Sunday, February 25, 2007

Benefits tangible; so is lost revenue
Some firms investing, but early results mixed

By Mark Niquette

The Columbus Dispatch

Gary W. James doesn't hedge when asked whether the sweeping tax cuts and other changes the state made to its tax code in 2005 are working.

Without them, nearly $4 million in equipment and more than 50 new workers at his Dynalab plant in Reynoldsburg would have gone to a nearby state or the South instead, he says.

"It's working for us, there's no question about it," James, Dynalab's president, said last week while standing in what had been an empty warehouse.

It now holds a humming assembly line with workers earning up to $20 an hour making circuit boards for commercial electricity meters.

Even so, nearly two years since the most-sweeping overhaul of the state's tax code in generations, not everyone is as convinced as James.

Although manufacturers rave about the changes and business groups credit them with generating new investment in the state, some retailers and other companies say they are being hurt unfairly. Others worry about the effect on state spending for education and important services.

Although the goal was to make its business climate more competitive and improve the economy, Ohio continues to trail most states in leading economic indicators.

For example, the state has created 23,500 jobs since the tax changes took effect in July 2005, an anemic 0.4 percent increase. Only hurricaneravaged Louisiana, Michigan and Rhode Island were worse during that period, according to federal data.

Supporters and critics of what was billed as tax reform say that because the changes are still relatively new, are being phased in over five years and are difficult to measure, it's too soon to reach firm conclusions about them.

But with tax cuts starting to limit the amount of revenue flowing to the state, few dispute that the changes are having a dramatic effect on key spending decisions that will be made in the coming months.

"It's going to require very tough choices, and there almost inevitably will be pain felt by some as a result of the constraints that we're facing with this budget," Gov. Ted Strickland said of the two-year state budget he will present March 15.

The major bond-rating company Moody's Investors Services also cited the tax changes and resulting effect on Ohio's financial flexibility as one of the reasons it lowered the state's credit outlook to "negative" last week.

"Ohio's historically strong financial management capabilities will be tested," Moody's concluded.

After 40 years of tinkering with its tax code, state leaders decided in 2005 to overhaul it. They slashed income-tax rates paid by both individuals and businesses, eliminated what was seen as an onerous tax on business equipment as well as a loophole-ridden tax on business profits, and cut half of a previous penny increase on the state sales tax.

The idea was to make Ohio more competitive for new investment by reducing the tax burden on companies and individuals and encouraging business growth thereby improving the economy and job prospects for the state.

Jon Allison, chief of staff for former Gov. Bob Taft, said the state suffered from "sticker shock": It had high rates and taxed investment and profits rather than consumption, which discouraged growth and hit manufacturers especially hard.

So the corporate taxes were replaced with a low-rate, broadbase tax on businesses' receipts, changes that state officials are convinced lowered more tax bills than they raised and make Ohio more inviting for business to locate or expand.

A 70-cent per-pack increase in the state's cigarette tax and better-than-expected collections of the new tax on business receipts have helped offset reduced revenue from the state's sales tax and corporate-franchise tax, state data show.

Although net tax collections grew by 3.4 percent in the first full year after the tax changes took effect, state projections for the next two budget years starting July 1 call for revenue growth of 1.4 percent and 0.9 percent, respectively.

That's less than inflation and well under a much-ballyhooed annual spending cap of 3.5 percent a year enacted last year. Projections suggest that by the time the changes are phased in completely by fiscal 2010, the state will have collected $3.5 billion less than it would have without the changes.

Supporters of the tax overhaul made it clear in 2005 that meaningful tax reform could not be accomplished without significant spending restraints, and they stand by that belief today.

They argue that although the changes mean less state revenue in the short term and Ohio's economy continues to struggle, there will be long-term growth even if it's not as fast as everyone wants.

People don't make business decisions without careful study, said Ty Pine, state director for the National Federation of Independent Business/Ohio.

"Anybody that looks at reforms that are 18 months old and says, 'See, as soon as we did it, businesses didn't spring up,' are not familiar with the business process. That is a multiyear process, and a lot of that stuff hasn't been fully implemented."

Ohio House Speaker Jon M. Husted, R-Kettering, and state manufacturers go a step further. They argue that the state's economy would be in much worse shape if the changes weren't made.

"We've stemmed the tide," said Eric Burkland, president of the Ohio Manufacturers' Associattract jobs and growth.

"It's not a pretty picture," Honeck said.

Rep. Steven L. Driehaus of Cincinnati, a member of Democratic leadership, said the jury is still out on the tax changes.

"Tax reform was a good idea," he said. "I don't know ... whether this particular tax package was the appropriate tax reform."

Still, although the tax changes were enacted by Republicans whose 16-year control over the governor's office ended when Strickland, a Democrat, was elected last fall, Strickland has stood behind the changes while also vowing not to raise taxes.

He has called the results of tax changes "spotty" so far but says he doesn't want to tinker with them until they have been in place long enough to be evalation, noting the state had lost more than 200,000 manufacturing jobs in the previous five years.

But critics point out that's impossible to prove or disprove, and they're concerned tax changes aimed at making the state more business-friendly will have the opposite effect.

Jon Honeck, an analyst with the Cleveland-based research group Policy Matters Ohio, is dubious about the power of tax cuts to spur economic growth and says having enough qualified workers and other factors play a much more important role.

Thus, he and others say a state forced to limit investment in education, worker training and other areas affecting quality of life because of reduced revenue only hurts its prospects to uated properly, with sufficient data.

"Much of what we think we know about the tax reform I believe to be anecdotal and based on limited or specific experiences," Strickland said. "I think we need to give it more time so we have a broader view of the effects of this reform."

Richard Levin, Strickland's tax commissioner, said although the tax changes are costly in terms of income for government, he thinks they eventually will improve the economy.

"I don't think we'll look back and say it was the wrong thing to do," Levin said. "It's certainly good for business and it's certainly what the business community has asked for.

"There's no such thing as a free lunch; if you cut taxes, cut tax rates, you'll have less revenue, and so you'll have less money for programs, and that's just the way it is."

Dispatch reporter Jim Siegel contributed to this story.

mniquette@dispatch.com