FISCAL

January 7, 2010
No. 207 FACT
Ohio’s Poor Tax Climate at the Heart of the
State’s Economic and Fiscal Woes
By Scott A. Hodge

Ohio lawmakers recently reached a last-minute deal to close the state’s $851 million budget
shortfall by delaying a scheduled 4.2 percent income tax cut. As many lawmakers acknowledged,
the deal was just a band-aid solution and avoids addressing the more structural issues facing the
state’s finances.

At the heart of Ohio’s fiscal problems is a tax system and business climate that has been driving
people out of the state for more than 15 years, resulting in a shrinking economy and a smaller tax
base. At the same time, state government spending grew unchecked, resulting in a heavier tax
burden on the state’s remaining citizens. Ohio taxpayers now have one of the highest tax burdens
in the nation.

The key to reversing these trends and improving the long-term fiscal health of the state is a
sensible reform of the state’s tax system.

15 Years of Taxpayer Flight

For more than 15 years, Ohio has seen more taxpayers leave the state than move into it. Chart 1,
based on Tax Foundation analysis of IRS migration data, shows the net loss of taxpayers (or tax
returns)1 to other states between 1993 and 2008.

We can see that while the state lost a substantial number of taxpayers during the early and late
1990s, the out-migration accelerated dramatically after 2003. Overall, the state lost 231,000
taxpayers between 1993 and 2008, but more than 105,000 of those taxpayers left within the past
five years.

1
A tax return can represent a single individual, a married couple with children, a sole proprietor or a larger business
enterprise such as an LLC or S-corporation. The 231,000 tax returns that Ohio lost during this period had 347,000
personal exemptions associated with them, so the state lost 1.5 persons for every tax return that left the state on net.

Scott A. Hodge is President of the Tax Foundation

 Chart 1: Ohio Lost 231,000 Taxpayers
Between 1993 and 2008
0

-5,000

-7,076 -7,129
-10,000

-11,741
-12,949 -13,306 -12,892
-15,000 -14,155 -14,646
-15,333
-16,096
-16,673

-20,000
Annual Difference Between Taxpayers Moving
-20,954
Out of State to Those Moving In -22,041
-22,959 -23,276
-25,000
1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007-
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Source: Tax Foundation calculations based on IRS data

Naturally, as people leave the state, they take their incomes with them. This means that as the
population shrinks, the tax base shrinks with it. IRS migration data allows us to calculate the net
amount of adjusted gross income that moves in and out of a state each year due to migration. For
Ohio, these figures are startling.

Chart 2 shows that between 1993 and 2008, Ohio lost a total of $19 billion in adjusted gross
income after adjusting for inflation. Since 1996, those losses have averaged $1.4 billion per year.

Chart 2: Ohio Lost $19 Billion in Adjusted Gross Income

Due to Out-Migration Between 1993 and 2008
$0.0

-$0.2

-$0.4

-$0.6
-$0.60 -$0.58
-$0.69
-$0.8

-$1.0
-$1.03 -$1.03
-$1.2

-$1.27
-$1.4 -$1.33 -$1.32
-$1.40 -$1.40
-$1.49 -$1.51
-$1.6
$Billions Lost Annually Due to Out-Migration

-$1.8 -$1.72
-$1.72 -$1.79

-$2.0
1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007-
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Source: Tax Foundation calculation of constant 2008 dollars based on IRS data

2
During the same period, however, Ohio’s state spending grew from $31.6 billion in 1993 to over
$67 billion in 2008, a 47 percent increase even after adjusting for inflation and population
growth.2 What this means is that the state has had to raise a growing amount of money each year
from a smaller pool of income.

From Low-Tax to High-Tax State

Today, Ohio has the seventh highest state and local combined tax burden in the nation with taxes
consuming 10.4 percent of the state’s income.3 As Chart 3 shows, this was not always the case.
Forty years ago, Ohio had the fifth lowest state/local tax burden in the nation, with taxes
consuming 8.7 percent of the state’s income.4 In just the past 10 years alone, the state has dropped
10 places in the rankings as the population flight accelerated.

Chart 3: In 30 Years, Ohio's Tax Burden Has Gone From 5th

Lowest To 7th Highest

0
Ranking of State/Local Tax Burden as % of State Income 7
5
10
10
16
15

20
25
25

30

35
35
40
45
45

50
77

79

81

83

85

87

89

91

93

95

97

99

01

03

05

07
19

19

19

19

19

19

19

19

19

19

19

19

20

20

20

20

Source: http://www.taxfoundation.org/taxdata/show/474.html

From a regional competitiveness standpoint, Ohio is surrounded by states that, generally speaking,
have much lower tax burdens. Michigan, Indiana, Kentucky, and West Virginia are all clustered in
the middle of the national rankings (27th, 28th, 25th and 29th respectively), while Pennsylvania’s
tax burden is 11th highest in the nation, but still lower than Ohio’s.5

2
Erratum: Until January 12, this sentence mistakenly stated that state spending had grown from approximately $38
billion to $60 billion.
3
Gerald Prante, “State-Local Tax Burdens Dip As Income Growth Outpaces Tax Growth,” Tax Foundation Special
Report, No. 163 (Aug. 2008), http://www.taxfoundation.org/publications/show/22320.html.
4
Id.
5
Id.
3
Ohio’s Poor Tax Structure
In order to get a more complete picture of a state’s tax system, it is important not only to
understand how much a state raises, but also how they raise it. The Tax Foundation’s State
Business Tax Climate Index assesses the structure of each state’s tax system, producing a measure
of business-friendliness based upon more than 100 different factors.6 The Index assesses the five
major elements of a state’s tax system: the corporate tax, individual income tax, sales tax,
property/wealth tax, and the unemployment tax. These individual rankings tier up into a national
ranking.

The Index most rewards states that don’t have one of the major taxes, because foregoing one of the
major taxes eliminates the complexity associated with that tax. The Index also rewards state taxes
with broad bases and low rates. It punishes states that have complex, highly progressive tax
systems.

In the Tax Foundation’s 2010 Index, Ohio ranked 47th in the nation—one of the worst business
tax climates in the country. All of Ohio’s neighbors rank better on this index.

The Damaging Commercial Activity Tax

When it comes to corporate and business taxes, Ohio is an outlier. Since the introduction of the
commercial activity tax (CAT) in 2005, Ohio has been imposing two tax systems on businesses
because the old corporate franchise tax was phased out over five years. This double-tax has clearly
impacted the state’s rankings. Finally, when Ohio firms pay their 2010 taxes, the franchise tax will
be fully repealed, and the state’s ranking will improve modestly in the Tax Foundation’s State
Business Tax Climate Index.

But having only the CAT will not necessarily give Ohio a comparative advantage regionally or
nationally over its neighbors who impose traditional corporate income taxes because the CAT is a
particularly harmful type of tax known as a gross receipts tax.

Ohio is one of just seven states to impose a gross receipts tax, which is imposed on businesses
regardless of their profitability. While politicians like gross receipts taxes because they have
deceptively low rates and they are thought to be a more stable source of tax revenue, economists
have found gross receipts taxes to be particularly harmful because they tax all transactions,
including intermediate business-to-business purchases of supplies, raw materials and equipment.
As a result, gross receipts taxes lead to taxes on taxes -something economists call “tax
pyramiding.”

Tax systems like the CAT are particularly damaging during economic downturns when businesses
have to pay the tax even when they are losing money and laying people off. This can lead to more
job losses and even bankruptcies. In contrast, a traditional corporate income tax would collect
more when companies are doing well, but little or nothing when companies are doing poorly.

The CAT is also harmful for grocery stores, department stores and other high-volume, low-profit-
margin businesses. Even during boom times, businesses with high volume and low profit margins
will pay a disproportionate tax compared to businesses with low volume and high profit margins,
like jewelry stores. Normal corporate income taxes put both types of firms on a level playing field.

6
Kail M. Padgitt, “2010 State Business Tax Climate Index,” Tax Foundation Background Paper, No. 59 (Sep. 2009),
http://www.taxfoundation.org/taxdata/show/22661.html.
4
Ohio, like all states, would do well to lower the overall tax burden on businesses. A recent Tax
Foundation study found that for every dollar that states increased corporate taxes, wages fell by
$2.50 over the next five years.7 And the opposite is true: When states cut corporate taxes, wages
tend to rise over subsequent years.

Ohio’s Complex Personal Income Tax System

Notwithstanding the promised 4.2% reduction in income taxes for 2010 that is now cancelled,
Ohio’s top income tax rate of 5.925% is about average regionally and nationally. However, this
does not include the income tax rates imposed by most Ohio cities and school districts which can
boost the overall rate to over 7 percent.

In addition, Ohio’s income tax system has nine separate tax brackets before the top rate kicks in at
$200,000 and these brackets are not indexed to inflation. Only a handful of states have more
brackets in their individual tax systems. By contrast, three of Ohio’s neighbors—Indiana,
Michigan, and Pennsylvania—have simple flat tax systems with relatively low rates.

Despite Ohio’s financial troubles, lawmakers should reject any calls for making its system more
progressive or imposing a millionaire’s tax. The states in the biggest financial trouble these days
all have highly progressive tax systems, which has made their fiscal systems highly volatile.8

Sales Taxes on Many B-to-B Transactions

Ohio’s combined state/local sales tax rate of 6.83 percent ranks 25th nationally, right in the middle
of the pack.9 However, all neighboring states except Indiana have a lower sales tax rate.

While Ohio’s sales tax rate is not exorbitant, the major fault of the system is that the sales tax is
applied to too many business-to-business transactions such as cleaning services, repair services,
software, and leased items. Taxing business-to-business activities not only adds to the cost of
doing business in the state, but it also raises costs to consumers as the sales tax cascades through
the price of goods.

Modest Property Taxes, High Taxes on Capital

Contrary to the perception of most homeowners, Ohio’s property taxes are a relatively modest
$1,165 per capita, ranking the state 24th in the nation. While voters are particularly vocal about
high property taxes, taxes on capital are far more harmful for long-term economic growth and
Ohio’s taxes on capital are among the highest in the nation. Ohio is undermining its growth
potential by being one of 22 states with a capital stock tax and one of only 10 states with an
intangible property tax.10

Capital stock taxes are levied on the wealth of a corporation, usually defined as its net worth. They
are often levied in addition to a corporate income tax, adding a duplicate layer of taxation and

7
Robert Carroll, “The Corporate Income Tax and Workers’ Wages: New Evidence from the 50 States,” Tax
Foundation Special Report, No. 169 (Aug. 2009), http://www.taxfoundation.org/news/show/24960.html.
8
Joseph Henchman, “State Budget Shortfalls Present a Tax Reform Opportunity,” Tax Foundation Special Report,
No. 164 (Feb. 2009), http://www.taxfoundation.org/news/show/24321.html.
9
Kail Padgitt, “Updated State and Local Option Sales Tax,” Tax Foundation Fiscal Fact, No. 196 (Oct. 2009),
http://www.taxfoundation.org/news/show/25395.html.
10
Padgitt, 2010 Index, p. 27-28.
5
compliance. A corporation’s financial troubles can be exacerbated when it has to use available
cash flow to pay its capital stock tax.

Intangible personal property taxes are imposed on such things as stocks, bonds, and even
trademarks. This tax can be harmful to businesses that hold large amounts of their own or other
companies’ stock and that have valuable trademarks.

Another tax on capital (accumulated capital) is the estate tax. Ohio makes itself unattractive to
entrepreneurs by imposing its own estate tax, particularly since the taxing threshold ($338,000) is
much lower than what exists at the federal level.

Improving Ohio’s Tax System

Ohio can improve its attractiveness to business by taking some decisive steps to improve its tax
system.

The first step should be to reduce Ohio’s reliance on business taxes by eliminating the
Commercial Activity Tax, the capital stock tax, and the intangibles tax. These are the most anti-
growth taxes within the Ohio tax system. Reducing the punitive effects of these taxes on business
should be job one for Ohio lawmakers.

Economic research supports moving away from these taxes. Economists are finding that in a
global economy, taxes on capital and income are more harmful for long-term economic growth
than are taxes on consumption or property. The reason is that capital and income are the most
mobile factors in production and, therefore, the most sensitive to high taxes.11

Next, lawmakers should simplify the individual income tax system by eliminating those multiple
brackets and moving toward a flatter system similar to those in Indiana, Michigan, and
Pennsylvania.

Another sound reform would be to eliminate the tax pyramiding in the sales tax base by exempting
more business-to-business transactions.

Finally, Ohio should get out of the business of doling out incentives to lure business into the state.
Fairness and experience tell us that lower tax rates for all are better than incentives for some.
North Carolina learned this lesson after giving Dell millions in incentives only to see Dell close
down its North Carolina facility in less than five years.

Conclusion
It is clear that without sensible reforms soon, economic growth opportunities will pass by Ohio
and the state’s finances will continue to worsen. Cutting the state’s tax burden and implementing
pro-growth tax reforms can go a long way toward reversing these dismal trends.

11
Organization for Economic Cooperation and Development (OECD), “Tax and Economic Growth,” Economics
Department Working Paper No. 620 (Jul. 11, 2008) (finding that corporate taxes are the most harmful tax for long-
term economic growth, followed by high personal income taxes, then consumption taxes and property taxes.)
6