Ohio Capital Gains Cut Move In The Right Direction
House Bill 258 would, over time, eliminate the taxation of capital gains and would return the Ohio residency test to the pre-1994 level.
The Buckeye Institute has a long record of advocating tax reform. There are two main themes running throughout our research and advocacy in this area. We think taxes should (1) be lower and (2) be as neutral with respect to economic activity as possible.
HB 258 is a step in the right direction on both counts.
First, it is a tax cut. Let me be blunt. Ohio is over-taxed. By almost any measure you want to use, Ohioans have gone from being on the lowest-taxed people in the country to being among the highest-taxed people. And our economic growth is anemic as a result.[1] To maintain any kind of competitive advantage with the other states (and in a global economy we should remember that we compete with the whole world for investment), Ohio needs tax and spending cuts.
Second, this bill would treat move away from an accretion definition of income (“Haig-Simons) and towards a system that is neutral between consumption and savings and investment.[2] An accretion concept of income defines income as the sum of consumption and change in net worth over a given period. Income that is consumed is taxed, income that is saved (or invested) is taxed, and earnings on that saving (or investment) are taxed as well.
A drawback of the accretion definition of income is that it biased against savings and investment. Saving and investment occurs after the payment of income taxes and the earnings on those savings are taxed again – resulting in the same income stream being taxed twice. By taxing the returns to saving and investment, the price of saving or investing increases relative to consumption and hence, people will save and invest less.[3]
This bias towards consumption can be viewed as the genesis of many tax provisions that help to alleviate the multiple taxation of saving and investment. The federal exclusion of contributions to employer-sponsored pension plans and exclusion of contributions and earnings on IRAs can be viewed as mitigating this bias against saving. House Bill 258 would be very much in the same vein.
I would like to note that the idea that the tax code should be neutral between consumption and taxation is by no means unanimous among economists. Substantial discussion exists about the merits of one system over another and the answer as to which view is correct is unlikely to be decided anytime soon.[4]
Regardless of one’s opinion about whether or not a bias against savings currently exists, however, moving away from an accretion definition of income – as this bill does – would enhance incentives for savings and investment. Combined with the positive impact of the tax cut involved, House Bill 258 would improve Ohio’s economic competitiveness.
Footnotes:
[1] See Richard Vedder, Grinding to a Halt: Ohio's Tax Policy and its Impact on Economic Growth (Columbus, OH: The Buckeye Institute for Public Policy Solutions, 2002).
[2] For a further discussion of the distinction between a tax system based on accretion and one based on consumption, see David F. Bradford and the U.S. Treasury Tax Policy Staff, Blueprints for Tax Reform (2nd edition, Arlington, VA: Tax Analysts, 1984).
[3] This paragraph draws information in Joshua Hall, Tax Expenditures: A Review and Analysis (Washington, D.C: Joint Economic Committee, August 1999), 4.
[4] See Joseph E. Stiglitz, Economics of the Public Sector (2nd edition, New York, NY: W.W. Norton & Company, 1988), chapter 25.
Joshua Hall is Director of Research at the Buckeye Institute and Robert Lawson is Senior Fellow for Economic Growth with the Institute and Professor of Economics and George H. Moor Chair at Capital University. This article was originally presented as testimony to the Ways and Means Committee of the Ohio House on November 13, 2003.
