes on wages. The Ohio Department of Taxation would keep 1 percent of the collections and distribute the rest back to localities. By comparison, some cities already use third-party administrators that retain 2.5-3 percent of the collections.
There are many ways for municipal tax systems to function more smoothly than Ohio’s currently does. My colleague Scott Drenkard highlighted some of these examples in a 2013 testimony to the Ohio House Ways & Means Committee:
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.
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.
Occasionally in the tax policy debate, tax administration gets forgotten; however, administrative and compliance costs are important facets of the conversation. It’s in everyone’s best interest to reduce the compliance burden associated with Ohio’s municipal income tax system, and Governor Kasich’s proposal for unified collection of the net profits tax is a big step in the right direction.
More on Governor Kasich’s budget proposal.