A Lesson in Good Tax Policy…Anyone? Anyone?

Andrew J. Kidd, Ph.D. May 14, 2019

With the Ohio House passing its version of the budget, tax changes could be coming to Ohio families. But the question is, are they the right changes?

Trying to discuss optimal tax policy is like being Ben Stein in Ferris Bueller’s Day Off.

A slow glaze settles over listeners’ eyes as they wait for the moment to say “Hmm, that’s interesting. Well, I gotta go.” The research and debates on these topics are enough to bore any normal human being for years. But taxes play a critical role in determining how our state operates, and knowing what’s best for the state helps us evaluate if our elected officials are making good tax policy that will help growth Ohio’s economy.

And so, I will take on the role of being your boring economics teacher and explain why good tax policy is so important.

Lesson 1: Taxes change the way people act.

We all know this. If I have to pay more for cereal because of taxes, I’ll buy less cereal. Yes, taxes pay for essential government services, but they also create disincentives and can reduce the value of work, or slow business growth. There is a critical balance that policymakers must achieve between paying for necessary services and letting businesses and families keep and spend their hard-earned money. Money in the hands of hard-working Ohioans ensures a growing economy. If the government taxes too much and spends taxpayer dollars needlessly, the economy shrinks (see dense economic research here).

Lesson 2: Different taxes have different effects on the economy.

We know there are different types of taxes, we begrudgingly pay them all the time. But these different taxes can have varying impacts on the economy. The taxes that slow economic growth the most (more economic research) are taxes that prevent families and businesses from investing in themselves and the economy, such as personal income taxes and corporate income taxes. An overwhelming amount of economic research shows us that taxes on businesses leaves less money for employers to invest in growing their businesses and their employees, these taxes slow job creation and they ultimately reduce economic activity and growth.

Taxes on work—such as income taxes and payroll taxes—reduce the value of work for workers and employers. In economic terms, they discourage work and discourage businesses from creating opportunities for employment.

While no one likes sales taxes, they are one of the least harmful taxes on the economy. For example, if sales taxes were 100 percent, groceries costing $50 would now cost $100. This may prevent us from buying that bag of Oreos, but we wouldn’t stop buying groceries because we need to eat. However, if income taxes were 100 percent, there would be no reason to work, economic activity would cease, and no taxes could be collected.

Not only are there different types of taxes, but there are different ways each tax can be implemented. They can include loopholes (some call these incentives or credits), but they are in fact distortions, and they lead to higher taxes on the rest of us. For example, if the government gives a tax break to attract a business, like we saw in the Amazon HQ2 competition or when Ohio gives a tax break to get studios to film their movies here, the rest of us—families and small businesses alike—must make up for that lost tax revenue by paying more taxes.

Lesson 3: What is the best tax policy to grow the economy?

There is in fact an ideal way to implement tax policy, and any tax system should be based on a few key principles. It should be pro-economic growth, simple, transparent, fair, and equitable. A system with one, low tax rate on all property, goods, and services would pay for needed government services and grow the economy. It is the best system because:

  • It does not create carve outs that benefit only a special few;
  • It does not discourage business investment or devalue work; and
  • It provides a consistent source of revenue that is tied to inflation and population growth—two essential elements to wisely grow the state budget.

The House budget did eliminate some costly credits and exemptions, and they did reduce income tax rates across the board. However, the House budget also increased taxes on some Ohio small business owners and the House increased spending by more than inflation and population by using the budget surplus which could have been used to lower taxes even further for Ohioans. Simply eliminating a tax loophole and moving that tax burden onto another group isn’t a move towards pro-growth tax policy. It may lower taxes for one group, but it places a heavier burden on another group and doesn’t distribute the benefit to all taxpayers.

If policymakers were to control spending (see our Piglet Book) and reduce the tax burdens for all Ohioans, we would see our economy grow and become a national leader in good tax policy.

Andrew J. Kidd, Ph.D., is an economist with The Buckeye Institute’s Economic Research Center. Piglet Book® is a registered trademark of Citizens Against Government Waste and is used with their permission.