A $457 million tax break designed as a stimulus for small businesses produces so little savings per filer — about $1,100 on average — that even proponents admit it’s not enough to spur job growth.
A tax break touted by Gov. Kasich as a way to help small businesses grow and hire more people has sparked criticism from both the political left and right.
More than 408,000 business owners and investors last year claimed $10.1 billion in deductions under the small business investor income tax deduction. The total tax savings was estimated at $457 million, or an average of $1,118 per filer.
Both the left-leaning Policy Matters Ohio and the conservative Buckeye Institute agree that the policy is flawed. The two think tanks typically argue opposite sides of economic policy positions.
Greg Lawson, policy analyst for the Buckeye Institute, said the policy doesn’t go far enough and the average tax savings isn’t enough to move any employment needles.
“It’s not huge,” Lawson said. “You’re not going to be hiring people that way. I think there were some very substantive flaws in how this was done.”
Zach Schiller, executive director of Policy Matters Ohio, doesn’t like the tax break for a different reason. The program, which he said could cost up to $800 million a year once it is fully in place in 2016, would have more impact if local governments and school districts were allowed to use the money for hiring police, firefighters and teachers.
Jim Lynch, a spokesman for Kasich, said the new deductions are only part of the solution and shouldn’t be judged in isolation from all of the governor’s policies.
Data from Secretary of State Jon Husted’s office through September of this year show new business filings are up about 5 percent from the same period of 2014, Lynch said.
“Our goal is to help small businesses become bigger businesses, and every little bit helps when you’re trying to grow your business,” Lynch said. “A small business person could say with $1,100 or $2,000, I can buy a new piece of equipment. I can advertise. I can do something different to help grow my business.”
Those are exactly the sentiments of Bill DeFries, owner of Copp Integrated Systems in Dayton.
DeFries, who bought the 96-year-old company on Keowee Street in 2012, said he took the deduction last year for the first time and received about the statewide average in tax savings.
“It’s certainly not anything that’s going to help me grow a job,” said DeFries, whose company has installed security and fire alarm systems in many of the biggest buildings in the Dayton region. “But I can take that money and I can buy a new computer for a new hire. I can invest in the infrastructure.
“I appreciate that little bit of money because I’m sinking it back in.”
Break will grow
The small business investor income deduction, introduced by the Kasich administration in 2013 and expanded in the current two-year budget, exempted half of the first $250,000 in business income in the first phase. Business owners and investors then paid the regular rate for the rest of their income.
For the 2014 and 2015 tax years, the exemption was 75 percent of the first $250,000 in business income. Next year it will exempt all business income under $250,000. Filers will then get an extra break by paying a flat 3 percent on any additional income.
The exemption applies to anyone who is a sole proprietor of a business, or who has set up a “pass-through entity” such as a limited liability corporation, partnership or S corporation that shields owners and investors from legal liability.
Schiller argues that the money could be better spent. “We have all kinds of unmet needs in Ohio,” he said. “We have the highest infant mortality rate among African Americans among any state in the country.
“How many cops are not on the street in Dayton compared to five years ago? How many school teachers could we pay with that? How many houses could you tear down among the thousands of vacant houses in the city of Dayton?
“Instead, it is going to business owners under the theory that it will somehow promote economic growth and jobs, when in fact we have yet to see evidence that it is doing so,” Schiller said. “And in fact, the evidence so far on jobs shows that it is not.”
Data from the U.S. Bureau of Economic Analysis on job creation by small businesses through 2014 appear to bear that out. Both the number of business births and the number of jobs added by new businesses have been flat since the policy was enacted in 2013. New jobs created by new businesses since the beginning of 2010 is averaging about 22,000 every quarter in Ohio — about half of what it was in the 1990s, the data show.
Lawson said the Buckeye Institute has long said that Ohio’s job creation numbers are “just not where we want them to be.”
“My criticism is not so much that it shouldn’t be done,” he said of the tax break. “It’s that it should have been enfolded into a much broader package and that it didn’t do enough.”
The institute wants to see all personal income taxes abolished in Ohio, as well as reforms on regulations and local income taxes.
“This is one piece of it,” Lawson said. “But I think doing tax cutting the wrong way doesn’t get you what you want. And it sometimes it gives a bad name to what is overall sound policy.”
‘Good talking points’
Scott Drenkard, an economist and director of state projects for the Washington D.C.-based Tax Foundation, is more sharply critical of the deduction, calling it a gimmick that gives politicians “good talking points.”
“It’s very politically popular to say that you’re cutting taxes on small businesses,” said Drenkard, who testified last March before the Ohio House Ways and Means Committee against the deduction. “But going about it this way is not true tax reform. It’s a gimmick.”
Real tax reform, he said, would involve changing the tax base and significantly lowering all individual income taxes.
“But just coming up with a very generous deduction for one particular type of business organization method, LLC, pass-through businesses, is not a comprehensive approach to improving the simplicity and competitiveness of Ohio’s tax system,” Drenkard said.
Drenkard warned that the tax break could motivate businesses to reorganize so they can qualify for the deduction without creating any new value in the economy. That’s what happened in Kansas, he said, when the state legislature passed a similar business exemption, although without the $250,000 limit that Ohio lawmakers enacted. Kansas officials expected 191,000 people would receive the exemption, Drenkard said, but some 330,000 applied for the deduction in 2013, causing a fiscal crisis in that state.
He worries that a similar effect could occur next year, when Ohio’s deduction goes up to 100 percent of the first $250,000 and a flat 3 percent tax on the rest.
Local accountants say they haven’t seen any such trend.
Jeff Kujawa, director of tax services for Brixey & Meyer accounting firm, said he hasn’t had any clients reorganize for the new deductions, nor would he recommend it.
Kujawa cited an example of one of his clients with $3 million in revenue. The income for the owner on that revenue was $93,000, he said. So at this year’s rate of 75 percent, he was able to deduct about $70,000 from his business income, which resulted in a tax savings of about $2,800.
“There would be a cost to restructuring, too,” Kujawa said. “In that particular example for like a $2,000 or $3,000 savings, it’s not worth the investment of restructuring your entire business.”
Kujawa said his small business clients really appreciate the deduction. “When everything else seems to be tax increases, it’s really nice to have a benefit out there on your individual tax return,” he said.
Dave Walls, director of state and local tax for the Brady Ware & Company, said Ohio lawmakers had previously set up the opposite incentive to restructure when they repealed the corporation franchise tax beginning in 2014.
That move exempted income from corporate taxes, but not from the pass-through businesses such as LLCs and S corporations.
“So, in essence, people would have gone the other way,” Walls said.
Wall said his firm has “lots of clients” who gladly take advantage of the deduction, even though, he agreed, it doesn’t amount to enough to hire a new employee.
“But we have a number of our larger clients that are looking to hire, and especially in 2016, when it’s 100 percent of the first $250,000,” Wall said.
DeFries, whose company installed the sound system in the University of Dayton Arena when it was built and runs the system for every event, said he is working hard to grow his business. But it’s not easy.
“We’re fighting out here tooth and nail to make a living,” DeFries said. “Every penny that I’m making, I’m investing in trying to get new people to come in here.”
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