Interested Party Testimony on Municipal Income Tax Reform Before the Ways and Means Committee, Ohio SenateNov 19, 2014
By Greg R. Lawson
Thank you Chairman Peterson, Ranking Member Tavares and members of the Ways and Means Committee for providing me this opportunity to discuss the urgent need to reform Ohio’s local tax system. My name is Greg R. Lawson. I am the Statehouse Liaison at the Buckeye Institute for Public Policy Solutions. The Buckeye Institute is a nonpartisan, non-profit, and tax-exempt organization as defined by section 501(c)(3) of the Internal Revenue Code, which was founded in 1994 as an independent research and educational institution—a think tank—to formulate and promote free market public policy solutions for Ohio. To that end, we believe that the key to Ohio’s prosperity is to maintain a low tax, limited regulation environment that is inviting to those wanting to start businesses.
Creating a hospitable environment for new businesses is the only way Ohio will ever be able to shake off its “rust belt,” laggard reputation. Of course, this is much tougher now in the 21st century than it was in our previous industrial heyday. The communications are faster and the competition is much stiffer.
First, we should clarify a singularly important fact. Even if the strongest imaginable uniformity legislation is enacted, Ohio will still be one of only ten states that levy a local tax on both individual and business income. Thus, Ohio will remain an uncompetitive environment relative to the forty states with no municipal income tax irrespective of what the General Assembly does. However, what the General Assembly does can have a more or less ameliorative impact on Ohio’s business environment so long as the municipal income tax remains in existence.
In a report I wrote for The Buckeye Institute, I noted several clear avenues for robust reform to the municipal income tax system:
- Standardize reciprocal municipal income tax credits across jurisdictions for tax fairness;
- Allow for an eventual 20-year Net Operating Loss Carryforward to facilitate start-up business formation regardless of jurisdiction;
- Use a simple, “bright-line” residency test that taxes non-residents based on their primary place of employment;
- Set a higher threshold for filing a net profit return (currently $10) to avoid taxpayers spending more in filing than they have in tax liability;
- Require a simple form for businesses to declare that they conducted no business in a specific municipality and therefore did not need to file a complete tax return for that municipality;
- Include a “Taxpayer Bill of Rights.”
Stepping back from the intricacies of the current debate, it is critical to understand the context within which reform to the municipal income tax is occurring.
Most businesspeople and entrepreneurs agree that high taxes drain private sector resources and re-allocate them according to external considerations that impact economic efficiency. Therefore, dealing with the full spectrum of Ohio’s tax burden at the state and the local levels is essential to our future job growth prospects. It is critical that Ohio taxes are simple, fair, and transparent. Unfortunately, Ohio’s municipal income tax is none of those things, which contributes to a subpar economic climate that for far too long has shackled Ohio’s economic vibrancy.
It is important to understand how devastating the decade between 2000 and 2010 was for Ohio. In fact, the state has only recently begun to climb out of the economic hole into which it fell after losing nearly 620,000 private sector jobs—the second most private sector jobs of any state in the country. Only our neighbor up north, Michigan, fared worse over the same time span. Despite private sector job growth in 2010-2012, there is far more that needs to be done in order to supercharge our recovery. A key component to our recovery remains to improve our state’s overall tax climate in order to invite private sector job growth that will in turn spur greater economic growth across the board.
According to the non-partisan Tax Foundation, Ohio’s overall state and local tax burden in the late 1970s was competitive among its sister states, ranking 40th in the nation. But by 2005, Ohio’s total tax burden had increased dramatically, rising to the unenviable position of 7th highest. In one generation, Ohio’s tax burden relative to the other states had moved from among the 10 best to among the 10 worst. That is not progress.
State tax reforms enacted by the General Assembly in the mid-2000s as well as recent tax cuts embraced by Governor Kasich and the past two General Assemblies have worked to reverse this trend and lessen the overall tax burden of Ohio’s citizens. One of the persisting burdens, however, remains Ohio’s local taxation. The Ohio Department of Taxation (ODT) confirmed this onerous burden in 2012, finding that the state’s local tax burden still ranks 12th highest nationally at 4.8 percent of personal income.
Though property taxes are obviously a part of the local tax burden, local income taxes in Ohio represent a real obstacle to economic growth. With over 600 taxing municipalities, Ohio falls behind only neighboring Pennsylvania in the number of municipalities levying these taxes. Further, nothing about the current system is simple or straightforward.
Employers and employees must file tax returns in each jurisdiction where the tax is owed, creating an administrative nightmare for businesses, like contractors, with employees working in multiple jurisdictions. An electrical contractor in northeastern Ohio with only 19 employees reportedly filed an astounding 221 W-2 forms and 39 business returns, many of which resulted in less than $5 of tax liability. Administrative absurdities like this can mean hundreds of hours devoted to tax compliance and thousands of dollars spent on accountants and staff dedicated to tracking tax withholdings and remittance. Often the cost of filing a return can easily exceed the tax liability owed.
For smaller businesses with limited accounting staff and resources, these may be significant costs that mean the difference between a “good year” and a bad one. And with similar filing requirements for individuals as well, employees must shoulder their own share of this administrative burden.
As the Tax Foundation makes clear,
Placing such severe burdens on small businesses keeps them from flourishing and leads to a bad business environment with low incentives for both starting businesses and for existing businesses to stay.
This is one reason the Tax Foundation ranks Ohio’s business tax climate an underwhelming 44th.best in the country—once again ranked in the bottom 10.
Entrepreneurial start-ups are a major driver in job creation. A 2010 Kaufmann Foundation study relying upon U.S. Census Bureau data concluded that between 1977 and 2005 existing firms had a net loss of jobs per year while first year businesses added an average of 3 million jobs per year. Ohio’s non-uniform Net-Operating Loss Carry forward (NOL) is thus particularly problematic for the state’s job-growth prospects. Without a standardized NOL, Ohio’s system packs a pernicious punch on start-up businesses and fledgling ventures. As with taxpayer credits, NOLs are left to the discretion of each municipality so some start-ups are either unable to or severely limited in deducting their initial losses once they begin turning a profit.
New small businesses are pivotal to Ohio’s future. By adding and increasing significant barriers to entry as start-up companies struggle for survival, Ohio’s business tax policies could well prevent the next Microsoft, Google, or Apple from ever getting off the ground. Making Ohio’s tax system work for fledgling enterprises is every bit as important as making it work for larger, established employers. Given that Ohio ranks 42 out of 50 states in the University of Nebraska’s U.S. Entrepreneurship Index, start-up companies face more than enough competition and obstacles to their success as it is. They certainly do not need defunct, inequitable tax policies compounding their disadvantages and difficulties.
Ohio could send a strong signal to the business community that it is serious about competing with our neighbors by eliminating the miasma of confusion surrounding our municipal income tax system. The current system fails to provide for uniform tax credits to be offered by municipalities where taxpayers reside. This failure is inherently unfair. Although most municipalities do offer credits to their residents to help offset income taxes paid to their employer’s municipality, this is not true of all jurisdictions. Instead, each municipality may decide whether and how much of a credit to offer for taxes paid in a neighboring municipality. Thus, the current system allows for an ad-hoc assessment of local taxes that may or may not require some workers unfortunate enough not to work where they live to pay taxes in two different municipalities and for two different amounts. Unfortunately, the current version of the reform legislation does not address this unfair burden.
Reform legislation proposals present a modest improvement to some of Ohio’s current tax burdens, but much more can and should be done to fix Ohio’s municipal tax system.
Mr. Chairman, I thank you for the opportunity to testify on this issue and welcome the opportunity to respond to any questions.
1. The Tax Foundation, “Ohio State-‐Local Tax Burden Compared to U.S. Average 1977‐2010,” at http://interactive.taxfoundation.org/burdens/burdensdata.php?format=print&state=Ohio&mode=al l_years_one_state&usa=false (May 6, 2013).
2. The Ohio Department of Taxation, “State and Local Tax Comparisons, 2010‐2011,” at http://www.tax.ohio.gov/tax_analysis/tax_data_series/state_and_local_tax_comparison/publications_tds_comparison/TC12CY11.aspx (November 17, 2014).
4. Ashley, Andrea. “Senate Finance Committee Testimony.” June 3, 2014 at http://www.agcohio.com/hb5testimonysenfinance632014.pdf (October 21, 2014).
5. Drenkard, Scott and Greg R. Lawson. “In State Tax Battle, Tar Heels Soar Above Buckeyes.” Forbes. September 23, 2013 at http://www.forbes.com/sites/realspin/2013/09/23/in-the-state-tax-battle-the-tarheels-soar-above-the-buckeyes/ (June 3, 2014).
6. Ashley, Andrea. “Senate Finance Committee Testimony.” June 3, 2014 at http://www.agcohio.com/hb5testimonysenfinance632014.pdf (October 21, 2014).
7. The Tax Foundation, “Ohio Considers Changes to Complex Municipal Tax Codes,” at http://taxfoundation.org/blog/ohio-‐considers-‐changes-‐complex-‐municipal-‐tax-‐codes (May 6, 2013).
8. The Tax Foundation, “2015 State Business Tax Climate Index,” at http://taxfoundation.org/article/2015-‐state-‐business-‐tax-‐climate-‐index (November 17, 2014).
9. Tim Kane, “The Importance of Startups in Job Creation and Job Destruction,” Ewing Marion Kauffman Foundation, accessed at http://www.kauffman.org/~/media/kauffman_org/research%20reports%20and%20covers/2010/07/ firm_formation_importance_of_startups.pdf (November 17, 2014)
10. Ohio Rev. Code § 718.01.
11. Thompson, Eric, PhD and William Walstad, PhD. “2013 U.S. Entrepreneurship Index.” University of Nebraska- Lincoln at http://cba.unl.edu/outreach/bureau-of-businessresearch/research/documents/BIN_August_2014.pdf (October 21, 2014).
12. For examples see, Regional Income Tax Authority. “Tax Rate Tables.” 2014 at https://www.ritaohio.com/resources/tax-rates-tables/ (October 21, 2014).