Larry Householder departed from the thinking of many fellow Republicans at the Statehouse and beyond when he engineered the narrowing of the tax break for limited liability corporations and other “pass through” businesses. The speaker did so, in part, to pay for an across-the-board tax cut. The House two-year state budget plan also routes additional resources to helpful investments such as children services and students carrying the burden of severe poverty.
On Tuesday, the Republican majority in the Senate launched an examination of the proposed tax change as part of crafting its version of the budget. It appears safe to say that Senate Republicans aren’t inclined to follow the speaker’s lead on the “LLC loophole.” That’s too bad. Perhaps as the budget process heads to the endgame in late June, they will recognize the tax break hasn’t delivered as proponents promised.
The speaker had as much in mind when he said recently: “We’re probably taking care of some folks who are putting it in the bank or putting it in their pocket.”
That isn’t what business organizations contend. Twenty-one, representing companies across the state, sent a letter to state senators this week voicing opposition to the House change. They see value in the current set-up, permitting the first $250,000 in “pass through” income to go tax-free with any remaining such income taxed at a lower 3 percent rate. They argue the tax relief is about parity, noting that general business corporations pay only the commercial activity tax while “pass through” businesses pay the CAT and the state income tax.
“Pass through” refers to business earnings going to owners and taxed as individual income. Owners choose to form the business in that way. They could adopt the structure of a general corporation.
Mostly, proponents argue the tax break encourages investment by businesses, especially the small variety, spurring the creation of new enterprises and new jobs. The letter from business organizations warns that reducing the exemption will result in fewer improvements to facilities, training, technology, equipment and wages, adding “all of which would be detrimental to Ohio’s overall economic growth.”
That sounds reasonable in theory. The reality is there has been little improvement in the growth of new businesses here, compared to the country as a whole. The same goes for new hires, a flat trend line for the past several years. To be sure, the state has been performing better in a strong national economy. The “pass through” loophole has not made much of a difference.
Perhaps that is partly explained by the vast majority receiving less than $1,000 a year through the break, or hardly enough to hire a new employee. Yet, as a whole, the exemption costs roughly $1 billion a year in revenue, inviting the question: Is there a better way to deploy state resources?
What does the House propose? It would reduce the exemption to the first $100,000 in “pass through” income and wipe out the special 3 percent tax rate. That would save $528 million a year. It would do so without affecting 86 percent of those claiming the exemption. Who would see a change? Policy Matters Ohio and the Institute on Taxation and Economic Policy calculate that four-fifths of the tax increase would be paid by the top 1 percent, those with incomes of $496,000 a year and above. Virtually all of the increase would be paid by the top 5 percent.
If the House misses the mark in devoting a large measure of the savings to a broad tax cut, income tax rates already reduced one-third since 2005, its overall instinct about the LLC loophole is right. It doesn’t generate a productive return.