Reforming Ohio's Tax System for the 21st Century
With economic and population growth in Ohio lagging behind the nation, it's about time that Ohio take a serious look at its outdated system of taxation. In short, we need a 21st Century tax code for a 21st Century economy.
In the cash-oriented 19th Century with primitive accounting standards the tax of choice in Ohio and elsewhere was the property tax. Property had the advantage of being easy to account for--we all have our deeds in the county courthouse--and therefore it was easy to tax.
As the industrial age matured in the 20th Century, state governments began to look to new sources of revenue. The federal income tax and advances in accounting standards made taxing different types of business and personal income and wealth easier for the state. Ohio jumped on this bandwagon fully in 1973 with the creation of the personal income tax. In addition, to personal income, corporate and estate (death) taxes, we also have specific taxes on producing and consuming various goods and services: alcoholic beverages, cigarettes, horse racing, insurance, electricity, gasoline, natural gas, and replacement tires.
Taxing income and wealth is risky business if the source that generates the income can move away to other states or nations, but it works reasonably well so long as the income source is immobile. This certainly was the case with the large industrial companies characterizing the 20th Century. A steel mill in Youngstown wasn't going anywhere. Or so we thought.
The 21st Century American economy is shaping up to operate quite differently from the industrial 20th Century economy. Ours is now a knowledge economy. Americans specialize less in industrial production and more in knowledge creation like medical drugs, software, financial products, etc. These knowledge companies are not nearly as immobile as their industrial counterparts of the previous age.
Furthermore, reductions in worldwide transportation, communication costs, and political trade barriers have ushered in a truly global economy. Businesses can and do move just about anywhere because their resource and product markets are typically national or global. Even retail businesses are no longer strapped to the mall with the rise of the Internet. Indeed, one reason businesses have become so successful at extracting tax concessions from state and local governments is that technology and global markets allow them to make good on the threat of leaving.
Like the economy, the 21st century tax system will have to look very different from the 20th century's, just as the tax system of the 20th Century was different from that of the 19th. As we enter the new century, we must remember that not all taxes are created equal. If we try to tax the income generated by the new, highly mobile knowledge industries, we will hurt our economy and struggle even to raise revenue. We will need to tax those economic activities that are less mobile in order to raise the desired government revenue and do the least damage to our economic health.
Thus, inevitably governments will be forced to enact broad-based sales taxes instead of income taxes that drive out high-income earners and small businesses. Rather than rely on general taxes to finance government, more and more government functions will have to be funded through user fees. And ironically enough, it is time perhaps for the property tax to make a comeback. Property taxes still have the advantage of being easy to administer; they are transparent to the taxpayers; and property is the most immobile of all economic resources. It remains the ideal tax for many local government services.
As Ohio begins to sort out the challenges facing its tax code in the coming century, we must issue a note of warning. In the last century, the government added new layers of taxes to the older ones and the government grew massively. We cannot repeat this mistake. As we look to emphasize the broad based sales tax, users fees, and even property taxes, we must reduce and ultimately eliminate the income tax and other distorting selective taxes. In the final analysis, Ohio cannot be competitive with other states and nations in terms of attracting human and physical capital unless the overall level of taxation is reigned in.
Robert A. Lawson, Ph.D. is Professor of Economics and George H. Moor Chair at Capital University in Columbus, Ohio and a Senior Fellow with The Buckeye Institute.
