Ohio’s 2005 Tax Reduction Law Diminished, By 21%, The Progressivity of Ohio’s Tax Code

Campaigns to elect representatives to Ohio’s Assembly should discuss Ohio’s budget crunch, and should debate possible solutions. A record loss of jobs and a general economic downturn has caused a shortfall in Ohio’s projected tax revenue. To balance the budget, Governor Strickland has already made $733 million in budget cuts and it appears more cuts will be needed. My article, Study Says Ohio Should Raise State Revenue $817 Million By Revising 2005 Income Tax Reduction Act, tells of Policy Matters Ohio’s recommendations to modify the 2005 Ohio Tax Reduction Law.

In cutting the state income tax by a total of $2.2 billion per year, the State Assembly chose a method of reduction that significantly changed the progressivity of the Ohio tax code. An across the board decrease of 21%, also changed the progressiveness of the tax code by 21%. Other methods of modifying the tax code were available to the Assembly that could have maintained the same level of progressiveness. The philosophy of tax reduction that produced the 2005 Tax Reduction Law needs to be understood and debated as a prerequisite for modifying that Law.

Some background information — this is what the Ohio Department of Development says about the Ohio Personal Income Tax:

“The state personal income tax – an adjusted net income tax on individuals, small businesses, estates, and trusts – was first enacted in 1971 as a state revenue source. When first enacted in 1971, the tax had a rate schedule comprised of six brackets, with a bottom rate of 1.0 % on income under $5,000 and a top rate of 3.5 % on income over $40,000. In 2005, this rate schedule had nine brackets, with a bottom rate of 0.712 % on income under $5,000 and a top rate of 7.5 % on income over $200,000.

“The Ohio tax reform plan calls for a reduction and restructuring of the state’s personal income tax. The main feature of the tax reform plan is a 21 % reduction in the Ohio income tax rate schedule. This reduction, phased-in over five years at 4.2 % per year, will result in a new top rate of 5.95 %, which is a 21 % reduction from the current top rate of 7.5%”

As explained by Personal Injury Lawyer from Law Office of Matthew S. Norris – Here is how it works. If someone had an income of $230,000, in 2008 the top rate is 6.24% (down from the 2004 rate of 7.5%). This rate would only apply to the $30,000 that exceeds the $200,000. In 2008, a family with a taxable income level of $24,000 would pay 0.618 % on its first $5,000 in taxable income, then 1.236 % on the next increment between $5,001 and $10,000; 2.473% on the increment between $10,001 and $15,000 and so on.

An across the board rate cut — every bracket receiving the same cut of 21% — changes the shape of Ohio’s tax code, making it less progressive, more flat. An across the board cut will always have the result of flattening a tax code, making the rate for the top bracket and the rate for the lowest bracket come closer together. It’s easier to see in a example that doesn’t have decimals. Suppose the top bracket had a rate of 90% and the bottom bracket had a rate of 10% — a very steep, very progressive code — and suppose a 50% across the board cut was made. The new top rate would be 45% and the new low rate would be 5%. Before the cut, the difference in top and bottom was 80% (90% – 10%); after the cut, the difference was 40% (45% – 5%). An across the board cut of 50%, causes a 50% decrease in the progressiveness of the code (from 80% to 40%). Similarly, the 2005 Ohio Tax Reduction Law that called for a 21% across the board cut, resulted in a tax code that was 21% less progressive than before.

An across the board rate cut means those who are paying at a higher rate get a much bigger reduction in their tax rate than those paying at the lower rate. In the 50% cut example, above, both top and bottom brackets get a 50% cut, but the result is that the lowest bracket gets a 5% decrease in taxes, while the highest bracket gets a 45% decrease in taxes. In a tax reduction strategy that decreased taxes, but kept the degree of progressiveness of the system unchanged, all tax brackets would be diminished by the same amount. This might mean that lower brackets would disappear completely.

The 2005 Ohio Tax Reduction Law, overall, returns $2.2 billion each year to Ohio taxpayers and does it in such a way that the tax code becomes 21% less progressive than before the reduction. The law gives the top 1% of incomes (in excess of $339,000) a reduction in taxes of 1.2% (as a % of Income), and those incomes less than $17,000, it gives a tax reduction of .2%. (as a % of income).

Here is my question: What would Ohio’s tax code look like if, in 2005, the State Assembly had determined to not only return $2.2 billion each year to Ohio tax payers, that otherwise would have been collected in personal income tax, but also had determined to not diminish the progressiveness of the tax code? To keep the same level of progressiveness, everyone’s taxes, as a percentage of income, would have needed to be reduced the same amount. In practical terms, a tax reduction structured to maintain the progressivity in the system, would have given taxpayers with lower incomes a bigger tax cut than the cut produced by the 2005 Tax Reduction Law.

The 2005 Tax Reduction Law gave an income of $38,000 a tax reduction of $187. If the tax code had been written to keep the same level of progressivity in the system as a whole, the tax reduction for a $38,000 income, I estimate, would have been closer to $300.

Impacting the State Assembly’s decisions about the 2005 Tax Reduction Law was a comparison of Ohio’s tax system with the tax systems in other states, and a desire to make Ohio’s taxes more competitive with other states. Even after the revision of Ohio’s tax code, brought about by the 2005 Tax Reduction Law, it appears that Ohio’s personal income tax is still more progressive than most other states.

Here is information about state taxes from the Tax Policy Center:

“Personal income tax systems vary widely across states, leading to different levels of progressivity. Forty-three states and the District of Columbia have an individual income tax. Arkansas, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not tax personal income, while New Hampshire and Tennessee only tax dividends and interest. Eight states (Colorado, Illinois, Indiana, Massachusetts, Michigan, New Hampshire, Pennsylvania, and Tennessee) apply a single tax rate to all taxable income. The remaining states mimic the federal income tax and have multiple tax brackets and rates. Although the definition of taxable income varies by state, it largely follows the federal definition, with the exception that taxpayers are not allowed to deduct state income taxes. In 2006 the top marginal tax rate ranged from 3 percent in Illinois to 9.9 percent in Rhode Island.

“Even among states with graduated tax rates, most systems are fairly flat. In several states, the top tax bracket begins at a very low level of taxable income ($3,000 in Alabama and Maryland). Other states have only a small difference between the lowest and highest tax rates (just 2 percentage points in Connecticut and Mississippi). In most states, however, credits and deductions lead to some progressivity in the income tax system. In Colorado and Michigan, two states with a flat tax, the top 10 percent of taxpayers still paid about half of all personal income taxes in 2003. High-income taxpayers pay an even greater share of income taxes in states with more progressive systems, including California, Delaware, Idaho, Maine, Rhode Island, South Carolina, and Vermont. For example, the top 10 percent of California taxpayers paid 73 percent of income taxes in 2003.”

This list from the Tax Foundation shows the top bracket for personal income tax for each state: Alabama 5% > 3K (meaning, in Alabama the top bracket is defined as all incomes over $3,000 and all income in that top bracket is taxed at a rate of 5%); Alaska, none, Arizona 4.54% > $150K; Arkansas 7% > $30,100; California, 9.3% > $44,815 and 10.3% > $1,000,000; Colorado, 4.63% flat rate; Conn. 5% > $10 K; Delaware 4.8% > $10K; Florida, None; Georgia 6% > $7K; Hawaii, 8.25% > $48K; Idaho, 7.8% > $24K; Illinois, 3% flat rate; Indiana, 3.4% Flat rate; Iowa, 8.98% > 60K; Kansas, 6.45% > 30K; Kentucky, 6% > $75K; Louisiana, 6% > $50K; Maine 8.5% > $19K; Maryland, 5.75% > $200K; Michigan, 4.35% flat rate; Minn., 7.85% > $70K; Miss, 5% > $10K; Missouri, 6% > $9K; Montana, 6.9% > $15K; Nebraska, 6.84% > $27K; Nevada, None; New Hampshire, 5% Flat Tax; New Jersey, 8.97% > $500K; New Mexico, 5.3% > $16K; New York, 6.85% > $20K; North Carolina, 8% > $120,000; North Dakota , 5.54% > $350K; Ohio 6.24% > $200K; Oklahoma, 5.65% > $8,700; Oregon, 9% > $7K; Penn., 3.07% Flat Rate; Rhode Island, 9.9% > $350K; South Carolina, 7% > $13K; South Dakota, None; Tenn., 6% Flat Tax; Texas, None; Utah, 5% Flat TAx; Vermont 9.5% > $350K; Virginia, 5.75% > $17K; Washington, None; West Virginia, 6.5% > $60K; Wisconsin, 6.75% > $142K; Wyoming, None; D.C., 8.5% > $40K