FORBES: Bucking the Trend in the Buckeye State

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The latest tax proposal from Governor John Kasich of Ohio is impressive. With this plan, we see a governor who seems to understand the lessons of history when it comes to economic growth. First, let’s take a look at those lessons and their implications.

The fastest-growing states in America have lower taxes, smaller government, and tend to rely more heavily on consumption-based taxes than the rest of the U.S. According to the Bureau of Economic Analysis, between 2002 and 2012 (the latest ten years for which a full set of data is available), the nine states with no personal income tax grew by 62% (on average), while those with the highest personal income taxes grew only 46.4%. At the same time the overall tax burden of the no-income-tax states was only 8.1%, while residents of the highest-taxed states paid on average 10.65%, according to the Tax Foundation. Finally, the no-income-tax states tend to rely on consumption taxes to fund government, which on average contribute 42.83% of the overall state budget in the no-income-tax states while the highest-taxed states brought in only 22.71% of their budgets this way. The evidence is overwhelming that low taxes are favorable to economic growth and that consumption taxes are far less damaging than income-based taxes.

Between 2000 and 2010, Ohio was the 49th state in terms of economic growth, with only Michigan performing more poorly. During this time period the state’s economy grew by a meager 2.5% per year while the nation as a whole expanded by 3.95% per year, on average, before accounting for inflation. This poor growth record is not just a peculiarity of the past decade. Whatever 10 year period one looks at in the last 50 years, Ohio always ranks in the bottom quintile of states in terms of economic performance. The overwhelming failures of Ohio can be seen not only in the economic growth numbers but also in its slow growth in personal income (35.7% vs 50.1% for the national average, between 2002 and 2012, according to the Bureau of Economic Analysis), strong out migration trends (-3.2% between 2002 and 2012 as a share of population, according to the US Census Bureau), and loss of net adjusted gross income ($19.7 billion lost between 1992 and 2011, according to the IRS Division of Statistics). Something must be done to reverse this dismal trend.

That “something” could (and should) very well be Governor Kasich’s new tax plan. His latest budget proposal is a bold move to reduce income taxes, raise consumption taxes, and address many areas of fairness and efficiency. To start off, the governor’s proposal would eliminate state income taxes paid by businesses with less than $2 million in annual revenue while those above this threshold would see the tax rate cut in half on the first $250,000 of income. This amounts to a tax cut of $696 million, which would be extra money that small business owners could use to invest in Ohio’s economic future. Secondly, personal income tax rates would be reduced from 5.925% to 4.1%. Third, the personal exemption would be increased to $4,000 for those earning under $40,000 per year and to $2,850 for those earning $40,000 to $80,000 per year. This by itself would completely eliminate taxes on an estimated 220,000 taxpayers.

To replace the lost revenue, the governor’s plan calls for increasing consumption taxes. The first element of the plan is raising the sales tax by a modest 0.5% to 6.25%. Second, the sales tax base would be expanded to cover services such as management consulting, lobbying, and public relations — services which are currently exempt from taxation. Third, the governor’s plan rightly raises taxes on cigarette and other tobacco products, with the tax on a pack of cigarettes going up from $1.25 to $2.25. This will not only increase revenue by an estimated $991 million but should discourage people from smoking and result in substantial savings to the state’s Medicaid program. The treatment of illnesses such as emphysema, chronic bronchitis, and lung cancer brought about by smoking is a substantial drain on state Medicaid budgets. While the governor does not claim in his plan that this will happen, it’s an important extra benefit worth pointing out.

Finally, the Governor’s plan would address a number of small but important issues in the tax code relating to fairness and efficiency. For starters, certain tax credits would now be means-tested with those earning above $100,000 now excluded. There would be reductions in the tax credit received on trade-in vehicles and new taxes on shale oil production. At the same time small natural gas producers (those extracting less than 10,000 cubit feet per day) would be excluded from paying extraction royalties at all. This would exempt most natural gas wells, and also greatly improve the efficiency of the tax code. In addition the governor’s plan calls for capping the vendor sales-tax discount, which is a tax rebate received by businesses for the timely remittance of the sales tax. The plan would also increase the rate of Ohio’s gross receipts tax for businesses with revenues above $2 million, from 0.26% to 0.32%, while capping the tax a flat $150 for businesses below the threshold.

All in, the latest Ohio tax plan is a huge step in the right direction. If fully implemented, Ohio’s tax code would rely substantially less on income taxes and more on consumption taxes. This would have the added benefit of reducing state revenue volatility, as consumption taxes are far more stable than taxes derived from income. More important, by changing its tax code and modestly shrinking the size of state government, Ohio would move closer to becoming one of the fastest-growing states in America.