Interested Party Testimony On Tax Provisions in the Biennial Operating Budget Bill Before the Ways and Means Committee, Ohio House of RepresentativesMar 11, 2015
By Greg R. Lawson
Thank you, Chairman McClain, Ranking Member Cera, and members of the Ways and Means Committee for providing me this opportunity to discuss various tax provisions that are under consideration in the current biennial operating budget proposal. My name is Greg R. Lawson. I am the Statehouse Liaison at the Buckeye Institute for Public Policy Solutions. The Buckeye Institute is a non-partisan, non-profit, and tax-exempt organization that formulates and promotes free market public policy solutions for Ohio. 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.
Clearly, the budget bill contains significant changes to the tax code. To Governor Kasich’s credit, he has eloquently outlined the punitive aspects of the personal income tax for long-term economic growth. A further reduction in this tax is sound policy and we support this general thrust by the Governor. However, how this is accomplished in the legislation before you raise concerns.
Ohio’s overall tax system, at both the state and local level, is an albatross around the neck of Ohio’s long-term economic vibrancy. While there are limited reforms to local taxes in the current budget bill, this issue should not be placed on the backburner as it remains a critical component of meaningful overall reform.
Good tax policy needs to adhere to several simple principles that The Buckeye Institute has outlined in a recent report on the subject. These include:
- Pro-growth: A tax system should minimize tax distortions, avoid high rates, and discourage tax avoidance. A good tax plan will reduce tax rates on investment and labor, key components for economic prosperity and job creation.
- Simplicity: The tax code should be made simpler by reducing loopholes, credits, and deductions. Complying with the tax code should not be burdensome. A simpler tax code makes it easier for both government administration and taxpayer compliance. A more complicated tax code increases the opportunity for special interest carve-outs and favors.
- Transparency: Taxes should be clear, allowing taxpayers to know what specific taxes they pay. Ohioans should be able to understand debates over changes in tax policy and know how their elected officials are representing their interests.
- Fair and Equitable: A good tax bill promotes equity by ensuring taxpayers face a similar system, income is not taxed multiple times, and industries aren’t singled out for preferential tax treatment. Alternatively, industries and individuals should not be punished and subject to punitive tax rates with government picking winners and punishing losers. People and businesses with equivalent earnings should pay similar taxes. Rates should not force individuals and businesses to change filing status for better tax treatment.
Pro-Growth Between 2000 and 2010, Ohio bled private sector jobs. It lost the second highest sum of private sector jobs of any state in the country, nearly 620,000. Only our neighbor up north, Michigan, fared worse over the same time span. While we have recovered some of those jobs over the past few years, Ohio has also seen a dramatic decline in its labor force. We also saw 32 consecutive months of shrinkage between March 2010 and December 2012. According to research we have done, over 56% of peak earners, or those between the ages of 30-59, moving into Ohio in 2012 had no college degree of any kind. By contrast, less than 49% of those moving out of Ohio had no college degree. In other words, Ohio is losing more of its best and brightest to other states than its attracting across its borders.
This is the backdrop for all tax reform that the General Assembly should consider and why adherence to good tax principles is so important.
Reducing tax rates on investment and labor, key components for economic prosperity and job creation is exactly what lowering the income tax does. We recognize that many are concerned with what a “shift” of taxes from incomes to consumption, as embodied in increasing reliance on the sales tax, means. However, arguments regarding “inequality” in our tax code ignore growth. Too much emphasis is placed on redistributing the economic pie, rather than increasing it. By contrast, The Buckeye Institute maintains that our focus should be on economic growth, job creation, and long-term wage increases.
As President Reagan said, if you want less of something, tax it. From an economic standpoint, most taxes are counterproductive as they create disincentives to produce whatever it is that is being taxed. Occasionally, they can address negative externalities, but more often they negatively influence the decisions that are made by economic actors by putting an exogenous burden on economic activity. Of course, we need taxes to pay for legitimate and necessary government activities. Therefore, the goal of good tax policy is to distribute the tax burden, both in terms of rates and in terms of compliance complexity, in such a way as to make its impacts on economic decisions as limited as possible.
A vast array of studies have indicated that the worst taxes for economic growth are corporate taxes followed by income taxes since those higher marginal taxes on income discourage work and investment. A recent study from the Organization for Economic Cooperation and Development (OECD) regarding tax policy in Switzerland states:
“Empirical research on OECD economies and on Switzerland specifically indicates that shifting taxation away from personal income towards the taxation of consumption would strengthen incentives to engage in economic activity.” Of course, this holds not only for Switzerland, but globally as well. 23 out of 26 empirical studies on the effects of taxes on economic growth from over 30 years and multiple countries reviewed by the Tax Foundation found income and corporate taxes reduce investment and growth. None found a positive correlation between income and corporate taxes and economic growth. I include a chart from that report at the end of my testimony.
This can also be helpful for entrepreneurial start-ups that 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.
Economists at the OECD also write,
“They (taxes) need to be set up to minimize taxpayers’ compliance costs and government’s administrative cost, while also discouraging tax avoidance and evasion. But taxes also affect the decisions of households to save, supply labor and invest in human capital, the decisions of firms to produce, create jobs, invest and innovate, as well as the choice of savings channels and assets by investors. What matters for these decisions is not only the level of taxes but also the way in which different tax instruments are designed and combined to generate revenues.”
Multiple studies make clear a better, or less distortive form of taxation, is on consumption. To the extent that provisions in the budget continue in this direction, we think this is a good thing. Additionally, it is well known that a sound and stable tax has a fairly large base, but a low rate. Consequently, provisions expanding the sales tax to better reflect the realities of a more service oriented 21st Century economy make sense. We would caution, however, moving with increasing rates at this time. First, Ohio already raised the sales tax in the previous budget cycle and, second, we should be mindful of the pancaking effect county piggyback sales taxes impose as well.
While the Governor’s push to continue income tax reductions is laudable, there remain challenges associated with the variety of “payfors” that are included to offset revenue losses.
Efforts to increase the Ohio severance tax will lead to less investment and violates the principle of tax equity by penalizing a single industry. While now is a particularly bad time to be increasing the severance tax given the rapid decline in oil prices globally, the very concept of increasing the tax is problematic. Ohio’s severance tax is far from the only tax paid by oil and gas exploration companies. Other taxes include the Commercial Activities (CAT) tax, ad valorem taxes, sales and use tax, and, in some cases, municipal income tax. I will note while many of these other taxes are levied by other oil and gas producing states, few have a gross receipts tax like the CAT. Additionally, the quality of the product being found, particularly in the Utica Shale, is very different from that being found in other states and requires additional investment. Another challenge with the present severance proposal is that raising this rate and basing it upon a spot price that often is not reflective of the actual supply contracts entered into by producers is fundamentally unfair and represents a disincentive for exploration.
As you heard last week from the non-partisan Tax Foundation, a higher CAT is not conducive to good tax policy or economic growth and violates the principle of equity, especially for businesses that are impacted more negatively by a gross receipts tax due to low profit margins. As Mr. Drenkard indicated last week, the imposition of the CAT is levied on every exchange of products between businesses and is a major reason for Ohio’s ongoing poor performance in its Business Tax Climate Index. The obvious disincentives this system creates may help explain why only four other states choose to levy taxes in this manner. Confronting the longer-term implications of the CAT is needed. For the purposes of this budget, we understand that real CAT reform is unlikely. We also recognize that the CAT was created in 2005 under the acknowledgement that it would remain a tax with a broad base and a low rate. It has not been increased since then due to concerns over its pyramiding effect. To increase it today opens Ohio businesses to a slippery slope where an inhibition about future increases may decline, making the CAT increasingly common and ever more pernicious.
The current proposal would raise the tax by $1 per pack, equalize the tax rate on other tobacco products with the cigarette tax rate, and again includes electronic vaporized tobacco products in the tax. The budget forecasts cigarette tax revenues increasing by almost 70% over baseline in one year. This forecast is dubious because a tax increase of the magnitude recommended in the budget is likely to drive tobacco users to purchase out of state or reduce smoking more than the current trend would forecast. This tax is a violation of the principle of tax equity by singling out a particular class of taxpayer for a disproportionate burden. The same rational can be applied to the tax’s imposition on vapor products.
As many members of this committee are likely aware, The Buckeye Institute has long been a champion of eliminating tax expenditures and not creating new ones such as the notorious “NetJets” loophole. According to the Office of Budget and Management, Ohio will forego nearly $8.5 billion in revenue in Fiscal Year 2016 and another nearly $8.9 billion in Fiscal Year 2017. This creates problems by narrowing the base. Problems emerge since the narrower the tax base becomes, typically, the higher and more confiscatory the rate for those that are not excluded from the base. While many tax expenditures are in no way reflective of crony capitalism, some can occasionally veer close. Fundamentally, this is a matter of tax fairness where the state is not picking a “winner” or a “loser.” While The Buckeye Institute has called periodically for a more rigorous review of these tax expenditures for years, along with other think-tanks from across the ideological spectrum, our position is that all revenue gained from any such elimination should be used to pay for across the board income tax cuts.
Despite the reforms contained in the last General Assembly’s House Bill 5, Ohio’s pyramiding local taxes continue to be a major problem. This is confirmed the latest analysis by the Ohio Department of Taxation (ODT). The ODT found that Ohio’s per capita state tax burden as well as its percentage of income burden ranks 34th among states. Meanwhile, the local tax burden ranks 19th and 8th respectively with a per capita local tax of $1,810 or 4.7% of personal income.
Though property taxes are obviously a part of the local tax burden, local income taxes and their cumbersome structure in Ohio represent a real problem for economic growth. Only sixteen states levy any kind of local income taxes, and of the majority of these local income taxes many include counties while those with municipal income taxes are limited to only a few cities. None have a system as complex as Ohio’s and lack in fundamental fairness through things such as non-uniform reciprocity of credits.
A final point I would like to raise regards state spending growth over the last several decades in Ohio.
The Governor’s proposal expends over $911 million more in the state-funded portion of the General Revenue Fund in Fiscal Year 2016. It also includes another increase of nearly $905 million on top of that in Fiscal Year 2017. That is a 4 and 4.2% increase respectively.
It is hard to imagine a compelling reason for such a dramatic increase. From 1996 to 2014, Ohio experienced a very low rate of population growth, averaging around .18% growth per year. In addition, inflation averaged 2.3% per year. If GRF spending per capita were confined to 1996 levels, and increased on pace with historic inflation and population growth rates, state GRF expenditures would have totaled around than $18.1 billion in 2014 rather than the $20.6 billion that was actually spent. That is another $2.5 billion in potential income taxes that could be eliminated without raising any other taxes for offset purposes. Applying the same experiment back to 1985, and the difference increases to nearly $5.7 billion. Once again to quote Ronald Reagan, “The problem is not that people are taxed too little, the problem is that government spends too much.” Rather than seek a multitude of tax increases, especially growth constraining tax increases, to fund income tax reductions, Ohio should continue further tightening its belt and use excess revenues to reduce income taxes across the board.
Mr. Chairman, I thank you for the opportunity to testify on this issue and welcome the opportunity to respond to any questions.
1. Rea S. Hederman, Jr., Tom Lampman, Greg R. Lawson, and Joe Nichols, “Tax Reform Principles for Ohio,” The Buckeye Institute for Public Policy Solutions, February 2, 2015, http://www.buckeyeinstitute.org/uploads/files/Tax_Reform_Principles_for_Ohio(FINAL).pdf
2. Thomas Kilbane. “Keeping Our Talents in Ohio,” The Buckeye Institute for Public Policy Solutions, September 17, 2014, accessed March 9, 2015 at http://buckeyeinstitute.org/the-libertywall/2014/09/17/keeping-our-talents-in-ohio/
3. See: Andres Fuentes, “Making the Tax System Less Distortive in Switzerland,” Organization for Economic Cooperation and Development, April 13, 2013, accessed March 5, 2015 at http://www.oecdilibrary.org/docserver/download/5k480c2rt1d3.pdf?expires=1425584553&id=id&accname=guest&checksu m=E9C4E39CC2514ABF41E5CEE5E3939287
4. William McBride, “What is the Evidence on Taxes and Growth?” Tax Foundation, December 18, 2012, accessed March 5, 2015 at http://taxfoundation.org/article/what-evidence-taxes-and-growth.
5. Tim Kane, “The Importance of Startups in Job Creation and Job Destruction,” Ewing Marion Kauffman Foundation, accessed at http://www.kauffman.org/uploadedFiles/firm_formation_importance_of_startups.pdf (July, 2010) 6 Christina D. Romer and David H,. Romer, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks”, American Economic Association, 100 (June 2010), ppg, 763801.
6. Christina D. Romer and David H,. Romer, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks”, American Economic Association, 100 (June 2010), ppg, 763801.
7. Laffer, A., Moore, S., & Williams, J. (2014, April 15). Rich States, Poor States 7th Edition. Retrieved January 6, 2015, from http://alec.org/docs/RSPS_7th_Edition.pdf
8. See Ohio Revised Code 5739.025 (G)(1).
9. Office of Budget and Management, “Tax Expenditure Report, Fiscal Years 2016-2017,” at http://blueprint.ohio.gov/doc/budget/State_of_Ohio_Budget_Tax_Expenditure_Report_FY-16-17.pdf (March 5, 2015).
10. The Ohio Department of Taxation, “State and Local Tax Comparisons, 2011-2012,” at http://www.tax.ohio.gov/Portals/0/tax_analysis/tax_data_series/state_and_local_tax_comparison/tc12/TC1 2CY12.pdf (March 3, 2015).
13. The Tax Foundation, “Local Income Tax Rates by Jurisdiction, 2011,” at http://taxfoundation.org/article/local-income-tax-rates-jurisdiction-2011 (May 6, 2013).
14. U.S. Census Bureau, “State Intercensal Estimates (2000-2010),” accessed March 5, 2015, https://www.census.gov/popest/data/intercensal/state/state2010.html
15. Population Estimates U.S. Census Bureau, “Population Estimates,” accessed March 5, 2015, https://www.census.gov/popest/data/state/totals/2014/index.html
16. U.S. Bureau of Labor Statistics. “CPI-U Midwest,” http://www.bls.gov/regions/midwest/data/ConsumerPriceIndexHistorical_Midwest_Table.pdf
17. William McBride, “What is the Evidence on Taxes and Growth?” Tax Foundation, December 18, 2012, accessed March 5, 2015 at http://taxfoundation.org/article/what-evidence-taxes-and-growth