A rosy revenue outlook has allowed Ohio to join eight other states (Arizona, Idaho, Iowa, Louisiana, Montana, Nebraska, New Hampshire, and Oklahoma) in providing tax relief this legislative session. The legislature agreed on a two-year budget ahead of today’s deadline, and the budget is now awaiting Gov. Mike DeWine’s (R) signature. It includes individual income tax cuts worth $1.7 billion and offers tax refunds for taxpayers who, in 2021, paid municipal income taxes to jurisdictions that collected taxes from commuters even though they weren’t commuting during the pandemic.
The tax cuts in dollar amounts agreed upon are larger than both the House and Senate proposals from earlier this year. The Ohio Senate had proposed income tax cuts of 5 percent and the Ohio House had proposed income tax cuts of 2 percent. After the two chambers’ deliberations, they agreed on changes to the income brackets along with 3 percent cuts (except for the new top bracket, which is reduced by over 9 percent).
The change to the income tax decreases rates for all income brackets and eliminates the top bracket. Moreover, the lowest bracket level is increased to $25,000, which will exempt anyone making less than $25,000 per year from any state income tax liability. According to the Legislative Budget Office, the reductions will decrease collections by $915.8 million in fiscal year (FY) 2022 and $784.5 million in FY 2023.
Ohio Individual Income Tax Rates and Brackets, Old & New
|Old Individual Income Brackets
||New Individual Income Brackets
Sources: Katherine Loughead, “State Individual Income Tax Rates and Brackets for 2021,” Tax Foundation, Feb. 17, 2021, https://www.taxfoundation.org/state-income-tax-rates-2021/; and Ohio House Bill 110,
The income tax changes are retroactive to January 1, 2021, and the budget suspends inflation adjustment of the brackets for tax year 2021. Although Ohio has moved from nine brackets to four in just six years, lawmakers have yet to address the marriage penalty, as the above rates and brackets apply to both single filers and to married filers. Under a progressive, graduated-rate income tax system, tax rates increase as a taxpayer’s marginal income increases. A marriage penalty exists when a state’s income brackets for married taxpayers filing jointly are less than double the bracket widths that apply to single filers.
The American Rescue Plan Act prohibits Fiscal Recovery Funds—Ohio is receiving $5.68 billion at the state level—from being used to facilitate net tax cuts, either directly or indirectly, but the U.S. Department of the Treasury has made clear that states are still free to cut taxes out of their own revenue growth without fear that any Recovery Funds would be recouped. In other words, Ohio must show that it can finance the tax cut without relying on federal aid.
To determine whether a tax cut is funded out of growth, Treasury plans to use Fiscal Year (FY) 2019—the last full fiscal year before the pandemic—as a baseline, looking at inflation-adjusted revenue growth since then. Even with a general fund revenue decline of nearly $900 million in FY 2020, Ohio’s revenue outlook is rosy, with projections from earlier this year showing aggregate revenue growth of $4.7 billion between FYs 2020 and 2023, for an average of $1.18 billion per year, and almost $4.3 billion in nominal revenue growth above FY 2019 levels in the two years of tax cuts within the covered period (FYs 2022 and 2023). The income tax cuts would return around 36 percent of the projected revenue growth since FY 2019 (slightly higher in inflation-adjusted terms).
The budget also provides an option for a refund for Ohioans who paid municipal income taxes to jurisdictions although they didn’t commute into those jurisdictions during the pandemic. While the majority of these taxes were paid in 2020, the budget only offers the option for a refund for tax year 2021.
In Ohio, municipalities levy income taxes on nonresidents’ income earned within their jurisdiction. It is not uncommon for localities to levy income taxes on nonresidents for work performed within their borders as a way to recover the cost of the local services utilized by commuting nonresidents. However, during the pandemic, many people worked from home, which severed the fiscal relationship between the taxing jurisdiction and income generated by commuters. Nonetheless, Ohio passed HB 197, which allowed jurisdictions to continue collecting taxes from nonresidents who had been commuting before the pandemic. The Budget would reverse that policy, incorporating the policy outlined in HB 157.
Remote work is likely here to stay, and cities and states will have to grapple with the revenue implications and may find it necessary to adopt policies to better compete with outlying areas. As the Ohio Senate proposal acknowledges, taxing people in places in which they no longer work is not a solution.
There are several positives in the budget—cutting income taxes and rectifying the problematic taxation of nonresidents during the pandemic in particular. Yet, some issues with the income tax remain, particularly the marriage penalty. The state’s nonneutral treatment of pass-through income is less than ideal as well, though in considering modifications, policymakers must bear the additional impact of the Commercial Activity Tax (CAT) in mind.