Principles Critical to Effective Tax Reform

Principles Critical to Effect Tax Reform

Kentucky Faces Serious Challenges with Next Budget

Lawmakers face a grim financial situation when they meet in January to craft a new budget for 2013 and 2014. The state has balanced past budgets in part by pushing costs off to future years and making deep budget cuts. Modest expected revenue growth and reduced federal financial support are increasing pressure to reform Kentucky’s tax system.

Budget Preview Updated

Op-Ed: Principles Critical to Effective Tax Reform

Published in the Lexington Herald-Leader, December 18, 2011.

In his inaugural address, Gov. Steve Beshear called on the state to build a “foundation for a better tomorrow” by restructuring Kentucky’s tax system in his second term.

His call for action is critically important. Because tax reform is complex and far-reaching, gubernatorial leadership is key.

But as this issue moves forward, we will need more than the will to act on tax reform. We will need the will to act on reforms that are in fact beneficial to the commonwealth. These days, some ideas presented under the banner of tax reform are limiting or even harmful to the goal of moving our state forward.

Tax restructuring plans must meet some basic principles:

Tax reform should result in more revenue.

Kentucky’s last debate on tax reform in the mid-2000s was restricted by the prevailing notion that any plan should be “revenue-neutral,” meaning changes to the tax code should result in no net new dollars. Revenue-neutral reforms sidestep the reason that the issue arises in the first place — inadequate state funds. That’s why Kentucky is already talking about tax reform again despite passing a revenue-neutral package in 2005.

The immediate need for more funds is clear. Ten rounds of budget cuts over the last few years have meant reductions of up to 30 percent in many critical state functions. Hardly a day goes by without news of how funding gaps are straining our essential systems, whether in child protective services, environmental protection or the judicial system.

Funding has also been a key missing piece of education reforms passed over the last 20 years, resulting in large tuition increases and limited access to early childhood education. We simply need a stronger base of funds from which to make core investments.

Tax reform should not increase inequality and poverty.

Some want to eliminate or reduce Kentucky’s individual and corporate income taxes and become more narrowly dependent on the sales tax. Such plans shift responsibility for paying taxes away from wealthy individuals and large corporations and over to low- and middle-income Kentuckians.

The Institute on Taxation and Economic Policy conducted an analysis for my organization on the impact of such a plan in Kentucky.

Its report shows that the poorest 60 percent of Kentuckians would see their taxes go up on average, while the highest-earning one percent of Kentuckians, who make more than $323,000 a year, would receive an average tax cut of $27,851.

Proponents say that such proposals will draw business and individuals to the state, but the economic evidence does not support these claims. The evidence does suggest, however, that a state is more attractive when it has good schools and a high quality of life.

Because eliminating income taxes makes the tax system less diverse, and because income taxes (particularly on higher-income people) are more responsive to economic growth than most other tax forms, such an overhaul can harm the state economy by reducing revenue for needed investments.

Tax reform should align our system with long-term revenue growth.

Holes in Kentucky’s tax system, such as a limited sales tax on services, make it unable to generate the revenue needed to even maintain current levels of services, much less increase them.

Meeting this third principle requires making the tax system more diverse, not less diverse. It means fewer loopholes and exemptions that unreasonably favor powerful groups or businesses, not more.

But when the tax code is opened up, it is inevitable that such interests will step forward to call for changes that benefit them but make the system less robust.

It is essential for leaders to resist such pressure and, as Beshear stressed in his inaugural address, put the long-run interest of Kentucky first.

Reforming the state’s tax system is perhaps the most important issue facing Kentucky. Funding limitations are a barrier to progress in countless areas of Kentucky life. Increased revenue alone is not sufficient to improve schools, health and the economy, but it is a necessary part of any real solutions.

Because tax reform is so important, and because a window of opportunity for addressing it comes along so rarely, we must do it right.

Jason Bailey is director of the Kentucky Center for Economic Policy.

A Tasty Tax Deal

Rep. Farmer Pre-files New Tax Reform Bill

Get Corporations to Pay More Taxes

Study: Yum Brands Avoided Paying State Income Taxes Despite Large Profits

New Report Shows Major, Profitable Corporations Paying No State Corporate Income Taxes

Report: “Corporate Tax Dodging in the Fifty States, 2008-2010

Yum! Brands among Major, Profitable Corporations Paying No State Corporate Income Taxes

Profiled in New Report Showing Corporate Tax Avoidance Costs All States $42 Billion Over Three Years

A comprehensive new study that profiles 265 consistently profitable Fortune 500 companies finds that Louisville-based Yum! Brands paid no net state corporate income taxes over the last three years while reporting over a billion dollars in profits to its shareholders.

The finding is included in “Corporate Tax Dodging in the Fifty States, 2008-2010” a report released today by the Institute on Taxation and Economic Policy (ITEP) and Citizens for Tax Justice (CTJ) in conjunction with the Kentucky Center for Economic Policy. The report finds a total of 68 companies that paid no state corporate income tax in at least one of the last three years. Twenty of them averaged a tax rate of zero or less during the 2008-2010 period, including Yum! Brands.

“The report’s findings are troubling. At a time of record corporate profits, many large corporations are avoiding paying their fair share for the public services from which they benefit,” said Jason Bailey, Director of the Kentucky Center for Economic Policy. “By deepening Kentucky’s budget woes, corporate tax avoidance directly harms our ability to provide quality education, improve health and build a foundation for a strong economy.”

“Corporate Tax Dodging in the Fifty States, 2008-2010” concludes that these 265 corporations cost states $42.7 billion in lost revenues in the last three years. Matthew Gardner, Executive Director at the Institute on Taxation and Economic Policy and the report’s co-author, identifies three chief causes for why state corporate tax revenues have been steadily declining for two decades. First, state lawmakers continue to enact tax subsidies requested by corporations, most of which don’t produce the promised economic results. Second, federal tax breaks enacted in the past decade further reduce state corporate income tax revenues since states generally accept corporations’ federal tax numbers. Third, said Gardner, “and most insidious, is that multi-state corporations themselves devote their money and legal firepower to coming up with tax avoidance schemes.”

Shoring up corporate taxes is an important part of needed tax reform in Kentucky. Bailey notes that there are widely recognized policy changes Kentucky could make to stop further erosion of corporate tax revenues, including the following:

  • Requiring combined reporting, under which a parent company and its subsidiaries are treated as a single corporation for state tax purposes. Combined reporting eliminates most of the advantage of shifting profits into Delaware, Nevada and other low- or no-tax states. 23 states have put in place combined reporting, and Kentucky could gain $27 to $54 million in additional revenue from combined reporting according to a Legislative Research Commission analysis.
  • Decoupling from the Qualified Production Activities Income deduction, which is a federal tax loophole that provides a tax break for business activities in the United States. Kentucky partially allows the deduction for state taxes despite the fact that it provides no incentive for business investment or location in Kentucky as opposed to another state.
  • Enacting a throwback rule, which prevents taxable income of multi-state corporations from falling between the cracks by assigning income that is not taxable in any state to the home state where the goods are produced. Twenty-five other states have such a rule.
  • Creating a process by which business tax incentive and tax subsidy programs are periodically analyzed for their effectiveness by a legislative committee and expire unless renewed by the legislature.

“Corporate Tax Dodging in the Fifty States, 2008-2010” follows up on “Corporate Taxpayers and Corporate Tax Dodgers, 2008-2010” which was published in November by Citizens for Tax Justice (CTJ) and the Institute on Taxation and Economic Policy (ITEP). The two groups released their first major study on the federal income taxes that large, profitable American corporations pay on their U.S. pretax profits in 1984. Because few states have transparency regarding business taxes, it is not possible to determine specific tax amounts paid by corporations to individual states; all figures in “Corporate Tax Dodging in Fifty States, 2008-2010” are aggregate for taxes paid to all U.S. states by each corporation.

The study is online at http://www.ctj.org/corporatetaxdodgers50states/.

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The Kentucky Center for Economic Policy is a non-profit, non-partisan initiative that conducts research, analysis and education on important policy issues facing the Commonwealth. Launched in 2011, the Center is a project of the Mountain Association for Community Economic Development (MACED). 

Founded in 1980, the Institute on Taxation and Economic Policy (ITEP) is a 501 (c)(3) non-profit, non-partisan research organization, based in Washington, DC, that focuses on federal and state tax policy. ITEP’s mission is to inform policymakers and the public of the effects of current and proposed tax policies on tax fairness, government budgets, and sound economic policy (www.itepnet.org).

Citizens for Tax Justice (CTJ), founded in 1979, is a 501 (c)(4) public interest research and advocacy organization focusing on federal, state and local tax policies and their impact upon our nation (www.ctj.org).