Tax reform's full effects not yet felt

2/9/2009

Over the next few months, The Blade will publish an occasional series of articles about Ohio's budget as the state struggles to close a $7 billion deficit. Today's story focuses on taxes.

COLUMBUS - The changes were supposed to revamp Ohio's reputation as a Rust Belt manufacturing state with a tax structure that scared away would-be entrepreneurs.

Backers promised short-term pain for long-term gain but four years into a five-year rollout of a widespread overhaul of Ohio's tax system, the pain has been deeper than predicted, and the jury is still out on whether the gain will be worth it.

"We win far more multistate competitions than we lose," said Lt. Gov. Lee Fisher, who doubles as Gov. Ted Strickland's development director. "I can't say the business tax reform is the reason, but it is at least a factor.''

Mr. Fisher said the state routinely calculates the savings in Ohio that the tax changes made possible for a business and includes them in the department's negotiations.

The then-Republican-controlled General Assembly and

Republican Gov. Bob Taft set the reforms in motion in 2005. Although Democrats cried foul at the time, providing a single "yes'' vote in the General Assembly, Governor Strickland has opted to allow the changes to run their course.

Personal income tax rates, paid by individuals and many small businesses, were slashed across the board by 21 percent over a five-year period. The final increment went into effect at the start of this year.

The rates now range from essentially zero after a tax credit for anyone making less than $10,000 a year to 5.9 percent for those making more than $200,000.

A highly unpopular tangible personal property tax on business inventory, machinery, equipment, and fixtures and a loophole-laden tax on corporate profits are gradually being replaced with a new, broader commercial activity tax on business gross receipts.

The Small Business and Entrepreneurship Council's 2008 Business Tax Index issued in April gave Ohio a big thumbs-up for its reductions.

The 70,000-member council ranked the state's tax system the 14th friendliest in the nation for small business, the highest ranking of any Midwestern state. Michigan was 20th.

Although he can't say there's any real buzz about Ohio, the council's chief economist, Raymond Keating, said the argument could be made that Ohio would be in worse shape economically if not for the reforms set in motion before the bottom fell out of the national economy.

"You can play the guessing game of looking backward," he said, "but if those higher taxes were still in place, it could be worse for the state's economy."

"Too often, elected officials get caught up in believing that government matters the most in the equation, that you have to keep funding every possible program and at that level," he said.

"For every government at the state and federal levels, it's a dire time. It will be interesting to see which elected officials get where economic growth comes from and which don't."

But the Tax Foundation, a nonprofit also based in Washington, looked beyond just the numbers and decided it doesn't like how Ohio applies its business and personal income taxes, although the lowered rates certainly help.

The foundation is a fan of simpler taxes, so its scoring system punishes Ohio for its nine personal income tax brackets. It also doesn't like that the business gross-receipts tax retaxes the same dollar on a product as it moves through the supplier-manufacturer-wholesaler-retailer chain on its way to consumers.

In its 2008 study, which also considered local property tax burden and local sales tax add-ons, the foundation ranked Ohio 47th in business-friendliness.

That means it considers only three other states to be less friendly to business than Ohio. Michigan ranked 20th.

Although Ohio's overall score has improved year to year since the reforms were started, the study author said he doesn't anticipate Ohio moving out of the bottom 10 anytime soon.

"It's a marginal improvement in Ohio's tax code which will have a marginally positive effect on growth,'' said Josh Barro, staff economist. "But it's not what they were looking forward to in terms of changing perception of Ohio and changing the comparisons with neighboring states."

Richard Levin, Ohio tax commissioner, said other states are watching Ohio, which is about to become one of just a handful with next to no corporate profits tax.

"We've gotten rid of a tax that the business community for the last half-century has said was the worst business tax, the tangible property tax," he said.

"Year after year, Ohio had talked about reducing or eliminating the tangible personal property tax on machinery, equipment, and inventory. Ohio stood out like a sore thumb for having a TPP with a heavy burden, which was a problem for us."

States are also watching to see what will happen with the commercial activity gross receipts tax. Grocers convinced a district appeals court last year that the tax's application to receipts generated from food sales violates the Ohio Constitution.

Mr. Levin predicted that if Ohio loses that case now before the state Supreme Court, other cases will follow, including one from out-of-state businesses taxed on their activity inside Ohio.

Excluding entire swaths of Ohio's economy could endanger the viability of the gross receipts tax, which was aimed at having a low rate spread across a very broad base.

In all, the national economic downturn combined with the effects of the tax reform package are expected to result in $824.8 million, or 4.5 percent, less collected in taxes in fiscal 2010 compared with fiscal 2009.

Policy Matters Ohio, a nonprofit organization that focuses its economic research on issues affecting low to moderate-income families, has predicted that the net effect of the reforms will be $1 billion less a year for education and other services.

"To my mind, it was a no-win proposition," said Zach Schiller, research director for Policy Matters. "And we're adding to the regressivity of the tax system. Typically, the bulk of the income tax cuts went to affluent people."

Dan Navin, assistant vice president on tax and economic policy with the Ohio Chamber of Commerce, said it's too soon to cast judgment.

"I felt all along it would take us at least three years after all the changes have taken effect before we could really see the full impact," he said. "You have to get beyond the phase-in and phase-out to see how the permanent reforms manifest themselves in new investment, new jobs created, and new companies located here."

Even with the fading economy and dwindling tax collections, Republicans introduced proposals last year to roll back taxes further.

Bills had been introduced in the General Assembly to eliminate Ohio's personal income tax and to get rid of what's left of the state's share of the estate or inheritance tax, which critics have dubbed the "death tax." The bills went nowhere.

Contact Jim Provance at:

jprovance@theblade.com

or 614-221-0496.