Prospects for Tax Reform

By John Gregory | 5/09/17 9:26 AM

Three things appear to certain in the debate about tax reform for the commonwealth:

  • It’s long overdue and desperately needed.
  • It won’t be easy.
  • And GOP lawmakers, enjoying their majorities in the state House of Representatives and Senate, want Gov. Matt Bevin to take the political heat for whatever gets proposed.

“It’s got to be his plan that he convinces the people of Kentucky that we need,” says Rep. Steven Rudy (R-Paducah), chair of the House Appropriations and Revenue Committee. “And then he convinces the General Assembly.”

Rudy joined Sen. Reggie Thomas (D-Lexington) on KET’s Kentucky Tonight for a discussion about comprehensive tax reform. The panel also included Anna Baumann, research and policy associate at the Kentucky Center for Economic Policy, and Ashli Watts, vice president of public affairs for the Kentucky Chamber of Commerce.

Loading video player...

Goals for Tax Reform
During his State of the Commonwealth address in February, Gov. Bevin outlined his goals for tax reform. He said it must generate more revenues for the state, it should shift the focus of tax policy from income taxes to sales taxes, and it should lower the overall tax burden for Kentuckians while broadening the tax base.

Beyond those broad brushstrokes, the governor pledged to repeal the state’s inventory and inheritance taxes, and he said every loophole and exemption must be reviewed.

“I’m talking about bringing every single sacred cow that people think can’t be touched on the tax front, bringing them all out of the barn,” Bevin said. “Some of those sacred cows are going to be returned to the barn and some of them are going to be turned into hamburger.”

Sen. Thomas says any new tax policies must be fair to middle class and working families, and they must result in more money for state coffers.

“This cannot be revenue neutral,” Thomas says. “We now have a structural budget deficit of over $1 billion, so we’ve got to raise at least that amount of revenue.”

Rep. Rudy says he’s not ready to put a specific revenue figure to tax reform. He says some of that will be determined once lawmakers see the results of an audit of the state pension systems. The unfunded liabilities in the public employee and teacher retirement plans are estimated to be some $35 billion, although Bevin contends they could be as high as $82 billion.

Rudy says everything related to taxes is up for discussion. He describes the current system as “antiquated.”

“We have a tax code that is currently based on a manufacturing economy that we just do not have,” Rudy says. “If we’re going to have comprehensive tax reform and move Kentucky’s economy into the next generation, we need to align with a more service economy that we do have.”

From the business perspective, Ashli Watts says the Kentucky Chamber of Commerce wants an overhaul that is pro-growth and makes the commonwealth more competitive with other states. She says chamber members are not philosophically opposed to a tax plan that increases revenues, especially if the additional funds help pay down the pension liabilities. Watts says Thomas’ goal of $1 billion in new moneys is too high, though, and that any proposed increase in revenues must be coupled with a review of state spending.

Whatever the specific amount, Anna Baumann of the Kentucky Center for Economic Policy says the state desperately needs more funds to invest in public education, health care, infrastructure, social services, and other civic needs that have languished during the recession. She says lawmakers should end tax loopholes for special interests and ensure that the reforms don’t favor wealthy individuals at the expense of working families.

Income versus Sales Taxes
Under Kentucky’s current tax system, the state receives 42 percent of its general fund dollars from income taxes, and 33 percent from sales taxes.

Some policymakers want to decrease or even eliminate income taxes and replace those revenues with more sales taxes. Legislators could increase the current 6 percent sales tax, or apply the levy to a greater range of goods (like groceries and prescription drugs) and services (like legal services or lawn care), or do both.

Baumann says moving to consumption taxes would be counterproductive and unfair to poor and middle-class Kentuckians. She says replacing half of the state’s income tax revenues with higher sales tax receipts would have the net effect of increasing the tax burden on the lower 60 percent of Kentucky wage earners. The wealthiest Kentuckians (those making an average of $1.2 million a year) would enjoy a $16,000 tax cut, she says.

Plus, Baumann contends that it makes no sense to try to grow the state’s economy on the backs of working class people whose incomes have been stagnant or even declining in recent decades. At the same time, she says, top wage earners have seen their incomes increase by 60 percent since 1979.

“If you’re relying more heavily on low and middle income people, your tax revenue is just not going to grow,” Baumann says. “If you’re cutting taxes for those people for whom the economy is growing, then you’re disconnecting your revenue system from your economy.”

Watts contends sales taxes aren’t regressive. She says Chamber members favor more sales taxes and lower income taxes, a model that she says has been successful for Tennessee. She contends Kentucky is too reliant on income tax revenues and so can’t completely abandon them, but she hopes lawmakers will begin the shift towards more consumption taxes.

But Tennessee’s strategy may not be nirvana. Although it has no income tax, the state has a 7 percent sales tax; cities and counties can tack on additional levies up to 2.75 percent, according to Thomas. He notes that Federal Reserve Bank economists (in a 2015 study) labeled Tennessee as the state with the most regressive tax system in America.

There’s also a question about whether cutting corporate and income taxes actually spurs the economic development and job growth that proponents of that tactic predict. Rudy argues that Kentucky is already on an upward trajectory with recent announcements by Toyota, Amazon, and Braidy Industries that they will make significant investments in the state. Rudy says he expects that positive growth to continue.

“The 2017 General Assembly did so much to improve the climate here in Kentucky and our economy is getting ready to explode, Rudy says. “I am convinced that if we make… sound tax decisions this year, that we will just see more growth.”

Thomas counters that the tax-cutting strategy hasn’t worked for Tennessee and Kansas. He says both states are struggling to collect the revenues needed to cover public services.

“States go down a dangerous path when they say we’re going to get this sudden, unaccounted for, assumed revenue growth [when] there’s no real reason to project that,” Thomas says.

And when states struggle financially, says Baumann, it’s the youngest citizens who tend to suffer the consequences.

“These states actually end up with a lot less revenue, they end up with huge holes in their budgets, and funding to kids get cut,” says Baumann.

One sales tax idea that does enjoy some bipartisan support is increasing the levy on tobacco products. The current state excise tax on a pack of cigarettes is 60-cents. Watts says the Chamber endorses an increase to at least $1 a pack, which she notes is still below the national average of $1.69. Baumann also supports increasing the cigarette tax as a way to raise revenues and discourage people from smoking. But Rudy warns that such an increase will be a difficult sell in state with such a strong tobacco-farming heritage.

Other Tax Options
Gov. Bevin and Kentucky lawmakers have a range of other ideas to consider in crafting a new tax plan for the commonwealth. For example, tax exemptions and incentive packages will face new scrutiny. Thomas says the state gives away about $12.3 billion in various loopholes every year. (In comparison, the annual state budget is about $10.4 billion.) He says he favors keeping the charitable deductions exemption, but he would put all other exemptions on the table for discussion.

Baumann says Kentucky is too generous in the itemized tax deductions it allows individuals to take. She says those deductions cost the state $500 million in revenue each year, and generally benefit those in upper income brackets.

Earlier this year the legislature considered but did not act on bills that would give tax credits to individuals and businesses that contribute to organizations that provide scholarships to low- and middle-income students who want to attend private or parochial schools. Watts says the Kentucky Chamber supports the idea, and Rudy says scholarship tax credit legislation has bipartisan support in both the House and Senate. But Thomas, a Democrat, says he opposes it.

“In effect what you’re doing is you’re taking money out of the public coffers and giving that to private schools or parochial/religious schools,” Thomas says. “It guts our public schools.”

Then there are the tax incentives that some corporations get for locating or expanding a business in Kentucky. Watts contends that most tax breaks like the ones that Braidy Industries will receive for building a steel mill in Greenup County more than pay themselves.

“But any loophole or incentive should be able to stand up to the light of day, they should be reviewed,” says Watts. “But just to broadly say incentives are good or bad, I think that’s really a little harsh… I think you have to look at it on an individual basis.”

Rudy says tax incentive packages are a standard tactic for luring business to the state. But he says those deals should include sunset clauses to end the tax break after a certain number of years, and clawback provisions that retract the tax benefit should the corporation fail to meet its obligations in the incentive agreement.

Next Steps
The Bevin administration recently released a RFP for a law firm to write a new tax plan for the commonwealth. Bevin is expected to call a special session of the legislature sometime this fall so lawmakers debate reforms of the tax codes and the public pension systems.

In the meantime, Rudy says the House Appropriations and Revenue Committee will discuss a range of tax issues in their monthly interim meetings. Although there’s a growing chorus for increasing state revenues, he says it will be difficult for Republicans, especially the 23 new GOP House members, to approve what could be perceived as a tax increase. All state representatives come up for reelection in 2018.

Watts says the Chamber has moved from advocating for revenue-neutral tax reform to accepting the fact that the state does need more money.

“There are things that need to be funded but until we can figure out the pension problem and pay for that, there will be no money for education, there will be no money for infrastructure… there will be no money for economic development,” Watts says. “That money that we owe and that billions of dollars in debt that we have in the pension system affects everything that state government does.”