A Cure for Bad Tax Policy in the Buckeye State

This just in from the Blackwell campaign. Can't say I disagree with any of it, actually...

By Ken Blackwell and Arthur B. Laffer

In 1970, Ohio had one of the lowest tax burdens in the Union -- it now has one of the highest. As of 2005, the state's tax burden, as estimated by the Tax Foundation, is 35.8% higher than it was in 1970, the largest increase in the nation over this period. The next largest, 26.5% in Arkansas, was far smaller, and the average increase in the U.S. tax burden was just 3.1%. Over the past decade alone, Ohio's state and local government direct spending per $1,000 of personal income has risen 19.6%, by far the highest such spending growth in the region and light years beyond the 6.8% figure for all states. To finance this expansion, higher taxes have come along hand- in-hand. The consequences have been harsh.

Since 1970, Ohio's share of the nation's personal income has declined from roughly 5.3% to under 3.8% today. In the fi rst quarter of 2005, Ohio had the fifth highest unemployment rate in the U.S. at 6.2% versus the overall unemployment rate of 5.3%. Meager Ohio employment growth of 0.3% through the first quarter placed the state third-to-last nationally, far behind the U.S. overall rate of 1.7%. With falling relative incomes, high unemployment and poor job growth, it is no wonder that people are voting against Ohio with their feet. State-to-state migration shows Ohio losing residents, while total population growth of 0.2% ranks it a dismal 47th in the nation.

Fortunately, there is now a proposed constitutional Tax and Expenditure Limit (TEL) amendment to re-establish fiscal discipline for Ohio's state and local governments. In short, Ohio's TEL initiative would limit state and local spending growth to the greater of 3.5% or the sum of inflation and population growth. The initiative also would quite properly safeguard the state from unforeseen contingencies by establishing a budget r eserve fund and would permit exceptions to the above rule only under prespecified (non-fiscal) emergency circumstances. Other excess revenues would be refunded to taxpayers on a pro-rata basis.

Ohio desperately needs this type of reform. Gov. Bob Taft's recently passed budget contains positive elements, most notably an increase in spending of only 4% over the prior biennium and an eventual 21% reduction in personal income-tax rates. However, the budget's positive steps are offset by an economically inefficient gross receipts tax, other tax increases, and the well-meaning but poor decision to phase in and phase out the major tax changes. If tax cuts are phased in over time, people will defer economic activity to take advantage of the lower future tax rates, which only makes the economy worse right now.

Even following Ohio's new budget, state and local taxes continue to place Ohio in an uncompetitive position:

-- In 1972, Ohio introduced a progressive personal income tax. As of June 30 of this year, the maximum state and local personal income-tax rate, using Columbus as a proxy for local taxes, was 9.50%. Only four states were higher. This rate was much higher and more progressive than those imposed by neighboring states. The new budget reduces the state portion of the personal income-tax rate 21% over a five-year period, yet will only modestly improve Ohio's national rank from 46th to 40th.

-- The new budget also phases out the state's traditional corporate franchise tax of 10.50% -- which was the third-highest in the nation -- over five years, and also phases out the tangible personal property tax on businesses over four years. In their place, businesses will now face, phased in over five years, a 0.26% tax on company receipts, an approximately revenue-neutral change to business taxation. We have serious concerns about this gross-receipts tax and its phased-in implementation.

-- Gov. Taft's new budget lowers the combined state and local sales- tax rate from 6.75% to 6.25%, improving Ohio's national ranking from 27th to 24th. However, under previous legislation the rate had been scheduled to fall to 5.75%, so this is, in effect, a tax increase.

-- Not addressed in the new budget, Ohio's property tax collections for every $1,000 of state personal income and its motor fuel tax remain significantly higher than the national average.

-- Under the new budget, the cigarette tax more than doubled to $1.25 per pack. Now, Ohio's workers can't even light up while they're between jobs.

The tragedy that is Ohio is a consequence, pure and simple, of bad economic policies perpetrated on the state's citizenry by politicians who should know better. We have never heard of a state that has been taxed into prosperity.

Our analysis suggests that had the proposed Ohio TEL been in effect over the 10-year period 1994 to 2003, state and local spending and the state's e conomy would have increased at roughly the same rate. In static terms, assuming no voter-approved tax hikes, by 2003 government spending in the state would have been over $10 billion less annually than actually occurred.

On a straight one-for-one basis, if implemented 10 years ago, TEL would have reduced Ohio's tax rates (all combined) from 18 cents per dollar of personal income to 15 cents per dollar. That is a reduction in tax rates of close to 17%. A cut of that magnitude today would take Ohio from one of the highest tax-rate states in the nation to one of the lowest.

Given that high-spending states underperformed low-spending states in key growth and productivity metrics from 1994 to 2003, under TEL the fiscal experience in Ohio would have been dramatically different. A 17% reduction in tax rates would have enhanced Ohio's attractiveness to investors, businesses and employers. Greater investment, more businesses and more employers would obviously have low ered unemployment rates, raised real wages and attracted migration into the state. This in turn would have increased allowable expenditures. Thanks to these dynamic effects, even with its cut in tax rates the Ohio TEL could well have increased tax revenues, allowing for even larger tax reductions and further enhancing economic growth.

For Ohioans, these results hint of what could have been, yet at the same time suggest what is possible in the future. These are the results of a well-conceived, carefully executed fiscal policy. The proposed TEL would be terrific for Ohio's prosperity.

Mr. Blackwell is Ohio's secretary of state. Mr. Laffer is chairman of Laffer Associates.