Too High and Too Low: Ohio's Corporate Tax Mess

Ohio lawmakers created the Committee to Study State and Local Taxes in June 2002. Comprised of seven legislators and three state agency directors, the committee was responsible for analyzing Ohio

 


Ohio lawmakers created the Committee to Study State and Local Taxes in June 2002. Comprised of seven legislators and three state agency directors, the committee was responsible for analyzing Ohio's overall tax structure and its impact on the state's economy.

In March, the committee released its final report, which underscores the success of companies' tax-avoidance strategies strategies by focusing on the large gap between Ohio's statutory tax rates — those that are codified in the state's laws — and the effective tax rates — the taxes actually paid by businesses, reflected as a percentage of income.

While it is both expected and accepted that statutory rates will be greater than effective rates, a large gap between the two often signifies a problem. High statutory taxes keep businesses from locating to or expanding in the state, while low effective rates produce little income. According to the committee, Ohio's corporate tax system is simultaneously a nonproductive income generator and an anti-productive barrier to growth.

"The committee recognizes that, from an economic development perspective, high rates and low collections represent a serious problem," the report says. "Making the tax more productive while lowering the corporation franchise tax rate would represent real progress in making this tax more competitive with other states' business income taxes."

When compared to the statutory rates of all 50 states and Washington, D.C., Ohio's 8.5 percent corporate income tax ranks in the top third. Furthermore, as noted in the committee's report, Ohio's local corporate income taxes, which average 1.5 percent statewide, push it even further up the list.

"The local [corporate] income tax is a big difference," the report says. "Ohio has it and uses it heavily, while most states do not have this tax."

Only Iowa and North Dakota have statutory corporate income tax rates higher than Ohio's combined 10 percent.

However, by shifting income to states with lower tax rates and by using pass-through entities, companies in Ohio often pay less in taxes than companies in other states, on average.

Income shifting is accomplished by paying, to subsidiaries located in low tax states, management fees approximately equal to the taxable income of the Ohio-based operations, thereby reducing Ohio taxable income to zero.

Income earned by pass-through entities, such as partnerships and S corporations, is taxed not at the corporate level but as individual income of the shareholders. Pass-through entities and their shareholders generally pay lower taxes than corporations and their shareholders, costing the state $357.7 million in foregone revenue for the four years ending June 30, 2003, as estimated by the Ohio Department of Taxation.

Due to successful tax avoidance using such strategies, Ohio businesses paid 5.1 percent of their taxable income as corporate income taxes in 2000, just under one-half of the combined state and local rates. In that same year, more than 44 percent of non-financial businesses in Ohio paid the minimum business tax of $50 and another 36 percent paid less than $2,000, according to Zach Schiller, a researcher with fiscal watchdog Policy Matters Ohio. Additionally, Ohio's per capita corporate tax collections are only $67, nearly 46 percent lower than the national average of $124 per head and 60 percent lower than Indiana's per capita collection of $167.

The Multistate Tax Commission, an agency of state governments that monitors state tax laws, highlighted Ohio's corporate tax collection problems in a report released last June. The commission found that, due to "structural weaknesses and loopholes" in its tax system, in 2001 Ohio lost an amount equal to 56.9 percent of the business taxes it collected. This compared to a nationwide loss of 35 percent and was the second greatest percentage loss of all states.

Although such statistics show that Ohio businesses do not generally pay high income taxes, the state's lofty statutory rates nevertheless repel companies.

"Prospective companies often eliminate Ohio from further site selection consideration based solely on reported tax rates," the committee's report says, attributing the opinion to committee member Bruce Johnson, the director of the Ohio Department of Development.

This focus on statutory rates is evident in a report produced by the Small Business Survivability Committee, an advocacy and lobbying group for small businesses and entrepreneurs. The report, published in June 2002, analyzed government-related costs that face small businesses and entrepreneurs in each of the 50 states and Washington, D.C. Statutory corporate income tax rates for each state, with no adjustments made for incentives, loopholes and legal avoidance strategies, were included as one of these costs. Only 10 states and Washington, D.C., had higher government-related costs than Ohio, according to the group's findings.

At least one neighboring state advertises its own rates by comparing them to Ohio's. The Indiana Department of Commerce, using statutory rates for corporate income taxes, workers' compensation and unemployment insurance, created a promotional chart showing that a company with 100 employees and $1 million of taxable income would pay 27.5 percent less by setting up shop in Indiana rather than in Ohio.

Sky-high statutory corporate tax rates could at least partially explain Ohio's abysmal performance at attracting jobs.

Ohio's private sector job growth from 1999 to 2000 was the sixth worst in the country, according to the U.S. Bureau of Labor Statistics. U.S. Small Business Administration statistics from 2002 rank Ohio 45th in attracting new employers. For at least the past five years, Ohio has been a bottom-dweller in this category, ranking 40th in 2001, 50th in 2000, 35th in 1999 and 43rd in 1998.

Ohio's corporate income tax structure is among the worst in the country, simultaneously driving new businesses away and producing scant revenue. Perhaps the report produced by the General Assembly's committee will spur lawmakers into scrapping Ohio's high rates — offset by incentives and loopholes — for lower rates in a broad-based system that will attract companies to the state and generate desperately needed revenue.