Ohio Governor John Kasich

CHICAGO — Ohio municipalities face steep revenue losses — and likely constraints on borrowing ability — under a proposed overhaul of the state's local income tax system.

House Bill 5 represents the culmination of months of lobbying from businesses and municipalities and years of debate over Ohio's infamously complicated local income tax structure. The bill establishes a common tax base by defining what kinds of income local governments can tax and what kinds they can't. Some local governments could face significant hits to their bottom lines if the bill becomes law, municipal officials and economists say.

The House passed the measure Nov. 13 by a 56-39 vote largely along party lines, with Republicans in favor. The Senate is expected to consider it in the next several weeks.

The legislation represents the latest in a series of blows to local government revenue in the Buckeye State. Gov. John Kasich, a Republican who took office in 2010 with a $6 billion shortfall, balanced the state budget in part with deep cuts in local revenue aid — 50% over two years. The state has also phased out its personal property tax, most of which went to local governments, and eliminated its estate tax, also earmarked for municipalities.

Income taxes are a key revenue source for most of the state's local governments, accounting for an average of 60% of total general fund revenue.

With less revenue, municipalities will face new limits on their ability to borrow, and could see a drop in debt service coverage for existing debt, experts said.

"There's a number of areas in the bill that will reduce revenue for our members, and for some members, they could lose a substantial amount of revenue," said Kent Scarrett, communications director with the Ohio Municipal League, which opposes the bill. "It certainly will affect the ability of municipalities to borrow to invest in long-term capital investments if the bill goes through as it is."

The league met with Senate leaders last Tuesday to discuss hoped-for changes to the bill, Scarrett said.

Ohio is one of only 17 states that allows all its municipalities to impose income taxes. Without a uniform local income tax policy, the Buckeye State has hundreds of different local income tax systems. Of the state's 943 local governments, 592 levy an income tax, with roughly 300 different structures.

Businesses for years have complained about the difficulty of compliance, and some observers say Ohio has the most complex local income tax structure in the U.S.

"The bill is part of the general discussion we're seeing nationally about the size of government and how much taxes are we going to pay for it," Mark Engel, the head of the state and local tax practice for Bricker & Eckler LLP. One of the firm's clients is the Ohio Manufacturers Association, which has lobbied for the measure.

Engel says the legislation is a big deal for the state, its local governments and businesses.

"We have over 600 cities and 580 of them have their own municipal income tax, so in that respect we're a little unique," he said. "There is no centralized collection or enforcement, so you can imagine if you are a business, say, that works in Cleveland or Columbus or Cincinnati, but have people who go out into the suburbs, you're facing potentially a very significant compliance burden.

The national Tax Foundation, a non-partisan tax research group, said the version of HB 5 that passed the House — a substitute bill from the original — was substantially weakened.

"Ohioans spend valuable time and money each year complying with a system that lacks uniformity or concrete rationale," the foundation said in a comment on the bill on its website. "The consideration of municipal income tax reform was the bright spot of tax discussions in Ohio this year, but this recent effort represents a watered-down attempt to declare victory on a complex issue that deserves real legislative attention."

The independent Ohio Legislative Service Commission, which analyzes bills, said the measure would mean a net revenue loss for local governments but the amount remains unknown.

"LSC economists believe that, on balance, the bill will probably decrease statewide revenues to municipalities," the LSA said in a recent fiscal analysis of HB 5. "Though total revenue losses to municipalities are undetermined, and delayed to future years, they may be significant, potentially millions of dollars annually."

Cincinnati and Columbus would both lose roughly $3 million in annual revenue, according to the municipal league. Dayton would lose $2 million, and Newark more than $1 million. "It varies, but it's significant," Scarrett said.

Local income tax rates range from a low of 0.4% to a high of 3%, according to the legislative services agency. Total municipal income tax revenue in Ohio was estimated at $4.31 billion in calendar year 2011. Of that, $3.98 billion was collected by cities and $0.33 billion by villages. The city of Columbus collected $677 million, according to the LSC.

"Some of the provisions could have the impact of reducing tax collections by the city, and depending on the extent to which a city has exercised its bond capacity I would think that this could possibly have implications for existing bonds," Engel said. "But more importantly it could have implications for their ability to issue future bonds because if there's less income tax available, there's less revenue available [for debt service]," he said. "Their capacity to issue bonds and get things done is going to be reduced."

The measure would require that businesses with an annual income of $500,000 or less only be charged income tax in the area that they're located in, not the areas in which they do business.

The bill also would require municipalities starting in 2017 to allow a five-year carryforward of net operating losses, a provision that allows businesses with cyclical income to have tax rates that track average income, avoiding high taxes during high-income years.

The so-called NOL, or net operating loss, provision, is one of the most controversial provisions, with critics saying it could mean big losses for municipalities, particularly those that have less than a five-year carryforward period or none at all. That accounts for 42% of local governments with an income tax, according to the municipal league.

The legislation also creates a temporary 11-member review committee that will produce a report by May 15, 2015, regarding the net losses on the carryforward provision. The committee is also required to propose measures to address shortfalls.

The Senate is expected to consider the measure later this year or in the first few weeks of the new year. Gov. John Kasich has not yet weighed in on the measure, but Engel said it's likely he favors it.

"It's being pitched as a business-friendly bill, and all states are trying to pass laws to make them more business friendly and Ohio is no different than anyone else," Engel said. "The governor is very big on simplifying business regulation, and this bill would be consistent with that."

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