Ohio Tax Reform - Success or Not?

In 2005, Ohio made significant changes in its tax law. It added a gross receipts tax called the Commercial Activity Tax (CAT) and phased out its corporate income tax and personal property tax; reduced the individual income and sales tax; and increased the cigarette excise tax. The CAT used a factor presence nexus standard and sourcing rules designed to tax companies with sales into Ohio and not those located in Ohio that make sales out-of-state.

With the 5 year anniversary of the changes approaching, I've seen a few stories telling of the success of the changes. For example, today's (April 5) Akron Beacon Journal had an article - "Tax reform brings kudos to Ohio - Analysis finds burden improves in last 5 years; changes are positive draw for business, leaders say" by Paula Schleis. It refers to a Federation of Tax Administrators (FTA) survey ranking Ohio as having the 16th lowest tax burden. Per the author, that ranking is 9 places better than in 2005.

Meanwhile, the Tax Foundation notes that the poor tax climate in Ohio drives businesses out of the state. In its blog post of January 7, 2010 - "Ohio's Poor Tax Climate at the Heart of the State's Economic and Fiscal Woes," the Tax Foundation suggests Ohio undertake tax reform. Ohio tax problems noted by the Tax Foundation include the use of a gross receipts tax and its inherent pyramiding problem and imposition even when a business has a loss for the year (for more on pyramiding, see my report here and some articles on gross receipts taxes here). Additional problems noted are Ohio's complex personal income tax and imposition of an income tax by most cities and school districts, as well as a sales tax that applies to many business purchases.

So, why the discrepancy in the views on Ohio's tax reform? Some of the difference may be due to the 5-year phase-in/phase-out of the changes where two types of businesses taxes applied. Another cause is varying perspectives on gross receipts taxes. Some say they are good in that they have a broad base (very broad) and thus, a low rate. Also, they are not subject to Public Law 86-272 or the physical presence nexus standard of Quill. This gives states more leeway in stating who is subject to the tax (within Due Process and Commerce Clause restraints) and the ability to "export" the tax. Of course, that would change if Congress enacts an update to PL 86-272 that calls for some degree of physical presence for any "business activity tax" which includes a gross receipts tax.

So, different perspectives on the nature of taxes, ways to measure tax burdens among the states, and the effect of transition rules for tax changes complicates the picture as to whether the Ohio tax reform has been a success. I think it is impressive that something was actually done rather than only talked about for decades with no changes made (as happens in many states including California which has already had two tax reform commissions in the 21st century with no changes enacted). (I don't think a gross receipts tax with its inherent pyramiding is an effective way to tax.) In addition, differences in the meaning of "successful tax reform" can lead to differences in opinion as to whether tax reform in Ohio has been successful.

What is your take on whether the Ohio tax reform effort enacted in 2005 has been a success or not?

Taxes and the Modern Economy

Ideally, tax reforms, of any size, should follow the principles of good tax policy. There are many views of exactly what these principles are, dating back to at least Adam Smith in the late 1700s (and even back to Aristotle if considering "fairness" in general - "equals should be treated equally and unequals unequally"). Most of the lists are fairly similar (see this chart for an example).

A while back I came across a 1967 report of the Ohio Tax Study Commission that included a principle to follow in its work that we don't often see. It ties well to the point of the 21st Century Taxation Blog. The extra Ohio principle was:

"Relationship to the Modern Economy

Insofar as possible, a tax or tax structure should be capable of growing with the economy of the state and should be revised from time to time so as to correspond with the true makeup of that economy as it develops and changes. Some products, habits of consumption, and classes of enterprise decline, while others rise to take their place. Ideally, a tax structure should be reviewed and revised as necessary so as to bear a relationship to the way people are doing things, regardless of whether additional revenues are needed at a given time."
That's great! Tax systems should be reviewed even when revenue isn't needed. Actually, that is likely the best time for reforms because in dire budget times, principles of good tax policy are often overlooked, which may put the state into a chronic state of budget problems.

btw - the other factors used by the 1967 Ohio Tax Study Commission to evaluate tax policy were:

• Effect on economic growth
• Neutrality
• Equity, or Fairness
• Administrative feasibility
• Compliance costs