Mike DeWine tried to be helpful. On Tuesday, the governor pointed to a way out of the current budget impasse, the Republican majorities at the Statehouse missing the July 1 deadline for having a new two-year spending plan in place, the state now operating on a 17-day interim budget. He told the Columbus Dispatch the chambers would do well to set aside their differences over a tax break for small businesses and proceed to reach a budget agreement.
The governor advised they take up the tax matter later in a separate bill.
That was the original DeWine plan: Leave the tax code as it is, and focus on targeted areas of investment, including substantial funds for schools with high rates of poverty. Then his fellow Republicans in the legislature called for yet another reduction in state individual income tax rates — on top of a one-third reduction the past 14 years. How would they cover the expense?
Larry Householder, the House speaker, landed on a keen idea: Narrow the $1.2-billion-a-year tax break for small business owners. He understands the exemption isn’t just a handy source of revenue. He knows it isn’t working as promised to accelerate job creation, proving wasteful as much as anything.
Consider the words of the speaker in May: “We’re probably taking care of some folks who are putting it [the tax break] in the bank or putting it in their pocket.”
How does the tax break work? It benefits those with “pass through” income, or business profits taxed as individual income as they flow to owners. This includes partnerships, sole proprietorships and limited liability companies (thus, the shorthand “LLC loophole”). The first $250,000 in such income goes tax-free. Income above that threshold receives a favorable 3 percent rate, or less than the 4.9 percent applied to others.
The House version of the budget lowers the threshold to $100,000 and eliminates the 3 percent rate. For its part, the Senate also ends the special rate, yet it calls for keeping the tax-free threshold at $250,000. That is the disagreement, or “huge stumbling block,” as the governor put it, the House version shrinking the tax break by roughly half, generating an estimated $528 million a year.
Business groups and other proponents insist this pass-through break spurs expansion. Yet, as Policy Matters Ohio notes in a recent report, the numbers reveal it hasn’t been the predicted boon. The growth in pass-through entities here has lagged behind the nation. First-time hires at new Ohio businesses have been flat since launching the tax break six years ago.
Policy Matters highlights the analysis of Michael Mazerov of the Center on Budget and Policy Priorities. He has found that the “vast majority” of those benefiting from such tax breaks either earn a small sum from self-employment on the side, or they are passive investors, or business owners who essentially work on their own with little intention or need to make a new hire. That includes an attorney with income of $500,000 a year, saving $15,000, the money more likely to end up in the bank, just as Speaker Householder suggested.
Adopt the House version, and 87 percent of those currently benefiting would be unaffected, revealing that most claim less than $100,000. More, the Institute on Taxation and Economic Policy found that 80 percent of the additional taxes would be paid by those in the top 1 percent of income earners, over $496,000 a year, with the rest paid by the next 4 percent.
In urging compromise, the governor acknowledged a fairness factor. It is evident not just in the tax break heavily favoring wealthy households. Policy Matters cites the different treatment of a contractor and an employee, performing the same job, earning similar incomes yet the former in position to avoid entirely the state income tax.
There is a case for targeting such a tax break to benefit those actually running businesses and hiring new workers. For now, Ohio doesn’t need another income tax cut, the House proposing a 6.6 percent rate reduction, the Senate 8 percent. After a decade of disinvestment, from local governments to education, that $528 million, a fraction of the $3 billion in tax cuts since 2005, could be put to good use.
In that way, the speaker has the better argument.
Douglas is the Beacon Journal/Ohio.com editorial page editor. He can be reached at email@example.com.