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What Would Happen if Ohio Abolished Its State Income Tax?

Nearly one-third of state senators sponsored legislation earlier this year to phase out state income tax over the next 10 years, though the bill is unlikely to pass. The state received $10.8 billion from income taxes last year.

(TNS) — Completely abolishing Ohio’s state income tax, long a conservative pipe dream, has never been closer to becoming a reality.

Since 2005, Ohio lawmakers have steadily reduced the state’s income tax rates, including by almost half for the state’s wealthiest residents. And earlier this year, nearly a third of Ohio senators sponsored legislation to phase out the income tax over the next 10 years. While that bill is unlikely to pass before the end of the year, the Ohio General Assembly next year is expected to be even more conservative than the current one, with Republicans increasing their already enormous majorities in both the Ohio House and Senate.

That raises the question: if Ohio’s income tax is done away with, what happens then? The state reported receiving about $10.8 billion from income taxes last fiscal year. If that money disappears, state leaders will have to either slash spending, raise other taxes, or some combination of the two.

“It can be done, and it can be done in a very prudent fashion,” said Greg Lawson, a research fellow with The Buckeye Institute, a conservative-leaning think tank. “But everybody needs to sort of think through what that is.”

Spending Cuts

Though state spending in the current two-year budget is about $162 billion, much of that is federal money that the state is only in charge of distributing, according to Policy Matters Ohio, a left-leaning think tank. When it comes to cutting state spending, most of the focus is on the $50 billion or so in general-revenue fund money ($24.2 billion last fiscal year, and $26.1 billion in the current fiscal year) that isn’t devoted to Medicaid spending.

That means if the income tax were done away with this fiscal year, general-revenue fund spending would have to be cut by more than 40 percent to make up the difference for the $10.8 billion in lost revenue in the first year.

Across the two-year budget, more than 40 percent of general revenue spending – about $23 billion – is reserved for primary and secondary education spending, which has been a contentious issue since the Ohio Supreme Court ruled in 1997 that the state’s education funding method was unconstitutional.

Other spending estimates include (among other things) $5.5 billion for higher education, $4.7 billion on health and human services, $4.4 billion on the state’s prison system, and almost $1.8 billion on local governments, according to Policy Matters Ohio.

Removing more than $10 billion in spending from those areas every year would require more than finding minor ways to cut costs – it would demand an unprecedented shrinking of state government in ways that every Ohioan would notice.

To Zach Schiller, research director for Policy Matters Ohio, making such enormous cuts to state spending to pay for erasing the income tax would be a “wildly irresponsible” move.

“To take $10 billion out of the state revenue is just not possible,” Schiller said, adding, “I mean, yeah, I suppose you could do it. But, you would have to just [be] savage.”

And if the state made major cuts to education, Schiller added, that would inevitably force school districts around Ohio to make up for the lost revenue by raising local property taxes.

Lawson said it would be “not impossible, but pretty challenging” to cover the lost income-tax revenue with spending cuts alone.

“Now, the question is whether that’s politically palatable or not,” he added.

Raising Other Taxes

The other way state government could absorb the shock of abolishing the state income tax is by raising other taxes.

Increasing the state sales and use tax rate, in particular, has been looked at as a way to offset income tax cuts in previous years – especially under former Gov. John Kasich, who succeeded in raising the state sales tax rate to its current level of 5.75 percent in 2013 to pay for a 10 percent income-tax cut.

The argument made by Kasich and other Republicans is that refocusing taxation from income to consumption would help the state’s economy by encouraging people to save and invest more. Democrats and other critics, though, note that such a shift results in the wealthiest Ohioans paying less in taxes, while the poorest Ohioans – who already aren’t charged any state income tax – would have to pay more in taxes.

Ohio collected nearly $14.4 billion in general sales and use taxes in fiscal year 2021, according to the U.S. Census Bureau. Divided by 5.75 percent, that means every 1 percent of the sales tax brought in about $2.5 billion.

Using those numbers, that would mean Ohio’s sales tax would have to be raised by more than 4 percentage points to make up for the $10.8 billion worth of lost income-tax revenue. That would give Ohio the highest sales tax rate of any state in the country, Schiller noted.

Besides the state sales tax, in 2015 Kasich also called for significantly raising Ohio’s severance tax on oil and gas fracking activity to help cover income-tax reductions. However, state lawmakers at the time didn’t go along with his plan, and it’s unclear whether the legislature would be any more receptive to the idea now.

While sales and income taxes are the major sources of tax revenue for the state, the state also collects money from the commercial activity tax (which raised $2 billion last fiscal year), taxes on cigarettes and other tobacco products (about $885 million last fiscal year), and taxes on insurance policies (about $641 million last fiscal year).

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