Last month, the Ohio House’s Ways and Means Committee held a hearing on House Bill 234, a bill that would repeal Ohio’s commercial activity tax.
The commercial activity tax raises about $2 billion a year by taxing revenues of businesses in the state. Lawmakers worry, though, that the focus on gross receipts hurt businesses with tighter profit margins to the benefit of those that enjoy healthier profit margins.
While the criteria policymakers champion here for this reform is fairness, there is also an economic efficiency consideration for this reform. If an investor is trying to decide whether to put her money into a low-margin new restaurant or a high-margin new jewelry retailer, a tax on gross receipts will encourage her to put her money toward the jeweler. This has nothing to do with the viability of the business or the economic fundamentals of the investment, specifically the value it will generate for consumers, suppliers, and investors. It is only based on the structure of profits within the company.
So there is both a fairness and economic justification for reform of the tax. Does this mean outright repeal is the right answer to this problem? Most of our largest taxes such as state income taxes and sales taxes are distortionary in some way, but we don’t jump straight to repeal as the policy solution. Inefficient taxes can actually have net economic benefits if they are used to fund investments like education which build human capital and grow our state economy in the long run.
Imagining that an inefficient or unfair tax requires a dichotomous choice structure between preservation and repeal is an oversimplification. Ideally, a state tax structure works to balance ideals of equity, efficiency, and fairness with the need to raise revenue for public projects that do the same. Do we have better tools to do this than the commercial activity tax?
A popular solution for this problem in Europe is the value added tax, a tax on sales that is levied at every level of production of goods and services, thus spreading the tax across the economy and making it much less distortionary than other taxes. European countries use this tax to fund safety net features that make up for its regressive nature, thus ending up with more equitable outcomes while distorting the economy less than an income tax or a simple sales tax.
Policymakers in the United States are not ignorant of value added taxation. A value added tax was in the original version of the Tax Cut and Jobs Act during the Trump administration. Our neighbor to the north Michigan had a state version of a value added tax for decades. Ohio could look to models overseas and proposed in the United States for inspiration.
In today’s polarized environment, it’s easy to talk about taxes like they are all good or all bad, but a more sober analysis reveals a more complex truth: taxes are simply tools. Taxes can destructively push people into poverty if designed poorly and can cause minimal economic damage while reducing inequality and funding vital public services if designed well. More thoughtful analysis will lead to a tax structure that is more efficient, fair, equitable, and robust than the one we have now.
This commentary first appeared in the Ohio Capital Journal.