Policy Matters Ohio Misses the Mark on Tax Reform

September 12, 2013

Recent testimony given to Ohio’s House Tax Reform Legislative Study Committee by Zach Schiller at Policy Matters Ohio has raised some questions about the effects of taxes. In it, he argued, among other things, that “Taxes, and the personal income tax in particular, are not the factor that determines state economic success.” Indeed, publications of the Federal Reserve Bank of Cleveland, the Iowa Policy Project, the Massachusetts Budget and Policy Center, and the Center on Budget and Policy Priorities were all cited to suggest that income taxes have little to no effect on important economic variables.

We respectfully disagree, but more importantly, some of the groups cited would disagree. Even the Center on Budget and Policy Priorities concedes that taxes at least might affect economic outcomes. Quoted in full (emphasis added):

Organizations advocating lower and less progressive taxes can find some studies by reputable economists that find that above-average state and local taxes have a measurable and consistently adverse impact on state economic performance. However, many equally reputable studies reach the opposite conclusion, and the results of many more are mixed, ambivalent, or show that any adverse impacts are small. There is simply no consensus whatsoever that cutting taxes is a good strategy to boost state economic growth and create jobs.

By limiting their analysis to just state-by-state studies of taxes and growth, CBPP suggests the literature is mixed, but notes that even in that limited scope there are reputable studies that suggest that high taxes are bad for the economy. It further turns out that with an expanding the literature review to international studies (in which tax rates vary more widely, making statistical techniques more illustrative) yields quite a few studies that show that taxes hurt growth. By our count, at least 20 such studies have been published since 1997.

Despite this evidence, Policy Matters Ohio goes even further to suggest that higher taxes may actually help economic growth, leaning on spurious anecdotal evidence from periods with unique economic conditions:

Ohio’s own experience bears this out. After General Assembly raised the top rate of the income tax to 7.5 percent in 1992, during the administration of Gov. George Voinovich, the state generated more than 100,000 jobs in each of the following three years. On the other hand, our tax cutting has not been followed by the same kind of growth. As you know, the General Assembly approved a phased-in reduction of the income tax by 21 percent beginning in 2005. Whether one begins with the approval date, the beginning or end of the recession, or January 2011, the results were the same: Ohio underperformed the nation. Since June 2005, we have lost a greater share of our jobs than all but three other states, Rhode Island, Nevada and Michigan.

The testimony then goes on to mischaracterize a peculiarity of Ohio’s tax policy: local income taxes. Mr. Schiller argues that, in regard to combined state and local income taxes, “the maximum [rate] may appear higher than in nearby states. However, this is not the rate that most, or even a substantial share, of Ohioans pay.” Regarding school income taxes, he says that “Ohioans who prefer to live in a district without such a tax can live in one of more than 400 other districts.”

These statements aren’t entirely accurate. Especially given that most states don’t have any local income tax at all, Ohio’s policy is a unique tax burden. But even among states with local income taxes, Ohio’s is among the higher rates. Furthermore, it is interesting that Policy Matters Ohio suggests that Ohioans that don’t like local income taxes should leave. Since 2000 Ohio has lost hundreds of thousands of residents due to migration out of the state: renewed emigration is not a solution, and will only erode Ohio’s tax base even further.

Unfortunately, not only are Ohio’s local income taxes relatively high; they are excessively complex. Local areas in Ohio can not only set their own rates, but can determine their own income tax bases as well (we call this base autonomy). While major corporations can perhaps afford the burdensome compliance costs associated with filing multiple complete tax returns with different definitions of income in several jurisdictions, this policy is extremely damaging for small businesses. My colleague Scott Drenkard testified before the Ohio House of Representatives Ways and Means Committee on exactly that subject several months ago:

[Base autonomy] 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 taxation.

Finally, there is one good recommendation in the testimony given: Mr. Schiller ends by suggesting an expansion of the sales tax base, an idea we have supported for Ohio in the past. However, Policy Matters Ohio’s position on sales tax base expansion seems inconsistent and unclear. It’s true that, in February, they said sales tax base expansion was “good tax policy.” But, in their official review of the budget, their tax policy section had little good to say about base expansion, saying that “even with a lower rate, [sales tax base expansion] has a negative impact on households of modest income.” And although their executive summary said base expansion was a “sound way of strengthening and stabilizing the [sales] tax,” they also identified it as “still regressive, hurting low-income families more.” Then, the very next paragraph said that the plan containing the base expansion was, overall, “bad tax policy.”

Whatever Policy Matters’ Ohio’s opinion on sales tax base expansion may be, the policy itself is a sound one. Lower rates and broader bases create a less distortive tax code with fewer special-interest carve-outs. Concerns about regressivity may be over-stated as well given that a sales tax base expansion to include services would tax consumption categories disproportionately consumed by higher-income Ohioans, like legal services. If an across-the-board rate reduction were also included, common consumption items like clothing and other taxed goods that make up a major share of low-income persons’ consumptions would actually see lower tax rates, not higher.

In sum, several of Policy Matters Ohio’s contentions don’t seem to be supported by the evidence. There are good reasons to argue that high taxes are harmful to growth, and Ohio’s local income taxes are uniquely harmful, both because of their rates, but also because of their excessively complexity. I’m hopeful that Policy Matters Ohio will come around on their position on sales tax base expansion.

More on Ohio.

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