Pensions Need Responsible Funding Plan, Not Exaggerated Claims

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The series of reports from PFM on Kentucky’s pension systems overstate serious challenges with the condition of the state’s plans to justify drastic cuts in benefits. PFM overgeneralizes about assumptions in the plans to assert employers should contribute $1.8 billion more in 2019 above what prior assumptions would suggest, in some cases nearly doubling what contributions would otherwise be.1

While Kentucky has substantial unmet pension funding needs, exaggerated numbers do not help the problem and inaccurately imply radical action should occur to roll back and cut already-modest public pensions. Kentucky must responsibly pay down its pension liabilities over a period of decades. The need to meet our obligations to workers and retirees is one of many reasons the state must clean up our tax code to generate additional revenue, which will allow targeted extra dollars for pensions in the short term and consistent funding in the long term. But overblowing the problem encourages actions that would cause unnecessary additional harm to workers and retirees and could make the pension funding problem even worse.

We Should Address Actual Problems, Not Create More By Overstating Crisis

PFM bases its huge funding gap assertion on claims that wrong assumptions are being used in all Kentucky pension plans to calculate what should be contributed each year. Particularly, PFM is critical of the method of calculating contributions as a percent of payroll (and assuming payroll will grow in the future) and what they claim are too-high assumptions of future investment returns (assumptions were until recently 6.75 percent to 7.5 percent per year across plans).

Payroll growth

If you look at the last decade, payroll costs have not been growing in some of the plans (especially the Kentucky Employees Retirement System (KERS) non-hazardous system, which has had negative payroll growth). That’s due to round after round of state budget cuts that have shed employment and denied raises to employees, and because some employers in the KERS non-hazardous system have responded to pressure from rising pension liabilities by privatizing and outsourcing services. When contributions are pegged to how much is paid to employees and payroll does not grow as assumed, contributions are too small to adequately pay down liabilities. That is especially problematic for KERS non-hazardous because the plan is so poorly funded already.

But political leaders have gone far beyond that empirical statement to claim using a percent of payroll method is itself fundamentally flawed. But the state’s existing method is not controversial: actuaries consider it standard practice. The Conference of Consulting Actuaries identifies the method as its “model” policy, noting it is the best approach to match benefits like Kentucky’s that are based on the pay of the covered employees.2 The method allows employers to contribute a stable amount as a share of compensation expenses over time, rather than having to find and contribute much more money as a share of total expenses at first and then much less money in later years (which is necessary under the “level dollar” approach that PFM says Kentucky should be using in all its plans, in which employers contribute approximately the same dollar amount of money each year). PFM admits in their report the level percent of payroll approach is “common nationally and widely accepted.”3 And the Legislative Research Commission recently reported 41 of 50 states use level percent of payroll.4

For the plans that are experiencing payroll growth, such as the Teachers Retirement System (TRS) and the County Employees Retirement System (CERS), percent of pay remains the right approach. A level dollar method may be appropriate in the short-term for other plans, but Kentucky must return to a status where workforce and salaries grow in order to provide an adequate level of services and attract the qualified teachers, social workers and other employees needed. We cannot continue on our current payroll-cutting path, which has created unreasonable employee caseloads, eroding payscales and damaging gaps in public services that ultimately hurt communities across the commonwealth.

Investment returns

As for investment returns, because of the Great Recession returns fell short of the target over the last 10 years, although they come close to or even exceed the target over the last 5 years, 20 years and beyond.5

The poorly-funded KERS non-hazardous plan has a more difficult time achieving its investment targets due to depleted assets and negative cash flow necessitating a more liquid portfolio to pay benefits. Despite that challenge, the plan earned returns of 12.09 percent in the year that just ended, and thanks to investment earnings and additional state contributions in 2017, its cash flow is finally positive for the same time frame.

The better funded plans do not face the same barriers in achieving investment goals. Those plans’ return assumptions are in line with other pension plans around the country, and nationwide systems are a healthy 76 percent funded as a whole and their financial status is improving.6 That’s because governments in most states — unlike Kentucky — made the required annual payments to those systems. The median investment return assumption for plans nationally is 7.52 percent, with only 8 percent of plans using an assumption below 7 percent. None of the 127 plans surveyed by the National Association of State Retirement Administrators uses an assumption as low as 6 percent, which PFM recommends for TRS, KERS Hazardous, CERS and the Judicial Form Retirement System (and 5.1 percent for KERS Non-Hazardous and the State Police Retirement System), as shown below.7

PFM takes one-size-fits-all approach to assumption changes 

Dramatically and immediately adopting more conservative assumptions across the board causes the big increase in required contributions PFM says is necessary. Only 26 percent of the $1.8 billion in additional monies PFM calls for goes to the severely underfunded KERS non-hazardous plan, as shown the graph below. In contrast, 65 percent of those monies go to plans that are nearly 60 percent funded — TRS and the CERS non-hazardous plan.

PFM does not present a sound case for that level and allocation of additional resources as the smartest or most practical for the next budget period — especially if it is met in significant part through cutting other parts of the state budget and slashing workers’ benefits. The $862 million more PFM alleges is needed for TRS is over 80 percent above what is now being contributed, as shown in the graph below. Kentucky finally stepped up to nearly paying its full ARC contributions to TRS in the 2017-2018 budget, and the state’s failure to pay the ARC before those years is the main reason TRS is underfunded. Kentucky is only just now on the right track for funding TRS, but PFM is claiming that contribution is far too small.

That higher number for TRS comes from using a level dollar assumption that teacher payroll will not grow over the next 30 years — meaning we will fail to add any teachers to keep up with a growing population and fail to pay them any more than we pay them now, both of which are implausible and would be deeply harmful. The number is also derived, as mentioned, from assuming the plan’s investments will earn 6 percent annual returns on average, as opposed to their current assumption of 7.5 percent. Although no one can guarantee future returns, TRS has $17 billion in assets from which to invest in financial markets, and it earned 15.4 percent returns in the year that just ended and 8.1 percent over the last 30 years. As noted above, in a national survey no plan had adopted an assumption as low as 6 percent and certainly not a plan with the assets of TRS.8  PFM itself was part of a survey of 35 investment advisors in 2016 that projected pension funds have a 48.8 percent chance of earning at least 7.5 percent returns over the next 20 years.9

Claims that dire actions are necessary today to radically increase contributions could lead to counterproductive and extreme changes to benefits. On the table now are clawbacks of past cost of living adjustments (COLAs) and elimination of future teacher COLAs, big increases in the retirement age and the closing of defined benefit plans to shift to less efficient and less attractive 401ks.10 Such cuts and changes will break promises to employees, reduce their standard of living, make it much harder to attract and retain qualified public servants and hurt the entire economy by reducing retiree spending in local economies.11 Existing benefits for employees and teachers are inexpensive for the state as long as they are properly funded, and have been reduced already through multiple rounds of benefit cuts including in 2008 and 2013 and a lack of employee raises that results in a subsequent decline in pension incomes (which are tied to an employee’s salary at the end of their career).12 Furthermore, moving to a 401k-style defined contribution plan would make it more expensive to pay down existing liabilities over time, worsening the challenge we now face.13

A Responsible Approach: Short-Term Aid and Long-Term Consistency

A sound approach would protect already-reasonable benefits and provide responsible funding levels in the near term to get the plans on the right path so that challenges diminish over time. The General Assembly has already made major strides in that direction recently. In 2015, the state began paying the full actuarially required contribution (ARC) for the KERS non-hazardous system and paid $58 million above the ARC in 2017 and $68 million above the ARC in 2018. And, as mentioned previously, in the 2017 and 2018 budget, the state paid about 94 percent of the ARC for the teachers’ plan after paying only about 50 percent in the prior year.

A responsible plan would include additional aid to the KERS non-hazardous plan, which needs higher contributions for the time being than its prior actuarial assumptions would suggest. Given that system’s depleted state, extra caution and resources are warranted to help the plan get back on its feet and headed in the right direction.

The state should contribute an amount that would improve the short-term financial condition for KERS non-hazardous. At a minimum Kentucky could target funding to the amount needed to pay benefits each year. By preventing negative cash flow, that would free up the plan’s existing $2 billion of assets from being liquidated to pay benefits — allowing it to maximize its investment portfolio for long-term returns.

How much is that? In 2017, the plan paid $948 million in benefits and it received $703 million in employer contributions, so a payment achieving that target would be at least $245 million or 35 percent above what is now being contributed. That’s a big increase in the next budget, but is less than the consultant group’s suggestion that the plan needs $474 million or 67 percent above the current contribution for the KERS non-hazardous plan.

While KERS non-hazardous needs special attention, other plans like the local workers’ plan (CERS) and teachers’ plan are in much better shape and will be on their way to healthy funding levels as long as annual required contributions continue to be made (local governments must make those full contributions by law). Since the state paid 94 percent of the teachers’ contribution in the current budget, that means an additional contribution in the neighborhood of $50 million a year beyond that level. There is not a demonstrated need for dramatic changes in assumptions for these plans. If their boards wished to err on the side of caution, they could phase in modestly lower assumptions over a period of years rather than making large changes all at once.14 PFM actually recommends such a cap for CERS in how much annual contributions change due to assumption changes, but does not apply the same logic to the state-level plans.

Some will inevitably charge that an approach ratcheting down the alarmism around assumptions across the board is just “kicking the can down the road.” But, as noted above, Kentucky is only recently beginning to make much more aggressive contributions to these systems, and the suggestions above would increase contributions further. Pension liabilities cannot be paid off overnight, but the obligations are also not owed to retirees immediately, and getting the systems back to healthy funding levels will take decades.

Additional Revenue is Key

The real challenge we face now is this: even just replicating the historic increase in pension contributions made in the current budget looks to be very difficult moving forward. That’s because the budget was built with significant one-time money unlikely to be available for the next budget.15 Revenue growth is modest with another shortfall of $200 million expected at the end of the year, and the state is on track to deplete its rainy day fund in 2018.16 There is also pent-up demand for reinvestment after years of budget cuts that have led to strain on nearly every public service the state provides, soaring college tuition and a lack of employee raises.

Our budget challenge can be solved, but we need to take a responsible approach and not one based on overgeneralizations about assumptions. The key to solving it will be action to clean up the tax code and raise new and more sustainable revenue — to meet our obligations to employees and retirees and invest in a stronger Kentucky.17

 

 

  1.  PFM, “Pension Performance and Best Practices Analysis, Report #3: Recommended Options, Summary Presentation to Public Pension Oversight Board,” August 28, 2017, https://pensions.ky.gov/Documents/2017%2008%2028%20-%20KY%20Report%203%20FINAL%20PFM%20Briefing%20Presentation%208.28.pdf.
  2. Conference of Consulting Actuaries, “Actuarial Funding Policies and Practices for Public Pension Plans,” October 2014, https://www.ccactuaries.org/Portals/0/pdf/CCA_PPC_White_Paper_on_Public_Pension_Funding_Policy.pdf.
  3.  PFM, “Pension Performance and Best Practices Analysis, Interim Report #2: Historical and Current Assessment,” May 22, 2017, https://pensions.ky.gov/Documents/2017%2005%2022%20-%20Report%202%20FINAL%205.22.17%20-%20Historical%20and%20Current%20Assessment.pdf.
  4.  Legislative Research Commission, “Payroll Growth Assumption,” Public Pension Oversight Board, March 27, 2017.
  5. Rates of return for KRS are: 1-year 13.47%, 5-year 8.08%, 10-year 4.86%, 20-year 6.46%; inception to date 9.16%. KRS Monthly Performance Update, June 2017, https://kyret.ky.gov/Investments/Documents/June%202017%20Monthly%20Update.pdf. Rates of return for TRS are: 1-year 15.37%, 5-year 10.1%, 10-year 6.3%, 30-year 8.1%. TRS, “Teachers’ Pension Fund Gains 15% with New Funding,” https://trs.ky.gov/news/.
  6.  National Conference on Public Employee Retirement Systems, “Economic Loss: The Hidden Cost of Prevailing Pension Reforms,” May 2017, http://www.ncpers.org/files/NCPERS_2017%20Economic%20Loss.pdf.
  7.  NASRA Issue Brief, “Public Pension Plan Investment Return Assumptions,” February 2017, http://www.nasra.org/files/Issue%20Briefs/NASRAInvReturnAssumptBrief.pdf.
  8.  NASRA, “Public Pension Plan Investment Return Assumptions.”
  9.  Horizon Actuarial Services, “Survey of Capital Market Assumptions: 2016 Edition,” http://www.horizonactuarial.com/blog/2016-survey-of-capital-market-assumptions.
  10.  Jason Bailey, “PFM Report Uses Exaggerated Claims to Justify Harsh, Counterproductive Cuts,” Kentucky Center for Economic Policy, August 28, 2017, http://kypolicy.org/pfm-report-uses-exaggerated-claims-justify-harsh-counterproductive-cuts/. Jason Bailey, “Clawback of Cost of Living Adjustments Would Be Major Hit to Retiree Checks,” Kentucky Center for Economic Policy, August 30, 2017, http://kypolicy.org/clawback-cost-living-adjustments-major-hit-retiree-checks/.
  11.  Jason Bailey, “Pension Benefits Inject $3.4 Billion into the Economies of Kentucky Counties,” Kentucky Center for Economic Policy, June 6, 2017, http://kypolicy.org/pension-benefits-inject-3-4-billion-economies-kentucky-counties/.
  12.  Jason Bailey, “Kentucky Public Pensions Are Not Expensive — If You Fund Them,” Kentucky Center for Economic Policy, June 21, 2017, http://kypolicy.org/kentucky-public-pensions-not-expensive-fund/.
  13.  Jason Bailey and Stephen Herzenberg, “Switch to 401k-Type Plan for Kentucky Public Employees Will Cause More Harm,” Kentucky Center for Economic Policy and Keystone Research Center, August 22, 2017, http://kypolicy.org/switch-401k-type-plan-kentucky-public-employees-will-cause-harm/.
  14.  The Board of Kentucky Retirement Systems already recently lowered the investment return assumption of CERS from 7.5% to 6.25 %.
  15.  Jason Bailey, “Budget’s Reliance on One-Time Funds Presents Challenge Next Time Around,” Kentucky Center for Economic Policy, August 30, 2016, http://kypolicy.org/budgets-reliance-one-time-funds-presents-challenge-next-time-around/.
  16.  Pam Thomas, “Four Added Concerns About Kentucky’s Fiscal Outlook,” Kentucky Center for Economic Policy, August 4, 2017, http://kypolicy.org/four-added-concerns-kentuckys-fiscal-outlook/.
  17.  Anna Baumann, “Revenue Options that Strengthen the Commonwealth,” Kentucky Center for Economic Policy, February 2, 2016, http://kypolicy.org/new-report-kentucky-can-take-balanced-approach-to-budget-with-revenue-options/. Anna Baumann, “What Good Tax Reform Looks Like,” Kentucky Center for Economic Policy, April 17, 2017, http://kypolicy.org/good-tax-reform-looks-like/.

Switch to 401k-Type Plan for Kentucky Public Employees Will Cause More Harm

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Click for a one-page summary of the report.

Kentucky needs solutions that work to pay down its unfunded pension liabilities. A new report from the Kentucky Center for Economic Policy and the Keystone Research Center shows shifting state employees to inefficient 401k-type defined contribution plans won’t reduce the liabilities but will make the funding challenge worse while harming the workforce and economy. Highlights from the report are below.

Defined Contribution Plan Will Fail to Save Money Compared to Inexpensive Existing Plan While Introducing New Costs
Regular costs of state pension plans are already low, and plans have been through multiple rounds of cuts.

New Kentucky employees contribute more toward their pensions than does the state, and the low state contribution is comparable to what private sector employers contribute for 401k plans and Social Security. The legislature already cut benefits and required more years of service for retirement eligibility in 2008, ended cost of living adjustments for state worker retirees in 2012 and moved new state and local employees into a hybrid cash balance plan that shifts risk to those workers in 2013.

State studies show new plan designs aren’t cheaper.

Past actuarial analyses of moving Kentucky workers to a defined contribution plan and creating a hybrid plan showed they would be no cheaper for new workers than the existing defined benefit plan.

Defined contribution plans cost more to deliver the same retirement benefit.

Defined contribution plans are less efficient than defined benefit plans because of portfolios less balanced by workers of different ages and the cost of purchasing annuities, among other factors. Experts say it costs between 42 percent and 93 percent more for a defined contribution plan to provide the same level of retirement benefit as a defined benefit plan. An actuary hired by Kentucky in 2015 said it would cost substantially more to shift Kentucky teachers to a defined contribution plan than keep the existing plan.

Switch would make it more expensive to pay down unfunded liabilities.

A switch to defined contribution plans would close the existing pension plans to new members, which would lower investment returns on the existing plans’ assets over time, adding large costs to pay down unfunded liabilities. Studies in 14 states that have considered a switch to defined contribution plans projected that closing a defined benefit plan lowers investment returns and increases the costs of paying down legacy debts.

Switch to Defined Contribution Plan Undermines Ability to Attract Skilled Workforce and Weakens Local Economies

Switch would raise costs by making it harder to attract and retain a skilled workforce.

Kentucky public employees already make less in total compensation than comparable workers do in the private sector, research shows. Especially since governments are large, permanent employers, it makes sense for them to use defined benefit pensions as a tool to compete for qualified workers in lower paying public sector jobs. Workers in positions that provide defined benefit pensions tend to have lower turnover and longer average tenure, meaning lower recruitment, hiring and training costs for employers.

Shift would weaken local economies.

A less secure retirement from inferior 401k-type plans would also harm local economies where pension benefit checks play a major role, and raise public benefit costs as more workers retire into poverty. Pension benefits inject $3.4 billion into the Kentucky economy each year. As those monies are spent at local businesses, they have a multiplier effect that results in the creation of jobs.

Critical Investments in Kentuckians at Risk in U.S. House Budget

The House budget resolution that passed out of committee last night sets out a harsh framework over the next 10 years that would lead to deeply damaging cuts to many federal investments that help Kentucky families meet basic needs and support our economy. The budget proposes cutting federal entitlement programs by $4.4 trillion over 10 years — including Medicaid and Medicare and income assistance programs such as SNAP food assistance. Also in the resolution are big cuts to Non-Defense Discretionary (NDD) programs that help to improve Kentucky’s economy and quality of life, including by funding improvements in education and economic development opportunities.

With its deep cuts to basic assistance, health programs and core investments in our economy combined with tax cuts to benefit the wealthy, the House budget resolution is broadly very similar to President Trump’s budget proposal.

In addition, the budget plan contains an immediate threat to begin implementing these cuts while making room for enormous tax cuts that will benefit the wealthy. The proposal would use the reconciliation process to fast-track at least $203 billion in cuts to entitlement programs that benefit many low-income Kentuckians and our communities.

Proposed Budget Deeply Cuts Programs that Help Low-income Kentuckians Meet Basic Needs

The House budget plan would cut $4.4 trillion over the next decade from entitlement programs, a category that includes Medicaid and Medicare, basic food assistance, income assistance for working poor and other struggling families, and assistance for students to go to college. These cuts would make it more difficult for Kentuckians to afford food, housing, health care and a college education.

Here are some of the programs that are at risk for cuts:

Medicaid & Medicare

Medicaid is a cornerstone of our system of health care coverage, providing 1.4 million Kentuckians access to important preventative services, substance abuse treatment, care for chronic conditions and more. Overall funding for “Medicaid & other programs” (the category listed in the budget materials) would be cut by $1.5 trillion over the decade.

Medicare provides health insurance to people ages 65 and over as well as to younger people with disabilities. The programs helps pay for health care services including physician visits, hospitalization, prescription drugs, skilled nursing facility care, home health care and hospice care. The House resolution proposes to cut Medicare by $487 billion over the decade. In 2015, 826,296 Kentuckians were insured through Medicare.

Income Assistance

While the budget lacks sufficient detail to determine the precise level of cuts in many programs, the resolution indicates cuts to income assistance programs that help Kentuckians — which include SNAP food assistance and could include Supplemental Security Income (SSI), Temporary Assistance for Needy Families (TANF), the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC).

  • SNAP: The Supplemental Nutrition Assistance Program (SNAP), formerly known as “food stamps,” helps low-income Kentuckians afford basic food needs, and boosts the economy during downturns when more people become eligible. The House resolution proposes $150 billion in SNAP cuts over 10 years, more than 20 percent of the SNAP budget. In February 2017, 651,889 Kentuckians (308,453 households) were receiving SNAP.
  • SSI: This program provides income support for individuals who are disabled or elderly and have little income and few assets. As of December 2016, there were 180,613 Kentuckians receiving Supplemental Security Income (SSI) benefits. Of those, 58 percent are women and 61 percent live in rural areas.
  • TANF: Temporary Assistance for Needy Families helps low-income Kentuckians make ends meet. The majority goes to basic cash assistance (55 percent), and some goes to support work activities (13 percent) and child care assistance (18 percent). But the program is already stretched so thin that only 19 of every 100 families living in poverty receive any kind of cash assistance. As of January, there are 18,300 Kentucky families receiving cash assistance through TANF. This number includes 32,124 children and 7,778 adults earning an average monthly benefit of $101.33 per person.
  • EITC & CTC: The EITC helps raise living standards for low and moderate-income workers. The CTC helps low-income working families by offsetting part of the cost of child rearing. The EITC and the refundable portion of the CTC lift more people out of poverty than any other program besides Social Security. In 2015, 397,439 tax filers in Kentucky received $968 million worth of tax credits through the EITC program, an average of more than $2,436 per filer. In 2014, 280,000 Kentucky households received the low-income part of the CTC.

Student Aid

The House budget resolution includes deep cuts to the Pell Grant program — $80 billion over 10 years — which provides grants to low-income students attending college. In Kentucky in 2017, 102,360 students received Pell grants. The resolution also cuts federal student loans.

Fast-Track Process for Cuts

The budget resolution itself just provides a framework for spending in the future. But this year’s budget action includes an additional component that puts the entitlement programs at immediate risk for at least $203 billion of these cuts through the fast-track process of budget reconciliation. Through reconciliation, Congress is able to pass cuts with only a simple majority in the Senate (i.e., without any Democratic votes) using the same process that has been used recently to try to repeal and replace the Affordable Care Act.

Big Cuts to NDD Programs Would Severely Impair or Eliminate Core Public Services

Federal NDD programs improve Kentucky’s economy and quality of life in multiple ways — including by funding improvements in education, help for kids and families, healthier and safer communities, workforce and economic development and cultural enrichment opportunities. Kentucky currently receives approximately $2 billion a year in NDD funding.

In the House budget resolution, NDD programs are cut by $1.3 trillion over the next decade. Overall funding for this part of the budget has already fallen significantly since 2010 because of the Budget Control Act’s caps on discretionary programs and sequestration cuts. With the cuts in this budget proposal, by 2027 NDD funding would be 44 percent below its 2010 level, after adjusting for inflation.

Cuts Pave the Way for Tax Cuts That Disproportionately Benefit Those at the Top

It is important to note that at the same time the House is proposing these incredibly harmful cuts to such important programs, the resolution also includes tax cuts that would disproportionately benefit those at the top of the income scale and large, profitable corporations. The budget creates a fast-track process to enact these tax changes, which are in part dependent on the entitlement cuts as the budget calls for deficit-neutral “tax reform.”

A House vote on the resolution could happen as early as next week.

Click to see fact sheets on what’s at risk in all six Kentucky Congressional Districts

Year-End Revenue Results Underscore Need for Right Actions on Tax Reform

Kentucky ended the 2017 fiscal year with $138.5 million less in General Fund revenue than economists predicted would be collected. The shortfall puts slightly more pressure on investments in our schools, universities and community colleges, health and human services and other building blocks of Kentucky communities. And its details reinforce the need to generate more revenue in ways that will work.

Total General Fund receipts in FY 2017 totaled $10.5 billion. Receipts did grow compared to FY 2016 by $138.9 million (1.3 percent), but the forecast predicted twice as much growth (2.7 percent). In general, year-over-year revenue growth is to be expected and has been the case historically in Kentucky, with total General Fund receipts growing 8 out of the last 10 years despite a major recession from which we’re still recovering.

A shortfall occurs when actual revenue does not meet the revenues estimated by the Consensus Forecasting Group. Those estimates are based on past revenue performance of the various taxes and fees levied by the commonwealth, and a review of general economic conditions in Kentucky and the nation. The estimates against which 2017 revenues are compared were made in late 2015. To put the shortfall in context, the amount actually generated is only 1.3 percent less than was predicted, which, given the length of time and number of factors considered, is pretty close. The governor has the ability to address the shortfall through a reduction plan that includes an already-ordered cut to agency spending of 1 percent, transfer of unspent funds and use of up to $59 million from the already-modest rainy day fund.

Even though the estimates were close and the deficit is not large, when considered in the context of Kentucky’s overall fiscal health, the shortfall underscores the inadequacy of our current tax structure to meet the needs of the commonwealth. We simply do not have the resources necessary to pay down the state’s unfunded pension liability, meaningfully respond to the opioid addiction or child protection crisis or recover from 16 rounds of budget cuts since 2007.

Kentucky’s main revenue sources – the individual income tax and the sales and use tax which comprise 41.9 percent and 33.2 percent, respectively, of total General Fund revenue in 2017 – both underperformed and contributed to the shortfall. The individual income tax was 0.4 percent below predictions and sales tax receipts were 1.5 percent lower than expected.

When comparing the overall strength of the individual income tax and the sales tax over time, it is important to note that since 2007, the individual income tax has grown by 44.5 percent while the sales tax has only grown 23.7 percent. The relative strength of the income tax showed up this year as well, as income tax receipts grew by 2.6 percent and generated $112 million more than the year before, while the sales tax grew by only 0.7 percent and generated $23 million more than 2016.

A major reason for the stronger growth in the income tax – which is more progressive (people with more income generally pay a larger share of their income in taxes than low- and middle-income people do) – is that it better aligns with the rapid income growth at the top in today’s increasingly unequal economy. The sales tax, on the other hand, asks more of middle and low-income people who have not seen their income or their purchasing power grow in decades. The sales tax also suffers from a relatively narrow base because it doesn’t generally apply to services, a faster growing sector of our economy.

Other revenue sources also contributed to lackluster overall growth in receipts: corporate income taxes, which are inherently volatile, fell 5.5 percent relative to 2016 and brought in 14.1 percent less than predicted. In fact, at $81.9 million less than was forecast, corporate income taxes were the largest nominal contributor to the shortfall. Factoring limited liability entity taxes (which businesses also pay) into corporate income taxes, these receipts grew by 1.8 percent compared to 2016 but underperformed estimates by 7.5 percent. Coal severance revenue fell for the 6th consecutive year to just a 1/3 of 2012 receipts, and cigarette taxes fell by 1.3 percent since last year.

Later this month, the state will close out the expenditure side of the budget and we will have an overall picture of where we stand fiscally. Later this year, in preparation for the 2018 budget session, the Consensus Forecasting Group will begin developing revenue estimates and agency heads will develop budget proposals for the 2018-2020 biennium. In addition to these processes moving forward, the governor has indicated that he plans to call a special session to address tax reform and pension reform – all further opportunities to examine Kentucky’s fiscal health.

As legislators consider the needs of the commonwealth and the ability of our tax code to generate sufficient revenues to meet them, the shortfall for 2017 should serve as a warning. Cutting income taxes for those at the top and shifting to heavier reliance on slower-growing sales taxes – which some Kentucky’s leaders are falsely promoting as a solution to not only budgetary but also economic woes – would deepen the fiscal challenges we face today. The real solution lies in cleaning up expensive special interest tax breaks that provide little to no benefit to the commonwealth. Real tax reform wouldn’t prevent shortfalls, but it would greatly improve the context in which they must be addressed.

How At-Risk Federal Discretionary Funds Are Important to Kentucky

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Similar to President Trump’s initial budget blueprint, or “skinny budget,” his full budget proposal slated for release next week is expected to include cuts to non-defense discretionary (NDD) program funding in order to pay for increased spending for defense and border control — and pave the way for tax cuts for the wealthy. These NDD programs are separate from mandatory federal programs like SNAP (formerly known as “food stamps”) that are also expected to face major, damaging cuts in the president’s plan. 1

Cuts to NDD programs would be harmful to Kentucky as they provide more than $2 billion a year, the equivalent of 20 percent of our state’s General Fund, in critical funding for improving education, supporting children and families, making our communities safer and healthier, providing assistance for the state’s most vulnerable, developing our workforce and economy, and increasing cultural enrichment opportunities. Such federal budget cuts would occur in the context of our state already experiencing declines in federal funding in recent years, and struggling under state budget cuts.

Here are some highlights of what federal NDD funds do in Kentucky and what would be at risk with cuts.

Improvements in Education

Cuts to federal grants that provide funding to improve education would be harmful in Kentucky, where educational attainment levels are not where they need to be and state budget cuts are already being deeply felt. Just half of Kentucky kids are considered to be ready when they enter Kindergarten; achievement gaps persist in our K-12 system; more than 344,000 Kentuckians have no high school diploma or GED credentials; and we are far from reaching our state’s higher education goals. 2

Meanwhile, K-12, adult and postsecondary education are all struggling under frozen funding levels and state budget cuts in recent years. Cuts make it hard for our schools to address achievement gaps, for adult education programs to improve access to a GED credential and for tuition at the state’s public universities to be affordable. 3

Here are some of the NDD programs that provide funding to help improve education in Kentucky:

  • Head Start. This program provides low-income Kentucky children across the state with early childhood education and care that has significant short- and long-term benefits, including improving the likelihood that participants graduate from high school, attend college and receive a postsecondary degree or credential. 4
  • Special Education. Federal NDD funds help to educate children with disabilities — including early intervention services for infants and toddlers, preschool children and older school-aged children.
  • Adult Education. Federal funds support local adult education centers that provide free adult education services across the state. Earning a GED credential improves employment opportunities and more than a third of Kentuckians earning GED diplomas go on to postsecondary education. 5
  • College Work-Study. By providing mostly on-campus jobs for qualifying students, federal college work-study funding helps more Kentuckians be able to afford college — and research has shown work-study students are more likely to graduate than those in non-work-study jobs and more likely to be employed after graduating than students who do not work during college. 6
  • School Improvement Grants (SIGs). These funds help to raise achievement of students in low-performing schools. A SIG grant, for instance, was a critical part of Leslie County High School’s dramatic jump from scoring poorly on standardized tests prior to receiving school improvement funds, to scoring in the 94th percentile in Kentucky a few years later and being designated as a distinguished school 2 years in a row. 7 Twenty-five schools in Kentucky are currently receiving SIG funds. 8
  • 21st Century Community Learning Centers. These federal funds are used to design and implement effective after school programs. They enable schools to provide students with homework assistance and an array of activities that complement their regular academic programs; funding can also be used to offer literacy and other educational services to the families of participating children. As an example, through 21st Century Community Learning Centers funding South Livingston Elementary School offers an after-school computer coding program. 9 President Trump’s “skinny budget” proposal recommended completely eliminating this program.
  • Supporting Effective Instruction. This grant provides funding to increase student academic achievement; improve the quality and effectiveness of teachers, principals and other school leaders; and provide low-income and minority students greater access to effective teachers, principals and other school leaders.
  • Rural and Low-Income Schools Program and Small, Rural School Achievement Program. These two federal programs provide assistance to rural school districts that often lack adequate resources due to a weak local tax base.

Help for Kids and Families

Children and families in our state already face many challenges and additional cuts to federal funding would be detrimental in particular to at-risk children. Our state’s child welfare system is already overstretched and child abuse and neglect is unfortunately on the rise. 10 In addition, Kentucky’s child care assistance program is already relatively weak compared to programs in other states in terms of eligibility limits, parent co-payments, reimbursement rates to providers and how much leeway parents have when looking for a job. 11

These are some of the federal NDD programs that support children and families in Kentucky:

  • Child Welfare Services. The Stephanie Tubbs Jones Child Welfare Services program provides states with funds to provide preventive intervention, to place children in foster care when they cannot stay safely at home and to provide family reunification services to enable the safe return of children to their homes when possible. These funds can also be used for child protective services — including investigations of child abuse and neglect, counseling and emergency assistance. Kentucky received funding in 2016 for protective services, foster care maintenance payments and administrative costs. 12
  • Community-Based Child Abuse Prevention. Kentucky receives funding through this program to develop, operate, expand and/or enhance community-based prevention-focused programs and activities.
  • Healthy Start. This program helps to reduce the rate of infant mortality and improve perinatal outcomes in high-risk communities. In Kentucky, there is a Healthy Start program in Louisville to address high infant mortality rates in several of the city’s zip codes where babies are more than twice as likely to die before their first birthday than in the Louisville Metro area as a whole. 13 The program provides home visits and other outreach methods to make sure women begin getting prenatal care early on and continue to get consistent care through pregnancy and after delivery.
  • Child Care and Development Block Grant. These funds make child care assistance available for low-income families and children. In Kentucky, they are an important source of funding for Kentucky’s popular Child Care Assistance Program (CCAP), which provides important support to more than 26,000 low-income Kentucky families struggling to afford care while they work. 14

Healthier and Safer Communities

Despite important health improvements likely resulting from the Medicaid expansion, Kentucky still ranks toward the bottom on many health indicators compared to other states. Kentucky has the highest rate of cancer and cancer deaths in the nation, and more than one in four Kentucky adults reports having a chronic health condition. 15 Our state has also been hit particularly hard by the opioid epidemic and has the third highest rate of death due to drug overdose, alongside Ohio. 16 In addition, Kentucky faces many environmental concerns, including water pollution that degrades our drinking water, and state budget cuts have weakened environmental enforcement. 17

Federal NDD programs are a critical source of funding for health services in our state, including the following:

  • State-Based Comprehensive Breast and Cervical Cancer Early Detection
  • Mental Health Block Grant
  • Substance Abuse Prevention and Treatment Block Grant
  • Family Planning Services
  • State Offices of Rural Health
  • Universal Newborn Hearing Screening
  • Preventive Health Block Grant, Preventive Health Services, Preventive Health – Rape Prevention and Education

Other NDD programs that improve health and safety in Kentucky include:

  • Black Lung Clinics Program. Kentucky receives grant money to seek out and provide health services to current and former coal miners. There are currently two Black Lung Clinics in our state. 18
  • Office of National Drug Control programs. The High Intensity Drug Trafficking program provides federal funding to address drug trafficking and production in 32 Kentucky counties. 19 The Drug Free Communities Support Program helps prevent and reduce youth substance use/abuse; in 2015, 21 projects in Kentucky received funding through this grant program. 20 In the upcoming budget proposal, the Trump administration is expected to slash funding for the Office of National Drug Control Policy by about 95 percent, eliminating these two federal grant programs, among others. 21
  • Poison Control Center Program. This program provides funding to improve access to quality poison control treatment and prevention services.
  • Environmental Protection Agency (EPA) grants. These funds help provide clean water, pollution control and the safe management of hazardous waste in Kentucky. Currently about a third of the Kentucky environmental protection staff is paid for with federal EPA funds. 22

Assistance to Vulnerable Kentuckians

As a high-poverty state with one of the nation’s fastest growing aging populations, Kentucky has large numbers of people in need of assistance with housing and aging supports. Like other areas of the state budget, these services have experienced cuts in recent years and additional cuts to federal programs that serve our most vulnerable Kentuckians could cause harmful reductions in critical services.

The following federal NDD programs help some of the most vulnerable Kentuckians:

  • Battered Women’s Shelters
  • Developmental Disabilities
  • Enhanced Mobility of Seniors and Individuals with Disabilities
  • Homeless Mental Health
  • Services for Older Blind Individuals
  • Mental Health Block Grant
  • Emergency Food and Shelter Program
  • Public Housing
  • Refugee Assistance
  • Sexual Assault Services
  • Runaway and Homeless Youth
  • Low Income Home Energy Assistance (slated for elimination in President Trump’s “skinny budget”)
  • Community Development Block Grant (can be used to fund Meals on Wheels as well as a wide range of other community development needs, including repairs to a historically African American community center in Mount Sterling) 23
  • Administration on Aging Support Services; Administration on Aging Home Delivered Meals; Administration on Aging Congregate Meals

Workforce and Economic Development

Kentucky also faces serious needs for worker training and job creation. The state’s unemployment rate has improved but is still higher than it was in 2000. The economic challenges are particularly deep in the eastern part of our state. In 62 of the state’s 120 counties the unemployment rate is higher now than in 2007. 24

  • Workforce Innovation and Opportunity Act (WIOA) funds provide employment and training services for adults, dislocated workers and youth through formula grants to states. WIOA also funds adult education and literacy programs and vocational rehabilitation state grant programs that assist those with disabilities in obtaining employment.
  • The Appalachian Regional Commission (ARC) makes important investments in economic opportunities, workforce development, infrastructure, natural and cultural assets, and leadership and community capacity in Kentucky (as well as other states in the region). The “skinny budget” proposed completely eliminating this agency. 25
  • The POWER (Partnerships for Opportunity and Workforce and Economic Revitalization) Initiative has recently provided funding through ARC and a number of other federal agencies and offices to address the economic crisis faced by communities and workers reliant on the coal economy. In 2016, Kentucky received 4 of these grants, totaling around $14.8 million. 26 One of these projects provides training and employment opportunities in Information Technology (IT) careers to young adults who are out of school and older adults who are unemployed, laid-off or underemployed; this workforce development initiative will train 200 new workers, create 160 jobs and bolster sectors that require a skilled IT workforce in 23 eastern Kentucky counties. Another project provides retraining and entrepreneurial assistance to dislocated coal workers, creating 200 new jobs and 100 new enterprises as well as serving 500 existing businesses and bringing $12 million in leveraged financing to a 54-county region in Eastern Kentucky.

The “skinny budget” proposed rolling back funding that benefits coal miners and their communities, which according to a recent policy brief “would stunt economic revitalization where it is needed, and additional cuts to other assistance programs would compound the economic challenges facing coal communities and the families who call them home.” 27

Cultural Enrichment Opportunities

State budget cuts have already limited funding for the state’s libraries and the arts. Additional federal budget cuts in these areas would only worsen the situation.

  • Federal NDD programs include National Endowment for the Arts, National Endowment for the Humanities, the State Library Program and the Historic Preservation Fund.

Upcoming Budget Proposal

President Trump’s previously released “skinny budget” for 2018 proposed cuts to NDD programs — an approximately 15 percent cut in NDD programs outside of Veterans Affairs and Homeland Security — and even the elimination of many programs entirely to offset a $54 billion increase in defense spending. 28 The President’s full budget proposal is expected to be released next week and will likely include funding levels for defense and non-defense programs overall for years beyond 2018. Although some of what was outlined in the “skinny budget” will change, big cuts to NDD funding are expected. Harmful cuts to important mandatory safety net programs are also expected be included in the full proposal, as well as further details on the President’s tax plan, which would give massive tax cuts to the wealthiest Americans.

Click to see a list of discretionary federal grants received by Kentucky in 2015.

 

  1. Paul M. Krawzak, “Trump Wants $800 Billion, 10-Year Cut in Entitlement Programs,” Roll Call, May 15, 2017, http://www.rollcall.com/news/policy/trump-wants-800-billion-10-year-cut-entitlement-programs.
  2. Kentucky Department of Education, “Readiness Results Highlight Need for Quality Early Learning,” News Release, December 7, 2016, http://education.ky.gov/comm/news/Documents/R16-159%20Kindergarten%20Screener_final.pdf. Prichard Committee for Academic Excellence, “Excellence with Equity: It’s Everybody’s Business,” August 2016, http://prichardcommittee.org/wp-content/uploads/2016/08/2016-Achievement-Gap-Study-Group-Report.pdf. High school diploma/GED attainment data is from the Working Poor Families Project.
  3. Ashley Spalding, “Tuition Ceilings Announced,” Kentucky Center for Economic Policy, March 31, 2017, http://kypolicy.org/tuition-increase-ceilings-announced/.
  4. Diane Whitmore Schanzenbach and Lauren Bauer, “The Long-Term Impact of the Head Start Program,” The Brookings Institution, August 19, 2016, https://www.brookings.edu/research/the-long-term-impact-of-the-head-start-program/.
  5. Kentucky Center for Education and Workforce Statistics, “New Report Shows Benefits of Kentuckians Earning GED Diplomas,” News Release, September 19, 2016, https://kcews.ky.gov/Content/News/New%20report%20shows%20benefits%20of%20Kentuckians%20earning%20GED%20diplomas.pdf.
  6. Judith Scott-Clayton and Veronica Mina, “Should Student Employment Be Subsidized? Conditional Counterfactuals and the Outcomes of Work-Study Participation,” National Bureau of Economic Research, July 2014, https://www.insidehighered.com/sites/default/server_files/files/NBER-workstudy.pdf.
  7. Greg Anrig, “Lessons From School Improvement Grants That Worked,” The Century Foundation, July 23, 2015, https://tcf.org/assets/downloads/Anrig_LessonsFromSchoolImprovementGrants.pdf.
  8. Kentucky Department of Education, “School Improvement Grants (SIG),” http://education.ky.gov/federal/progs/sigi/Pages/default.aspx.
  9. Mike Marsee, “Making Coding More Friendly,” Kentucky 21st Century Community Learning Centers, September 9, 2016, http://ky21cclc.org/.
  10. Deborah Yetter, “Feds Rip Kentucky Child Protection System,” Courier-Journal, February 23, 2017, http://www.courier-journal.com/story/news/politics/2017/02/23/feds-rip-kentucky-child-protection-system/98306250/. John Cheves, “Child Abuse and Neglect up 55 Percent in Kentucky Since 2012,” Lexington Herald-Leader, February 3, 2017, http://www.kentucky.com/news/politics-government/article130535059.html.
  11. Karen Schulman and Helen Blank, “Red Light Green Light: State Child Care Assistance Policies 2016,” National Women’s Law Center, https://nwlc.org/wp-content/uploads/2016/10/NWLC-State-Child-Care-Assistance-Policies-2016-final.pdf.
  12. Administration for Children and Families, “Stephanie Tubbs Jones Child Welfare Services: 2016 Planned Use of Funding by State and Service Category,” https://www.acf.hhs.gov/sites/default/files/cb/cfs101_report_congress_2016_attach_c.pdf.
  13. Louisville Metro Health Start, “Healthy Start,” https://louisvilleky.gov/government/health-wellness/healthy-start.
  14. Kentucky Center for Education and Workforce Statistics, “2017 Early Childhood Profile,” https://kcews.ky.gov/Content/Reports/ECP/ECP_2017_FullReport.pdf.
  15. Kaiser Family Foundation, “Health Status,” State Health Facts, http://kff.org/state-category/health-status/. State Health Access Data Assistance Center, “Final Report: Study of the Impact of the ACA Implementation in Kentucky,” February 2017, https://www.healthy-ky.org/res/images/resources/Impact-of-the-ACA-in-KY_FINAL-Report.pdf.
  16. Centers for Disease Control and Prevention, “Drug Overdose Death Data,” https://www.cdc.gov/drugoverdose/data/statedeaths.html.
  17. James Bruggers, “Kentucky Braces for Big Trump EPA Cuts,” Courier-Journal, March 3, 2017, http://www.courier-journal.com/story/tech/science/environment/2017/03/03/kentucky-braces-big-trump-epa-cuts/98650188/.
  18. Health Resources and Services Administration, “Active Grants for HRSA Program(s): Black Lung/Coal Miner Clinics Program,” 2016, https://ersrs.hrsa.gov/ReportServer/Pages/ReportViewer.aspx?/HGDW_Reports/FindGrants/GRANT_FIND&ACTIVITY=H37&rs:Format=HTML4.0.
  19. National HIDTA Assistance Center, “HIDTA Counties by State,” http://www.nhac.org/news/HIDTA_Counties.htm.
  20. Substance Abuse and Mental Health Services Administration, “SAMHSA – Fiscal Year 2015 Discretionary Funds,” https://www.samhsa.gov/grants-awards-by-state/details/Kentucky.
  21. Alan Rappeport, “White House Proposes Cutting Drug Control Office Funding by 95%,” The New York Times, May 5, 2017, https://www.nytimes.com/2017/05/05/us/politics/white-house-proposes-cutting-drug-control-office-funding-by-95.html.
  22. James Bruggers, “Kentucky Braces for Big Trump EPA Cuts,” Courier-Journal, March 3, 2017, http://www.courier-journal.com/story/tech/science/environment/2017/03/03/kentucky-braces-big-trump-epa-cuts/98650188/.
  23.  Jose A. DelReal, “Trump Asked African Americans What They Had to Lose. For This Rural Kentucky Community, the Answer Is Tangible,” The Washington Post, April 7, 2017, https://www.washingtonpost.com/national/trump-asked-african-americans-what-they-had-to-lose-for-this-rural-kentucky-community-the-answer-is-tangible/2017/04/06/0bf500fe-1a61-11e7-bcc2-7d1a0973e7b2_story.html.
  24. Anna Baumann and Jason Bailey, “The State of Working Kentucky 2016,” Kentucky Center for Economic Policy, August 2016, http://kypolicy.org/dash/wp-content/uploads/2016/08/State-of-Working-KY-FINAL.pdf.
  25. Renee’ Marcum-Losey, “Trump Budget Beats Up on Appalachia,” Courier-Journal, March 17, 2017, http://www.courier-journal.com/story/opinion/contributors/2017/03/17/trump-budget-beats-up-appalachia-losey/99297824/.
  26. The White House, “Fact Sheet: Administration Announces New Economic and Workforce Development Resources for Coal Communities through POWER Initiative,” August 24, 2016, https://www.arc.gov/images/grantsandfunding/POWER2016/POWER2016_Awards_WHFactSheet_8-24-2016.pdf.
  27. Ashley Spalding, “Important Federal Investments in Kentucky’s Coal Communities at Risk,” Kentucky Center for Economic Policy, April 28, 2017, http://kypolicy.org/important-federal-investments-kentuckys-coal-communities-risk/. Luke Bassett and Jason Walsh, “The Trump Budget Cuts Hit Coal Communities and Workers Where It Hurts,” Center for American Progress, April 24, 2017, https://www.americanprogress.org/issues/green/reports/2017/04/24/430842/trump-budget-cuts-hit-coal-communities-workers-hurts/.
  28. Jason Bailey, “Trump Budget Eliminations Would Be Major Hit to Kentucky,” Kentucky Center for Economic Policy, March 21, 2017, http://kypolicy.org/trump-budget-eliminations-major-hit-kentucky/.

What Good Tax Reform Looks Like

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Though the details remain unknown, Governor Bevin has described the kind of tax reform he’ll introduce in a special session this year as shifting Kentucky toward a “consumption-based” tax system, or from income to sales taxes. As shown in multiple other states that have enacted such a shift, this approach would give more tax breaks to the wealthiest Kentuckians and leave the state with less revenue over time to invest in our commonwealth. 1 In contrast, HB 263, filed in Kentucky’s 2017 General Assembly by Rep. Jim Wayne with 12 co-sponsors, is an example of comprehensive tax reform that would address inequities in our tax system and strengthen our ability to make the investments that build thriving communities. 2

The bill draws from the best elements of Kentucky’s 2012 Blue Ribbon Commission on Tax Reform along with other needed changes to make the state’s tax system more adequate, fair and reliable. According to the Legislative Research Commission’s fiscal note, HB 263 would raise $579 million annually at full implementation. 3 It would clean up tax breaks for powerful interests and help address the upside-down nature of Kentucky’s tax system, which asks the least of those with the most as a share of income. It would also result in revenue better keeping up with growth in the economy, improving Kentucky’s ability to sustain investments in our schools, health, infrastructure and more while paying down our liabilities.

HB 263 Cleans Up Expensive, Extensive Tax Breaks

Shifting from income taxes to greater reliance on sales taxes would be a huge tax cut for the wealthy; and Kentucky already spends billions of dollars on income tax breaks that primarily benefit those with the greatest ability to pay taxes. 4 Reducing those breaks, as HB 263 proposes, would generate more revenue for the investments that benefit all Kentuckians. Related to the individual income tax, the bill would:

  • Cap itemized deductions at $17,500 and index the amount to inflation, raising $200 million annually. High-income filers typically have more deductions and therefore benefit disproportionally from this tax expenditure. The majority of Kentucky’s neighbors allow little or no income tax deductions.
  • Phase out the pension income exclusion over $35,000, generating $220 million a year and helping ensure wealthy retirees don’t receive a large income tax break. Kentucky’s current exclusion is more generous than what the vast majority of states provide, and it will cause an increasingly large hole in the budget as baby boomers retire in the coming years. 5
  • Create a new higher top tax rate and reduce rates for brackets under $75,000. Though this particular measure would cost $110 million a year, it would make our tax system less upside-down overall by asking more of those with greatest ability to pay (at the very top of our income distribution) and less of low to middle-income families.

The bill would raise $25 million by reinstating the estate tax on wealthy Kentuckians as it existed before federal tax changes in 2003 eliminated it. 6 Only very few, very wealthy estates pay the tax.

At the corporate level, HB 263 would:

  • Lower the income threshold for the limited liability entity (LLE) tax from $3 million to $1 million and phase it in to $2 million instead of $6 million, generating $13 million in revenue a year. The threshold is currently so high that 82 percent of LLEs don’t even pay the tax (paying the $175 minimum instead), even though some are subsidiaries of large corporations.
  • Tighten loopholes that allow profitable corporations to avoid taxation by enacting a “throwback rule” on income from goods produced in Kentucky not taxed elsewhere; and by requiring corporations to report on their tax returns profits from all related subsidiaries, including in offshore tax havens. To address tax dodging, the majority of corporate-income taxing states require that method, called combined reporting. These measures would generate $66 million a year. 7
  • Trim $9 million from what we spend on ineffective corporate incentives to the film industry and businesses with production activity in the U.S. (the latter incentive does not require that production take place in Kentucky). 8 The bill would also create a review and sunset process for all “economic development tax incentives,” ensuring greater scrutiny of the cost-effectiveness of what we spend on businesses through the tax code. 9

Ending these individual and corporate income tax breaks would help address the core problem with Kentucky’s tax system: revenue growth is not keeping up with the economy, making it impossible to sustain investments over time. Because consumption does not grow as quickly as income in our economy – and because such a large share of the gains from economic growth are going to those at the very top – shifting from income taxes to sales taxes (from the wealthy to everyone else) would worsen this flaw.

Other elements in HB 236 would also help restore the relationship between our economy and revenue system by:

  • Expanding the sales tax base to include a number of luxury services. Despite operating in a service economy, Kentucky’s sales tax base includes very few services. Adding more, and starting with luxury services such as golf course and country club fees, landscaping and armored car services, would raise $104 million a year.
  • Freezing the property tax rate at 12.2 cents. Since 1979, Kentucky’s real property tax rate has fallen from 31.5 cents to 12.2 cents as a result of a cap on revenue growth that was enacted by the legislature. That cap (a less strict version of which also exists at the local level) has made Kentucky’s property taxes among the lowest in the country. Freezing the rate and letting state property tax revenues rise with property values will compensate for times when property values grow slowly, such as the years after the Great Recession.

Additionally, the bill would help offset the high public cost of tobacco use by increasing taxes on cigarettes and other tobacco products, including e-cigarettes. Though tobacco taxes are not a reliable revenue source over time, this measure would generate $155 million initially and would provide important benefits by serving as a disincentive to tobacco use.

HB 263 Would Make Kentucky’s Taxes Less Upside-Down

Because Kentucky’s income taxes are mostly progressive and sales taxes are regressive, an income-to-sales tax shift would worsen the imbalance in Kentucky’s existing tax system (see below). In other words, such a shift would make our system even more upside-down than it already is, asking less of the wealthiest Kentuckians and more of lower income families.

Source: Institute on Taxation and Economic Policy.

In contrast, HB 263 would ask more of those at the top and less of low- and middle-income people who currently pay a larger share of their income in taxes. To further help with inequities, the bill would create a state level Earned Income Tax Credit (EITC) – an effective poverty-fighting tool that supports work and helps families afford basic living expenses, pay off debt and invest in education. At 15 percent of the federal EITC, this refundable credit would cost $115 million a year. 10

Combining the distributional impact of HB 263’s individual income tax changes including the EITC; the expansion of the sales tax base to luxury services; and gas tax, cigarette and “other tobacco products” tax increases shows that HB 263 would make our tax system less upside-down overall even as it generates more revenue for investments that benefit all Kentuckians.

Source: Institute on Taxation and Economic Policy (ITEP).

As legislators consider what kind of tax changes deserve to be called “tax reform,” and what kind of tax reform warrants a special session, HB 263 provides a good example of the kind of sound approach that is needed: one that cleans up tax breaks and generates revenue for stronger investments in our commonwealth. It also provides a clear benchmark against which harmful tax-shift proposals should be measured.

 

  1. Nic Albares, “Moving from Budget Cuts to State Investments: A Blueprint for a Stronger Louisiana,” Louisiana Budget Project, February 22, 2017, http://www.labudget.org/lbp/wp-content/uploads/2017/02/Blueprint-for-a-stronger-Louisiana.pdf. Anna Baumann, “Kentucky Should Not Follow Kansas Down the Income Tax Cutting Road,” Kentucky Center for Economic Policy, November 28, 2016, http://kypolicy.org/kentucky-not-follow-kansas-income-tax-cutting-road/. Tazra Mitchell and Cedric Johnson, “2017 Fiscal Year Budget Falls Short of Being A Visionary Plan for North Carolina’s Economic Future,” North Carolina Budget and Tax Center, July 2016, http://www.ncjustice.org/sites/default/files/BTC%20Reports%20-%20FINAL%20BUDGET.PDF. Zach Schiller, “The Great Ohio Tax Shift,” Policy Matters Ohio, August 18, 2014, http://www.policymattersohio.org/tax-shift-aug2014.
  2.  HB 263, “An Act Relation To Taxation,” Kentucky General Assembly, 2017, http://www.lrc.ky.gov/record/17RS/HB263.htm.
  3. Legislative Research Commission, “Commonwealth of Kentucky State Fiscal Note Statement,” 2017 Regular Session, http://www.lrc.ky.gov/recorddocuments/note/17RS/HB263/FN.pdf.
  4. Anna Baumann, “Revenue Options that Strengthen the Commonwealth,” Kentucky Center for Economic Policy, February 2, 2016, http://kypolicy.org/new-report-kentucky-can-take-balanced-approach-to-budget-with-revenue-options/.
  5.  Jason Bailey, “Retirement Income Growing Much Faster than Wages, Spelling Trouble for State Revenues,” Kentucky Center for Economic Policy, July 14, 2015, http://kypolicy.org/retirement-income-growing-much-faster-than-wages-spelling-trouble-for-state-revenues/.
  6. Anna Baumann, “Reinstating Kentucky’s Tax on Extreme Wealth a Part of Making State Taxes Fair and Adequate,” Kentucky Center for Economic Policy, September 24, 2015, http://kypolicy.org/reinstating-kentuckys-tax-on-extreme-wealth-a-part-of-making-state-taxes-fair-and-adequate-2/.
  7.  Jason Bailey, “Closing Corporate Tax Loopholes to Fund Investments in Kentucky Families,” Kentucky Center for Economic Policy, February 10, 2015, http://kypolicy.org/closing-corporate-tax-loopholes-fund-investments-kentucky-families/.
  8. Anna Baumann, “Expanding Kentucky’s Film Tax Credits Not a Strategy that Will Pay Off,” Kentucky Center for Economic Policy, February 10, 2015, http://kypolicy.org/expanding-kentuckys-film-tax-credits-strategy-will-pay/.
  9.  Jason Bailey, “Report’s Findings Suggest Kentucky’s Business Tax Incentives Not Very Cost-Effective Way to Create Jobs,” Kentucky Center for Economic Policy, July 19, 2012, http://kypolicy.org/reports-findings-suggest-kentuckys-business-tax-incentives-cost-effective-way-create-jobs/.
  10. Ashley Spalding, “State EITC Would Help Working Kentuckians Afford Necessities,” Kentucky Center for Economic Policy, February 5, 2014, http://kypolicy.org/state-eitc-help-working-kentuckians-afford-necessities/.

The Impact of the 2017 General Assembly on the Kentucky State Budget

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The just concluded 2017 legislative session was not a budget session. However, the General Assembly passed a number of bills that will have an impact on state finances including the current budget as well as future budgets and revenues.

The most significant legislation affecting the budget is discussed below. Various measures that passed will add to growing costs in the criminal justice system, expand or extend special tax breaks and subsidies for businesses, spend additional money, clarify how funding in the budget would be spent and create new expenses moving forward.

Criminal Justice Penalties Stiffened, Reentry Improved

The General Assembly enacted several criminal justice bills that increase penalties, establish new crimes or restrict the availability of probation and parole. The General Assembly also passed SB120, which originated with the Criminal Justice Policy Assessment Council (CJPAC), and which includes provisions to help ease the transition back into the community after incarceration. Although Senate Bill 120 should have a positive impact, collectively the passage of these bills will have a significant negative fiscal impact on an already overcrowded and underfunded criminal justice system.

HeroinHB 333, which enhances penalties for trafficking in heroin or fentanyl in small amounts, will have the most significant negative fiscal impact on the criminal justice system.  Due to the very broad definition of trafficking included in the bill, an addict sharing drugs with another addict (with no exchange of money) could be charged with trafficking.  As a result, there will likely be more criminal charges, which will increase the burden on our court system, including prosecutors and public defenders. The correctional impact statement for a similar bill filed earlier in the session estimated the increase in correctional costs to be $30-$35 million.

Other New or Enhanced Criminal Penalties – There were other new penalties or penalty enhancements passed by the General Assembly that individually are expected to have a minimal impact, but could have a significant collective cost.

  • HB 14, known as the “Blue Lives Matter” bill, includes peace officers and first responders in the hate crime statute, which could result in longer sentences, unavailability of community supervision or denial of probation, shock probation or conditional discharge.
  • HB 38 adds public playgrounds to the locations where a registered sex offender cannot be without written permission. Violation of this provision is a Class A misdemeanor for the first offense, and a Class D felony for 2nd and subsequent offenses.
  • HB 93, relating to assault of a service animal, removes the requirement the service animal be unable to return to work from the elements of enhanced sentencing, and adds levels of injury and criminal intent to the elements of the offense. Removing the requirement that the injury be so severe that the animal cannot return to work could result in additional convictions under the statute, which are Class D felonies.
  • HB 222 prohibits shock probation in cases of conviction of a driving under the influence (DUI) charge in combination with Manslaughter 2nd degree, Reckless Homicide and Fetal Homicide 3rd or 4th Degree. Those committing these crimes will therefore spend more time incarcerated than they would under the current law.
  • HB 329 enhances criminal penalties for securities fraud. There was no corrections impact statement prepared for this legislation so the impact is unknown.
  • HB 540, relating to drones, establishes penalties for anyone who operates or allows an unmanned aircraft to operate in a manner that allows entry into prohibited areas, or in a reckless manner, which may create a risk of serious physical injury or property damage. A person engaging in such behavior could be guilty of a Class A misdemeanor or Class D felony.

Tax Breaks Expanded

Although the General Assembly did not enact any new expensive tax preferences or tax expenditures, they did pass legislation extending, expanding or broadening some existing tax breaks for specific projects

  • Louisville Arena TIF Amendments – Estimated revenues from taxes collected within the tax increment financing (TIF) zone established to help pay for the bonds issued to build the Louisville Arena have not materialized as projected. Because of this, the Louisville Arena Authority anticipates that it will not be able meet its debt obligations for the arena in the near future absent statutory changes that would extend the life of the TIF, allowing debt to be refinanced over a longer term. To assist in addressing this issue, HB 330 extends the period for which a pilot TIF may exist from 20 years to 45 years upon the issuance of a new bond by the Kentucky Economic Development Finance Authority, subject to specified conditions. (Note that these provisions will also apply to the Renaissance Zone TIF, located near the Louisville airport, should it meet the requirements for an extension). Although the passage of this legislation does not have a direct fiscal impact the Commonwealth, it is included here because even though the Commonwealth is not legally obligated to financially support the Louisville Arena, default on that debt would likely negatively impact future debt issued by the Commonwealth.
  • TIF Expansion HB 388 continues the trend established in previous sessions by expanding the TIF statutes to accommodate a project in Western Kentucky that did not meet the statutory requirements to qualify for state TIF participation. HB 388 also generally expands the mix of uses that can qualify a project as a mixed-use TIF.  With regard to the Western Kentucky project, the statute is amended to include: “a mixed-use development that includes a tract of previously undeveloped land that was owned by a liberal arts educational institution within four (4) years prior to the effective date of this Act  and the previously undeveloped land is bounded on one (1) side by a four (4)  lane United States highway on the effective date of this Act”. Because this definition is very specific, it is unlikely that any new project other than the one for which the changes were made will qualify as a TIF due to this change.  The other amendment included in the bill applies a more liberal definition of what qualifies as a “mixed-use” project. This amendment will have a more significant impact as many new projects could qualify under the revised standard.
  • Fuel Sales Tax Credit – To support an economic development package offered to Amazon to locate a facility in Northern Kentucky, HB 368 expands an existing sales tax credit on the purchase of fuel for certificated air carriers to include entities that contract with those carriers but independently purchase the fuel. The estimated fiscal impact is a loss of $3 million per year that would otherwise be deposited in the Kentucky Aviation Economic Development fund, which is used to support airports in Kentucky.

Budget Reopened and New Dollars Spent or Authorized

Several bills were enacted that direct or redirect spending of resources that differ from expenditures authorized by the 2016-18 budget or statutory language.

  • Funds for an Unnamed Economic Development Project – In the last hours of the last day of the 2017 session, HB 482, which was “AN ACT relating to law enforcement training”, was stripped of its original language and revised to amend the 2016-2018 biennial budget. The revised language appropriates supplemental funds to the Cabinet for Economic Development “for the sole purpose of facilitating a private sector investment of not less than $1,000,000,000 in one or more locations in the Commonwealth.” The funding is provided through the issuance of a new $15 million bond for the Kentucky Economic Development Finance Authority Loan Pool, supported by an appropriation of $641,000 for debt service, or at the discretion of KEDFA, the use of $15 million in cash from the General Fund Surplus Account or the Budget Reserve Trust Fund. The authorization expires on June 30, 2018 if the private sector investment has not commenced prior to that date. Explanations provided during discussion on the House floor revealed that the project is located in Eastern Kentucky.
  • Education and Workforce Development Cabinet Office of Employment and TrainingHB 482 also directs that up to $3,500,000 of proceeds from the sale of any state–owned real property operated by the Office of Employment and Training shall be deposited in the Office of Employment Training Building Proceeds Fund, which is established in the bill, to support workforce operations. Any balance at the end of the current fiscal year are carried forward to the 2017-18 fiscal year, with any amount remaining at the close of that fiscal year to lapse to the General Fund. This is, in effect, a supplemental appropriation to the Education and Workforce Development Cabinet of funds that otherwise would be deposited in the General Fund.
  • Department of Juvenile Justice Building SaleSB 173 allows the Department of Juvenile Justice to use proceeds from the sale of facilities in Owensboro to service debt relating to Guaranteed Energy Savings Performance Contract loans, with the remainder to be used for a grant program operated by the department to encourage the development of community alternatives. This legislation will result in overall cost savings to the department by reducing future debt payments; however it diverts funds that would otherwise be deposited in the General Fund for another purpose.
  • Bowling Green Veteran’s CenterHB 13 authorizes $10,500,000 in bond funds in FY 2016-17 to provide state matching funds for the Bowling Green Veteran’s Center so the project can be submitted to the United States Department of Veteran’s Affairs. The funding authorization is necessary for the project to be placed on a waiting list to receive federal funds. Debt service funding is provided from amounts already appropriated to the Finance and Administration Cabinet not needed to satisfy existing debt service obligations. The fiscal note on the bill indicates that the debt service would be $897,000 per year assuming a 5.5% interest rate and a 20 year payment on newly issued bonds. It is highly unlikely that this project will move quickly enough that the debt will be issued during the current biennium
  • Capital Plaza and Renovation to State Occupied BuildingsSB 238 allows the use of up to $600,000 in agency funds without additional approval of the General Assembly to renovate or retrofit a leased building that will eventually be owned by the state. This language addresses needs at a new building occupied by several state agencies, known as the “300 building,” that is a public/private partnership for which the lease cannot be modified. Any renovations or modifications undertaken as described above must be reported to the Capital Projects and Bond Oversight Committee.

SB 238 also authorizes the Finance Cabinet to enter into a public-private partnership, build to suit, or lease purchase for the renewal of the Capital Plaza, noting that the upkeep and maintenance of the Capital Plaza as it is could be up to $800,000 per year.  As such, this language does not have an immediate fiscal impact. However the language will allow the Finance Cabinet to move forward in issuing a RFP for the capital plaza in a public-private format structure that could impact future expenditures.

Bills Create Structure for Funding Provided in Budget

Three bills were enacted that establish a structure for the continuation of programs and funding provided in the 2016-2018 budget.  Those programs are as follows:

  • Performance Funding for Higher Education – The 2016-2018 budget bill transferred $42.9 million from the public university operating budgets to a newly created Postsecondary Education Performance Fund. The amount transferred to the fund is 5% of the fiscal year 2017-18 General Fund appropriations for public universities, including the Kentucky Community and Technical College System but excluding Kentucky State University. The 2016-18 budget provides that the amounts in the fund “will be distributed to postsecondary institutions, excluding Kentucky State, based on achievement of performance goals and metrics enacted by the General Assembly as recommended by the Postsecondary Education Working Group.” SB 153 establishes this fund in statute, and sets forth the framework recommended by the Postsecondary Education Working Group to distribute the funds in 2017-18 and future years.
  • Dual Credit Scholarship Program – The 2016-18 budget provides $5 million in 2016-17 and $10 million in 2017-18 to support a dual credit scholarship program for high school juniors and seniors. Legislation was enacted by the General Assembly in 2016 establishing the dual credit scholarship program, but that bill was vetoed by Governor Bevin after adjournment of the General Assembly. HB 206 represents the General Assembly’s second attempt to establish the parameters for the program. HB 206 does not include the appropriation of a specific sum to support the program, so continuation of the program in the future will depend on additional appropriations by the General Assembly. HB 206 also allows KEES (college scholarship) funds to be used for costs associated with participation in apprenticeship programs. This expansion will result in more students using their KEES funds, which will increase the amount needed to fully fund KEES scholarships in future years.
  • Additional Coal Severance Funds For Coal Counties – The General Assembly established the “Kentucky Coal Fields Endowment Fund” in the 2016-2018 budget bill, and appropriated $7.5 million from General Fund coal severance revenues in each year to the fund. In the budget bill, the Department for Local Government was to administer the fund, and amounts in the fund were to be used to diversify the economy of the coal regions of Kentucky. HB 156 creates the fund in permanent statutory language for the same purposes; appropriates $7.5 million annually from the General Fund portion of coal severance tax receipts to the fund; and establishes a board to oversee the expenditure of funds. There is no immediate fiscal impact from the passage of this bill as funds have already been appropriated for the 2016-18 biennium, but the bill will impact General Fund revenues in future years. HB 156 also establishes the Kentucky Mountain Regional Recreation Authority (KMRAA) ”to establish, maintain, and promote a recreational trail system throughout the Kentucky Mountain Region Area to increase economic development, tourism, and outdoor recreation.”  The KMRAA replaces the Kentucky Recreational Trails Authority.  The KMRAA s authorized to hire an executive director, which will cost an estimated $125,000 per year until the KMRAA is self-sustaining.

Other Legislation Amends the Current Budget

HB 471 makes several amendments to the 2016-2018 Budget, including the following:

  • Teacher’s Retirement System – Amended language allows the payment of a dependent subsidy for participants under the age of 65 from July 1, 2017 through June 30, 2018 similar to the dependent subsidy that Executive Branch agencies pay for their active employees who have similar coverage. The language requires reporting on the impact to the Appropriations & Revenue Committee if the KTRS Board of Trustees elects to provide the subsidy for the 2018 plan year.
  • Additional Transportation Funding For Schools – Language regarding the use of excess SEEK funds is amended to require the funds to be used for pupil transportation under the SEEK formula, rather than transferred to KTRS to address the unfunded pension liability.
  • Charter School Funding – Budget language addressing SEEK program funding is amended to include funding for Charter Schools. We have expressed our concern about charter school funding previously and those concerns remain. It is highly unlikely that the funding formula established in HB 471 will actually be the one used to fund charter schools because the language will expire before everything necessary for a charter school application to be submitted and reviewed can occur.
  • Use of Local District Capital Funds By Local School Districts – The 2016-2018 budget bill as originally enacted permitted local school districts to apply to the Commissioner of Education to use capital funds for general operating expenses during the 2016-2017 school year only. The practice of allowing this diversion of funds through budget language began during the recession as one way to help school districts meet continuing and ongoing expenses. The budget language was amended to allow the practice to continue for 2017-2018, however the amount approved cannot exceed 50 percent of a local boards’ trailing three-year average.
  • Volkswagen Mitigation Trust Agreement – Language is added to the budget to prevent the expenditure of any funds received from the environmental mitigation trust established by Volkswagen without express authority of the General Assembly.
  • University of Kentucky Lease Authorization – Language is added to authorize the lease of a building for a satellite medical facility for the University of Kentucky in Warren County.

Other Measures Will Have a Fiscal Impact

  • Tim’s Law – After several unsuccessful attempts in prior sessions, “Tim’s Law”, allowing court-ordered outpatient treatment for individuals meeting the statutory requirements, was passed during the 2017 session of the General Assembly, notwithstanding the Governor’s veto of the measure. SB 91, the implementation of which is “contingent upon adequate funding,” will cause increased workloads for prosecutors, public defenders, the courts and mental health providers in the state, and will therefore require additional resources or will require the already overburdened and underfunded agencies involved in implementation to stretch their insufficient resources even further. It is possible that one or more of the agencies required to participate in the process could refuse to do so without additional funding, since implementation is specifically contingent of adequate funding being available.
  • REAL IDHB 410 changes the method for issuance of instruction permits, operator’s licenses and personal identification cards from a decentralized system using 142 circuit clerk locations to a centralized system operated by Transportation Cabinet. Circuit clerk offices will still accept applications, but the issuance of all documents will be from a central location. The measure increases fees and lengthens the renewal period from four to eight years after a transition period. Applicants will have the option of obtaining a voluntary travel ID document that complies with the requirements of the federal REAL ID Act of 2005, or a standard document that does not meet the requirements. This legislation increases both expenditures and revenues, with a net positive fiscal impact, although the impacts will be delayed as implementation is not expected until 2019 or 2020 according to the fiscal note accompanying the bill. Additional revenues in the first five years are expected to be $11.4 million, with additional expenses of between $1.95 and $1.69 million for net positive revenue of $9.45 to $9.71 million annually. Both revenues and expenses are projected to decrease after the 5th Proceeds from the fees are distributed to several accounts with the majority going to the Road Fund.
  • Claims Commission HB 453 establishes the Kentucky Claims Commission and confirms an executive order. This legislation transfers the duties and responsibilities previously fulfilled by the Board of Tax Appeals and the Crime Victims Compensation Board to the Claims Commission.  The legislation also amends various provisions that will impact the finances of the Commonwealth or expenses of the commission, including:
    • An increase in the award cap from $200,000 to $250,000,or from $350,000 to $400,000 for multiple claims, which could result in larger awards;
    • An increase in the filing limit from $100 to $250, which could result in fewer filings,
    • Allowing claims under $2,500 rather than those under $1,000 to be handled internally rather than using a hearing officer, which should reduce expenses for the commission; and
    • Decreasing the date by which claims must be filed from 5 years to 2 years, which could result in a decrease in the number of claims.

Taxing Groceries in Kentucky Would Hurt Low-Income Families, Weaken Revenue Growth

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Governor Bevin has said he will propose tax reform in a special session this year that will move Kentucky toward a “consumption-based” tax system – in other words shifting from income taxes to greater reliance on sales taxes. One of the options for doing so would be to expand the state’s sales tax base to include groceries. But a tax shift package that includes groceries would make Kentucky’s tax system more upside-down – asking more of those with less – and would further reduce our lagging rate of revenue growth, putting needed investments in our communities at even greater risk.

Repeal of Grocery Exemption Would Ask More of Low-to-Middle Income Families

Since 1972, Kentucky has exempted food purchased for home consumption from the sales tax at an estimated cost of $700 million in fiscal year 2017. 1 Food purchased in restaurants and “to-go” and “take-out” items are taxed.

Reapplying the sales tax to groceries would be highly regressive, meaning it would cost people with low incomes a much larger share of their income than wealthier people. That’s the case for two reasons. First, sales taxes themselves are regressive. In Kentucky, the poorest 20 percent pay 5.5 percent of their income in sales and excise taxes, while the richest 1 percent pay only 0.8 percent. 2 The reason for this disparity is that people with less income, out of necessity, typically spend most or all of their income to make ends meet. Those with higher incomes are able to save a portion of their earnings – and those savings are not subject to sales taxes.

The second problem is that grocery taxes themselves are an especially regressive form of sales taxes. Rich or poor, everyone has to eat. Compared to other goods, there’s less a family can do – buying lower-priced items and less quantity – to cut grocery costs. Therefore, low-income families must devote a larger share of spending than those with higher incomes to meet this most basic need. Data from the Bureau of Labor Statistics’ annual Consumer Expenditure Survey show that food purchases for home consumption are a much larger share of total expenditures for the lowest income quintile than the top quintile (as shown in the graph below). 3 Also, it is notable that families in the lower income range spend a larger share of their total food budget on food to eat at home, while higher income households spend a larger share on eating meals out. 4

Source: Bureau of Labor Statistics.

Lower-income families therefore receive the most benefit from the exemption for groceries. Repealing it would disproportionately increase the share of income they pay in taxes, making Kentucky’s tax system more regressive than it already is. 5 The chart below from the Institute on Taxation and Economic Policy (ITEP), illustrating the estimated distributional impact of including groceries in the Kentucky sales tax base, shows that families in the bottom 20 percent would see their taxes increase as a share of income by 10 times more than families in the top 1 percent. 6

Source: Institute on Taxation and Economic Policy (ITEP).

ITEP’s distributional analysis accounts for the fact that if groceries are taxed, some purchases made by low-income families through SNAP (formerly known as food stamps) would continue to be tax-free, as required by federal law. The impact on low-income families remains large however, for a couple of reasons. To begin with, not all low-income people are eligible for SNAP and some who are eligible do not claim it. For those who do, benefits are based on a formula that still expects people to contribute a significant portion of their income to food purchases – and those purchases outside of SNAP would become taxable under a repeal of the grocery exemption. 7 SNAP benefits are not intended to fully cover a family’s basic diet, providing only about $1.40 per person, per meal. The tax increase for families in the bottom quintile from putting the sales tax back on groceries equals $118 a year on average. 8

Low- to middle-income families’ purchasing power is already being squeezed. Real wages for Kentucky workers in the bottom 30 percent are below where they were 15 years ago and wages at the median have grown by less than 1 percent. 9 Meanwhile, income at the top has soared. Tax changes that ask more of those for whom the economy is stagnant – such as an expansion of sales taxes to groceries – exacerbate this inequality. For families in the second lowest income quintile, a grocery tax would increase what they pay by $197 on average every year. For families in the middle-income quintile, they would pay $271 more.

It should also be noted that if a grocery tax were part of a tax package that decreases income taxes, the extent to which it would deepen disparities in Kentucky’s tax system is even worse than indicated above. Currently in Kentucky, the poorest 20 percent pay 1.2 percent of their incomes in personal income taxes while the richest 1 percent pay 5 percent. 10 A plan that taxes groceries in order to pay for a cut in income tax rates would be a massive redistribution of dollars from low- and middle-income Kentuckians to those at the top.

Combined with Income Tax Cuts, Repeal Would Worsen Kentucky’s Revenue Problems

Adding groceries to the sales tax base would also worsen the extent to which Kentucky’s revenue keeps up with growth in the economy. The reason groceries weaken the rate of revenue growth is that they have been declining as a share of household expenditures for decades. Food costs have declined dramatically relative to the cost of other goods, families eat out more than they used to and other purchases associated with a service-oriented economy make up a larger share of consumption. Between 1960 and 2016, food purchased for off-premises consumption has fallen from 18.9 percent of what Americans buy to only 7.2 percent. 11 Since grocery consumption is a shrinking part of the economy, expanding the sales tax base to include it would lower the overall rate of sales tax revenue growth. Especially if a grocery tax is enacted along with a reduction in much faster-growing income taxes, such a plan would worsen Kentucky’s ability to maintain public investments over the long term. 12

Additionally, if Kentucky were to repeal the grocery exemption, shopping patterns in border communities could be impacted. While research does not support the claim that significant numbers of people  relocate their entire lives to follow lower state income tax rates, it supports the concern that people who live in border areas – for instance in the greater Louisville and Cincinnati regions – would buy groceries across state lines. 13 Among our neighbors, Indiana, Ohio and West Virginia exempt groceries from sales taxes, with the rest taxing them at a lower rate than the general sales tax: Illinois at 1 percent; Missouri at 1.225 percent; Tennessee at 5 percent; and Virginia at 2.5 percent. 14  Changes in shopping patterns could reduce the anticipated state revenue from grocery sales taxes, as well as jobs in Kentucky and state and local revenue derived from Kentucky merchants’ income.

Kentucky Should Maintain Its Grocery Exemption

Of the 45 states that levy a sales tax, 31 exempt groceries from the base. For all the reasons this brief describes, the recent trend in state legislatures has been to reduce, rather than increase the sales tax on groceries. In our region alone over the last 20 years, Georgia, Louisiana, North Carolina, South Carolina and West Virginia have all exempted groceries from the sales tax; while Virginia, Tennessee and Arkansas have reduced their sales tax rates on groceries to below the general sales tax rate. 15

Taxing groceries won’t address the core problem with Kentucky’s tax system – that the revenue we have to invest in our communities is eroding relative to our economy. And the revenue a grocery tax would raise disproportionally impacts low-income families. Getting rid of special interest tax breaks for powerful interests and those with greater ability to pay is a better solution for Kentucky’s inadequate and upside-down tax system.

 

  1. Governor’s Office for Economic Analysis, “Commonwealth of Kentucky Tax Expenditure Analysis: Fiscal Years 2016-2018,” Office of the State Budget Director, http://osbd.ky.gov/Publications/Documents/Special%20Reports/Tax%20Expenditure%20Analysis%20Fiscal%20Years%202016-2018.pdf. This estimate includes the expenditures attributable to SNAP (formerly known as food stamp) purchases, which are exempt, and therefore overestimates the fiscal impact of a repeal. The Institute on Taxation and Economic Policy estimates a $588 million impact from eliminating the grocery exemption.
  2. Carl Davis, Kelly Davis, Matthew Gardner et al, “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States,” 5th Edition, Institute on Taxation and Economic Policy, January 2015, http://www.itep.org/whopays/.
  3. Bureau of Labor Statistics, “Table 1101. Quintiles of income before taxes: annual expenditure means, shares, standard errors, and coefficients of variation,” Consumer Expenditure Survey, 2015, https://www.bls.gov/cex/2015/combined/quintile.pdf.
  4.  Bureau of Labor Statistics, “High-income households spent half of their food budget on food away from home in 2015,” TED: The Economics Daily, October 5, 2016, https://www.bls.gov/opub/ted/2016/high-income-households-spent-half-of-their-food-budget-on-food-away-from-home-in-2015.htm.
  5. Currently in Kentucky, the top 1 percent of families pay 6 percent of their income in state and local taxes while the poorest 20 percent pay 9 percent. Carl Davis, Kelly Davis, Matthew Gardner et al, “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States.”
  6.  Some states that impose the sales tax on groceries attempt to address the disproportionate impact on low-income families by providing targeted income tax credits, usually in an amount that is much lower than what these families actually spend on groceries. Kentucky is better off maintaining its current exemption. In states that provide them, legislatures tend to let credits erode over time and even vote to cut them in times of fiscal strain. For instance, to help pay for income tax cuts for the wealthy in 2013, Kansas legislators voted to make their refundable credit for low-income families’ food purchases nonrefundable, which means that many low-income families with low or no income tax liability lost benefits.
  7. SNAP’s net income calculation includes a handful of deductions (standard, dependent, medical expenses and high housing costs) that reduce the base of the expected contribution calculation. Even though this adjustment reflects the limited income families have available for food purchases, SNAP benefits still do not make up the entire gap between what families can spend, and what they need to become food-secure. Research suggests that higher benefits would result in higher spending on groceries. Patricia Anderson and Kristin Butcher, “The relationships Among SNAP Benefits, Grocery Spending, Diet Quality, and the Adequacy of Low-Income Families’ Resources,” Center on Budget and Policy Priorities, June 14, 2016, http://www.cbpp.org/research/food-assistance/the-relationships-among-snap-benefits-grocery-spending-diet-quality-and-the.
  8.  The Center on Budget and Policy Priorities, “A Quick Guide to SNAP Eligibility and Benefits,” September 30, 2016, http://www.cbpp.org/research/a-quick-guide-to-snap-eligibility-and-benefits.
  9. Economic Policy Institute analysis of Current Population Survey data, using CPI-U-RS to adjust for inflation.
  10. Carl Davis, Kelly Davis, Matthew Gardner et al, “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States.”
  11. KCEP analysis of Bureau of Economic Analysis personal consumption expenditure data.
  12.  Jason Bailey, “Will More Revenue from Tax Reform Be Real and Sustaining?” Kentucky Center for Economic Policy, February 9, 2017, http://kypolicy.org/will-revenue-tax-reform-real-sustaining/.
  13. Michael Mazerov, “State Taxes Have a Negligible Impact on Americans’ Interstate Moves,” Center on Budget and Policy Priorities, May 21, 2014, http://www.cbpp.org/research/state-budget-and-tax/state-taxes-have-a-negligible-impact-on-americans-interstate-moves. Mehmet Tosun and Mark Skidmore, “Cross-Border Shopping and the Sales Tax: A Reexamination of Food Purchases in West Virginia,” Working Paper 2005-07, Regional Research Institute, West Virginia University, http://rri.wvu.edu/wp-content/uploads/2012/11/Tosunwp2005-7.pdf.
  14. Eric Figueroa and Samantha Waxman, “Which States Tax the Sale of Food for Home Consumption in 2017?” Center on Budget and Policy Priorities, March 1, 2017, http://www.cbpp.org/research/state-budget-and-tax/which-states-tax-the-sale-of-food-for-home-consumption-in-2017.
  15. Nicholas Johnson and Iris J. Lav, “Should States Tax Food? Examining the Policy Issues and Options,” Center on Budget and Policy Priorities, May 1998, http://www.cbpp.org/sites/default/files/atoms/files/stfdtax98.pdf. Eric Figueroa and Samantha Waxman, “Which States Tax the Sale of Food for Home Consumption in 2017.”

Inheritance Tax Repeal Is Giveaway to the Top Kentucky Can’t Afford

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Since 1906, Kentucky has relied on the inheritance tax to help pay for the good schools, infrastructure and other investments that strengthen the Commonwealth. A repeal of the inheritance tax would be a $51 million tax cut tilted to the very wealthy that would weaken those investments and make economic progress harder in the state.

Tax is already limited by previous legislation

Kentucky’s inheritance tax applies to few inheritances because of exemptions put into the tax by the General Assembly. In 1995, the legislature began phasing it out for children, grandchildren, parents and siblings so that by 1998, these beneficiaries became totally exempt from the tax (spouses were exempted in 1985).

Today, the tax only applies to more distant relatives and beneficiaries. It’s also graduated so that higher taxes are paid on larger gifts and more modest taxes apply to small gifts. For example, a gift of $10,000 is taxed at 3.6 percent while a gift of $100,000 is taxed at 8.5 percent (for what are called class B beneficiaries). To make it easier to pay the tax, those who owe more than $5,000 in inheritance taxes can pay the tax over a 10 year period 1. Funeral expenses, costs associated with representation, debts, property taxes and mortgages are deducted to arrive at the taxable amount 2. Furthermore, to reduce the tax on inherited farms, and as long as the inheritor maintains “agricultural or horticultural use” of the land for five years, such property is assessed at its much lower agricultural value rather than market value 3.

Instead of helping family farms, as is often claimed by opponents of the inheritance tax, repeal would further a pattern in which Kentucky is gradually eroding its taxes on wealthy individuals. In addition to expanded exemptions to the inheritance tax, the state let its estate tax expire in 2005 as part of federal estate tax cuts 4. The estate tax only applies to those with extreme wealth, and 11 states have taken action to protect the tax after the federal changes. But in Kentucky, estate and inheritance tax revenues have fallen 55 percent since 2001, once inflation is taken into account. If these taxes were the same share of state revenue in 2016 they were in 1995 (see graph), Kentucky would have $108 million more for its schools and other foundational investments. To put that amount in perspective, it’s about how much the state spends on preschool and school textbooks combined.

Repeal would benefit the wealthiest at the cost of vast majority

According to data from the Survey of Consumer Finances, the wealthiest 5 percent of American households received about half of the total value of inheritances in 2013, while just 7 percent of inheritances went to the bottom 50 percent of households. The average inheritance was $1.1 million for the top 5 percent but only $68,000 for the few in the bottom half of households who received any inheritance 5.

inheritance-tax

Source: KCEP analysis of Office of the State Budget Director data.

Those who would benefit most from inheritance tax repeal are the people whose incomes and wealth — and therefore ability to pay taxes — have grown the most in recent years. Over the last 35 years, the top 1 percent of income earners in Kentucky (those with average incomes of $620,000) saw their real incomes grow 60 percent while everyone else’s fell 2.6 percent 6.

Furthermore, the inheritance tax helps ensure fairer taxation of wealth that otherwise might go untaxed during a high-income individual’s lifetime. For households at the top, wealth is primarily in the form of direct ownership of financial assets like stocks and bonds 7. In the case of assets like stocks or real estate, income tax on the value of the asset applies only when an owner “realizes” a gain, usually by selling it. But if an individual holds onto such an asset until they die, that capital gain is never taxed. Inheritances taxes are a backstop to help address that loophole.

And since inheritance tax money goes into the General Fund to help pay for investments like Kentucky’s public schools, universities and more, an inheritance tax cut for the wealthy would harm the very systems that strengthen economic opportunities for everyone.

Repeal of the inheritance tax would also make Kentucky’s already upside-down tax system even more unbalanced. Currently, low to middle-income Kentucky families pay between 9 percent and 10.8 percent of their income in state and local taxes, while the top 1 percent pay only 6 percent 8.

Revenue needed for investments that work

The inheritance tax is a modest but critical source of revenue for Kentucky that repeal would eliminate entirely. In the year ending June 2016, the inheritance tax brought in $51 million in revenue.

Those who support eliminating inheritance and estate taxes make the unsubstantiated claim that these taxes cause residents to leave states that have them. But research fails to find a connection between where the elderly choose to live and state inheritance and other taxes. While many states have changed these taxes in recent decades, elderly migration patterns have not changed in response 9. More broadly, it is a myth that states should be worried about “tax flight:” few Americans move from one state to another each year and among those who do the most common reasons are for a job, family considerations, weather and lower housing costs — not taxes 10. Rather than benefitting the economy and therefore the budget, repealing the inheritance tax would result in a big loss of tax revenue to the state.

The lack of sound policy purpose for eliminating the inheritance tax is why it was missing from the 54 recommendations of the Blue Ribbon Commission on Tax Reform in 2012. None of Kentucky’s prior tax studies and commissions has recommended eliminating the inheritance tax. In addition to generating revenue and increasing the fairness of the tax system, inheritance and estate taxes encourage heirs to work and incentivize contributions to charities 11.

With the need to invest additional resources in education, health, human services and other state priorities and to pay down our large pension liabilities, Kentucky has more important budget priorities than a tax cut for wealthy individuals whose incomes have soared in recent years.

 

  1. Kentucky Department of Revenue, A Guide to Kentucky Inheritance and Estate Taxes,” http://revenue.ky.gov/NR/rdonlyres/6D844DC9-B300-4EE7-963E-DB141FC0AED6/0/guide_2012.pdf.
  2. KRS 140.210, http://www.lrc.ky.gov/statutes/statute.aspx?id=29001.
  3. KRS 141.300-360, http://www.lrc.ky.gov/statutes/chapter.aspx?id=37672.
  4. Anna Baumann, “Reinstating Kentucky’s Tax on Extreme Wealth a Part of Making State Taxes Fair and Adequate,” Kentucky Center for Economic Policy, September 24, 2015, http://kypolicy.org/reinstating-kentuckys-tax-on-extreme-wealth-a-part-of-making-state-taxes-fair-and-adequate-2/.
  5. Janet Y. Yellen, “Perspectives on Inequality and Opportunity from the Survey of Consumer Finances,” Conference on Economic Opportunity and Inequality, Federal Reserve Bank of Boston, October 17, 2014, http://www.federalreserve.gov/newsevents/speech/yellen20141017a.pdf.
  6. Estelle Sommeiller, Mark Price and Ellis Wazeter, “Income Inequality in the U. S. by State, Metropolitan Area, and County,” Economic Policy Institute, June 16, 2016, http://www.epi.org/publication/income-inequality-in-the-us/.
  7. Emmanuel Saez and Gabriel Zucman, “Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data,” October 2015, forthcoming Quarterly Journal of Economics, http://gabriel-zucman.eu/files/SaezZucman2016QJE.pdf. Appendix, http://gabriel-zucman.eu/files/SaezZucman2016QJEAppendix.pdf.
  8. Institute on Taxation and Economic Policy, “Who Pays? A Distributional Analysis of the Tax Systems in All Fifty States,” 5th Edition, January 2015,  http://www.itep.org/whopays/.
  9. Karen Smith Conway and Jonathan C. Rork, “No Country for Old Men (or Women)—Do State Tax Policies Drive Away the Elderly?” National Tax Journal, June 2012, http://www.ntanet.org/NTJ/65/2/ntj-v65n02p313-56-country-for-old-men.pdf. Conway and Rork, “State “Death” Taxes and Elderly Migration—The Chicken or the Egg?” National Tax Journal, March 2006, http://www.ntanet.org/NTJ/59/1/ntj-v59n01p97-128-state-death-taxes-elderly.html.
  10. Robert Tannenwald, et al., “Tax Flight is a Myth,” Center on Budget and Policy Priorities, August 5, 2011, http://www.cbpp.org/research/tax-flight-is-a-myth?fa=view&id=3556.
  11. David Joulfaian, “Inheritance and Saving,” NBER Working Paper 12569, October 2006, http://www.nber.org/papers/w12569.pdf. Aviva Aron-Dine, “Estate Tax Repeal—or Slashing the Estate Tax Rate—Would Substantially Reduce Charitable Giving,” Center on Budget and Policy Priorities, June 7, 2006, http://www.cbpp.org/research/estate-tax-repeal-or-slashing-the-estate-tax-rate-would-substantially-reduce-charitable.

The Path to a Stronger Commonwealth: Prioritizing Investments in Our Communities Over Tax Breaks for the Powerful

Kentucky faces a choice: cleaning up our tax code of special interest tax breaks so we can invest in excellent schools, a healthy and skilled workforce, modern infrastructure and other building blocks of thriving communities in the Commonwealth; or continuing to allow our tax code to be manipulated for the benefit of just a few, while essential investments fall farther behind. This report explores these two choices and provides direction for the road ahead. Moving forward means raising new revenue to invest in the foundations of thriving communities by cleaning up our tax code, eliminating breaks those at the top have managed to put there. Moving backward means undermining investments in a stronger state by failing to clean up tax breaks and continuing with more tax giveaways for those at the top.

You can view the report here.