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Yesterday, Governor John Kasich introduced his final biennial budget proposal. Coming as no surprise, the proposal includes $3.1 billion of personal income tax cuts offset by proposed increases to sales, severance and other taxes of $3.0 billion. The budget proposal also offers an aggressive and bold plan to centralize the collection and administration of municipal net profit taxes.
Personal Income Tax Rate Reductions and Reform
The Ohio personal income tax on individuals, trusts, and estates is currently imposed using nine income tax brackets, ranging from .495 percent to 4.997 percent. The governor’s proposed budget would reduce the existing income tax brackets from nine brackets to five brackets, as follows:
The governor’s proposed budget is forecasted to result in a 17 percent income tax cut over fiscal years 2018 and 2019. Additionally, the proposed budget would provide further tax relief for lower and middle income taxpayers by increasing the threshold for the low-income tax credit from $10,000 to $15,000 and increasing the personal exemption amount for taxpayers earning less than $80,000. The cost of the proposed bracket, low-income tax credit, and personal exemption changes is $1.244 billion in fiscal year 2018 and $1.883 billion in fiscal year 2019.
The budget proposal also calls for the elimination of the personal income tax campaign contribution credit, which will increase revenue by $3.6 million each year.
Sales and Use Tax Increase and Expansion of Taxable Services
The proposed budget includes an increase in the current sales tax rate from 5.75 percent to 6.25 percent, which is anticipated to generate $559.6 million in fiscal year 2018 and $878.9 million in fiscal year 2019. Certain services would also become taxable, including the following: lobbying, repossession services, cable subscription services, elective cosmetic surgery/procedures, landscape design, interior design, travel agent services, pre-packaged tours, and other travel services. The definitions of these services are not yet available. The sales tax on the additional services is anticipated to generate $135.9 million in fiscal year 2018 and $206.0 million in fiscal year 2019, before imposition of the proposed sales tax increase. Over half of this anticipated sales tax revenue increase would be generated from taxing cable subscription services.
Changes in Existing Commercial Activity Tax (“CAT”) Exclusions
The proposed budget includes two changes in existing exclusions from CAT. The first change would eliminate the interest exclusion for lenders, described as businesses whose business primarily produces interest income. Interest earned by non-lenders would continue to be excluded from CAT. The definition of a lender and the test for determining whether a business primarily produces interest income is not yet available. The revenue generated by this CAT change will be $2.8 million in fiscal year 2018 and $3.9 million in fiscal year 2019.
The second change involves the existing exemption for a supplier’s sales to qualified distribution centers (“QDCs”). Currently, CAT is only imposed on a QDC supplier’s receipts from goods that are ultimately distributed to Ohio purchasers. The proposed change would require that each supplier assume that 10 percent of its sales to QDCs are ultimately distributed to Ohio purchasers. The revenue generated by this change to the QDC provisions will be $5.1 million in fiscal year 2018 and $21.2 million in fiscal year 2019.
Over the biennium, the budget also shifts $347.5 million of CAT revenue away from local governments and directs it to the General Revenue Fund (GRF) by increasing the GRF’s share of total CAT revenues from 75% to 85%.
Municipal Net Profit Tax Reforms
Currently, each municipality with an income tax also administers a net profits tax on businesses. The proposed budget transfers the administration of all net profits taxes to the Ohio Department of Taxation (“ODT”) through the Ohio Business Gateway (“OBG”). This approach would allow a business to file electronically and use a standard form across all municipalities. ODT would charge municipalities a lower rate of 1.0 percent on collections versus the 2.5 – 3.0 percent currently imposed by third party administrators. The proposal argues that OBG has the capacity to provide cross-checking by the municipalities, which will increase compliance and collections. The municipalities would continue to control the income tax rates, credits, and employer withholding and individual filing obligations. Until the language becomes available, it remains unclear how an individual with net profits (e.g., sole proprietors, etc.) will file.
The proposal would also eliminate the anti-competitive municipal tax throwback rule. Under this rule, sales of tangible personal property that are shipped from an Ohio municipality to a location at which the seller does not have employees soliciting the sales must treat those sales as if delivered within the originating city for apportionment purposes (i.e., the seller must “throw-back” the sales to the originating municipality by including those sales in the numerator of the sales factor for the originating municipality).
Cigarette and Other Tobacco Products Tax Increases; Vapor Products Expansion
The proposed budget relies on significant revenue generated from increases in the cigarette tax, other tobacco products tax and extending the other tobacco products tax to vapor (i.e., e-cigarette) products. Specifically, the proposal includes the following changes:
Increases the tax rate on other tobacco products from 17 percent to 69 percent, but also provides a cap of $2.00 on certain specialty cigars. The increase is intended to be equivalent to the new $2.25 per pack cigarette tax rate and is anticipated to raise an estimated $83.6 million in fiscal year 2018 and $125.4 million in fiscal year 2019.
Subjects vapor products to the tax on other tobacco products at the new 69 percent rate. The inclusion of vapor products is anticipated to generate $4.8 million in fiscal year 2018 and $9.6 million in fiscal year 2019.
Eliminates the 2.5 percent early payment discount for the other tobacco products tax, to generate $3.2 million in fiscal year 2018 and $4.9 million in fiscal 2019.
Reduces the cigarette tax stamp credit to $1.25, to generate $7.9 million in fiscal year 2018 and $8.5 million in fiscal year 2019.
Severance Tax on Fracking and Natural Gas Extracts
Governor Kasich’s proposed budget includes a new severance tax on high-volume horizontal wells (hydraulic fracturing wells), similar to his proposal in the last budget. A 6.5 percent tax would be imposed on extracted oil and gas calculated by multiplying the volume of oil and gas extracted by the quarterly spot price at the exchanges where the commodities are traded. The proposal also includes a 4.5 percent tax on extracted natural gas liquids calculated by multiplying the volume of natural gas liquids extracted by the quarterly spot price at the exchanges where the commodities are traded. The combined taxes are anticipated to generate $136.6 million in revenue in fiscal year 2018 and $310.6 million in fiscal year 2019.
Increased Alcoholic Beverages Taxes
The governor's proposed budget increases the tax rates on most kinds of alcohol by approximately 70 percent. An additional tax rate increase would be applied to high alcohol beer. The proposal eliminates the deduction for early beer and wine payments and reduces the small brewers’ credit. The impact of these proposed changes is $26.4 million in fiscal year 2018 and $30.6 million in fiscal year 2019.
Medicaid MCO Sales Tax Replacement Plan
Ohio currently imposes a sales tax on health care services provided or paid by Medicaid Managed Care Organizations (“MCOs”) as a method of obtaining matching funds provided by the federal government. The sales tax is based on the amount of managed care premiums received each month by the MCO and is paid by the MCO. Ohio has imposed this sales tax since 2009. In 2014, the federal Centers for Medicare and Medicaid Services (“CMS”) notified Ohio that, as of July 2017, its sales tax on MCOs was not a permissible health care-related tax. The elimination of the sales tax on MCOs will reduce state GRF revenues by $839.7 million in fiscal year 2018 and by $986.0 million in fiscal year 2019, as well as reduce county and local transit authority revenues by approximately $200 million in fiscal years 2018 and 2019, each.
The state of Ohio obtained a waiver from CMS in December of 2016 for a MCO tax replacement plan. Assuming the legislature approves the budget proposal, a new broad-based tax would apply to all Medicaid MCOs and all non-Medicaid MCOs, starting July 1, 2017. The replacement tax will cover the anticipated state sales tax shortfall. Local taxing authorities, however, will no longer be able to generate revenue from taxing such services. The budget contains a transition plan to mitigate the impact of these revenue reductions on local taxing authorities. The plan would:
While the budget proposal contains more modest personal income tax cuts than his prior budgets, Governor Kasich continues the effort to pay for such cuts by shifting a significant portion of the cost of such cuts to businesses. Of course, the true nature of the proposal will depend on the proposed statutory language. For instance, in prior efforts to tax lobbying, the definition actually included much more than lobbying.
The statutory language is expected to be available next week. Once available, we will have a clearer view of how these proposals will impact taxpayers.
Businesses should quantify the impact of the sales tax and other tax rate increases on their business, while also determining what benefits, if any, the personal income tax bracket reductions may provide. Also, the proposal to centralize the administration of municipal net profits taxes is expected to generate major resistance from local governments. As a result, business taxpayers that like this proposal may want to consider ways to support this dramatic proposal.