BEFORE THE HOUSE WAYS & MEANS COMMITTEE
Opponent Testimony On Am. Sub. HB 58
Presented by Jeffery A. Walters, CPA, JD, MT, President, CBIZ Accounting, Tax & Advisory of Northeast Ohio, Inc.
Tuesday - June 29, 2004

Chairman Kilbane and Members of the Committee,

My name is Jeff Walters, President of CBIZ Accounting, Tax & Advisory of Northeast Ohio, Inc., (an affiliate of Century Business Services, Inc.) and a shareholder in Mayer Hoffman McCann P.C., Certified Public Accountants. I am here as a business owner and a member of the Ohio Small Business Council opposing Am. Sub. HB 58 as written.

By way of background, I have been involved in Ohio state and local taxes for 25 years. I began my career with the Ohio Department of Taxation and then spent a number of years as a state and local tax consultant for Coopers & Lybrand, an international accounting and tax-consulting firm. More recently, I have been the Managing Partner for a regional CPA firm while continuing to provide federal, state and local tax consulting services for a national business consulting firm. In addition, I spent 16 years as an instructor for a course on state and local taxation in the Masters in Taxation program at the University of Akron. Throughout those years, I have been on a number of committees and task forces dealing with Ohio’s state and local tax structure.

I had the pleasure of providing testimony to this Committee in Cleveland in July 2002, speaking in favor of tax reform in the State of Ohio. Although I commend your effort to provide comprehensive tax reform, I do not believe the provisions of Sub. HB 58 provide a fair and equitable tax system for the business community. In addition, I believe tax reform should encompass all of the Ohio taxes. Revision of the franchise and personal property taxes alone is a piecemeal approach to tax simplification that does not address the complications inherent in the current Ohio income tax, sales tax, and municipal income tax structure as well.

The Ohio Small Business Council has long supported a tax system, which is based on the taxation of profits or consumption rather than the taxation of capital or investment. As long as a business is profitable, we recognize that it should have the social responsibility to provide a fair portion of its profits to support state and local taxation. However, when a business is struggling due to a start up situation or an economic downturn, it needs assistance from the State development authorities rather than oppressive taxes from a State tax system. In addition, even businesses that prefer to locate in a particular State because of some local connection must generally at least consider site locations in other States, which allow them to maximize the reinvestment of capital in their business growth and development. A State tax system, which penalizes capital investment or the creation of jobs, is counter to the goal of expanding business development.

In essence, the Business Activity Tax ("BAT") appears to be a gross receipts tax that attempts to capture additional components of investment in real estate and employees where they are present. Although Sub. HB 58 provides welcome relief from the current personal property tax; the BAT is a regressive tax, which does not consider the profitability of a business enterprise. Net operating losses and manufacturing credits, which would be eliminated under the BAT, are not tax shelters or perks to small businesses. They are elements of survival. If monies needed for capital investment and payroll are instead diverted to the state taxation system, businesses are forced to close and jobs are lost. By the same token, investors in start-up enterprises expect their investment dollars to be invested in the business enterprise, not state taxes. Even the current personal property tax permits abatements for start up and expanding businesses.

Although the impact of a change from the current tax system to the BAT will have varying tax impacts on individual businesses, it appears that, in general, many profitable businesses will stand to gain a great deal of tax savings, while many struggling, start-up and low margin businesses are likely to have significant increases in their tax burden. As a tax practitioner, we have calculated the tax impact of the BAT on several of our clients from retailers to manufacturers to service industries. Many of our more profitable clients would reap a significant tax savings under the BAT due to the reduction in income and property taxes, while many of our clients which are still trying to recover from the difficult economic conditions we have experienced over the last three years would see a significant increase in their tax burden due to the repeal of the 10 percent rollback on real property tax and the taxation of gross receipts, ownership of real property, and compensation, regardless of the profitability of the enterprise. The additional tax on many of the struggling small businesses could be enough to put them out of business. The same policy decisions which have long called for the repeal of the personal property tax due to the regressive nature of the tax are merely being reformulated into another regressive tax base that continues to provide an unreasonable tax burden on the businesses that can least afford it. This burden could easily be increased even further by slight increases in the tax rate that could be imposed by future legislatures to balance State budgets in difficult economic times.

To compound matters, the benefit for profitable regular corporations (i.e. C corporations) due to the elimination of the franchise tax would not be available to profitable S corporations and other pass-through entities that do not distribute their income in the form of compensation to owners. Pass-through entities will have a heavier tax burden since the pass-through income will still be taxable on the Ohio individual income tax return. In effect, the BAT will encourage pass-through entities to distribute income in the form of compensation to the owners rather than reinvest in the business enterprise. Since most small businesses are S corporations or pass-through entities, this inequity will result in discouraging business reinvestment and/or an unfair and substantial tax burden on small business.

It also appears that the BAT could have some unintended impact on the attraction of new business to the State of Ohio. Profitable out-of-state companies with no property or payroll in Ohio, which may already be able to reap a windfall from the new tax structure, could merely make some nominal investment in Ohio real property or payroll to further reduce the tax base. At the same time, out-of-state companies will be discouraged from making substantial investments in real property (i.e. plant facilities) or jobs due to the impact on the tax base. A company that might be considering a plant facility in northeast Ohio would be better served to locate the plant in a Keystone site such as Sharon, Pennsylvania (which offers excellent tax incentives) and then open a small sales office in Youngstown to sell product into Ohio and minimize its Ohio BAT tax through dilution of the tax base.

Although I certainly favor tax simplification, the BAT brings with it a new set of complications. The definitions of "sales", "net book value", and "compensation" will have a greater significance and will likely spawn additional controversy and litigation. Pass-through entities will have to be careful not to slip into the trap whereby owner compensation is not enough to generate the appropriate credit to avoid double taxation of the pass-through entity's "activity."
In my June 2002 testimony before this Committee supporting tax reform to provide a simpler and more equitable tax structure, I cited two examples of inequities or deficiencies in the current Ohio tax structure:

1. A mold and machine shop that incurred a net operating loss due to the downturn in the economy and found itself continuing to have to pay substantial Ohio personal property tax on inventory and equipment as well as being subject to the net worth franchise tax. The funds that could have been used to maintain payroll (i.e. creating additional payroll taxes) were instead used to pay Ohio taxes even though it was attempting to recover from a loss year.

2. A manufacturing company that was considering a new plant site location in Ohio creating over 100 jobs. Despite real estate tax abatements, partial personal property tax abatements, manufacturing credits, job creation tax credits, and job training grants, the company would still pay substantially more state and local taxes than it would if it were to locate at sites in Pennsylvania or West Virginia which offer the same type of workforce. Pennsylvania offers 100 percent tax abatement of virtually all business taxes in its Keystone Opportunity Zones through the year 2013. West Virginia offers 100 percent property tax abatements for 10 years, an 80 percent Super Tax Credit for business taxes over 10 years and substantial economic development grants.

How would these examples fair under the BAT? The simple answer is worse.

In addition, consider a small business owner I know who is a 69 year old widow and runs a small retail shop to make enough income to pay for medical bills and prescriptions because her social security and small individual retirement account will not cover them. She recently underwent cancer surgery and her medical expenses will become even worse. She does not currently pay any Ohio income tax or personal property tax because she falls under the exemption and credit amounts. Under the BAT, she will have an annual tax liability. Although the tax may be small, it could mean the difference between being able to pay a portion of her uncovered medical costs or giving up her business to become another person on the Medicaid system. Clearly, if the BAT is enacted, it will need to include some small business exemption amount to address these situations.

Finally, I cite the Tax Study Committee's Guiding Principals of Tax Policy (as displayed on the Ohio Tax Study Committee's website) as a compelling reason not to adopt the BAT:

GUIDING PRINCIPLES OF TAX POLICY. Ohio's tax system should take into account and balance the following principles, widely accepted as key elements of a quality tax system.

SIMPLICITY. Our tax system should facilitate taxpayer compliance by being easy to understand and easy to administer. It should also minimize compliance costs for taxpayers and administrative costs of state and local governments.

EQUITY AND FAIRNESS. Our tax system should impose similar tax burdens on similarly situated taxpayers. It should also recognize differing abilities to pay. Further, it should fairly distribute tax liabilities across all sectors of the economy.

STABLE AND SUFFICIENT REVENUE. Our tax system exists to provide revenues that fund government services. It should provide adequate revenues to fund those services in both good and bad economic times.

NEUTRALITY. Our tax system should not unduly influence economic behavior.

COMPETITIVENESS. Our state's tax system represents a meaningful part of a state's living, working, and business environment. It should not impose an excess burden on taxpayers, particularly as compared to the tax systems of other states.

At times these principles may conflict or compete with each other. (For example, we may sacrifice some simplicity in the interest of equity.) Other over-riding policy considerations may take precedence over one or more of these principles in any particular case. Still, these principles of quality tax policy will provide the basic standard for our consideration of any proposed tax law changes.

As my previous comments and examples illustrate, the BAT is clearly lacking in all of the Guiding Principals other than "stable and sufficient revenue." For all of the reasons contained herein, I strongly urge the Committee to reconsider the BAT and instead adopt legislation that follows the Guiding Principals and, in the interest of equity and fairness, is based on profitability and ability to pay the taxes imposed.

Thank you Chairman Kilbane and Members of the Committee for your kind attention. I would be glad to answer any questions you may have.