Governor Beshear’s budget is now under consideration in the House. His plan has received praise for putting additional dollars in education, rolling back cuts to child care and identifying new capital projects despite Kentucky’s serious revenue challenges. However, more revenue is needed to sustain the budget the governor proposes and to make improvements. This brief outlines four key points to keep in mind as the plan is considered.
A limit on the state’s large retirement income tax break for higher-income people is an important component of tax reform, and Governor Beshear’s plan includes such a limit. Reforming the existing tax break will improve the fairness of Kentucky’s tax system, generate needed revenue for public services and reduce the revenue losses that would come with an aging population in future years.
By Greg Stotelmyer
The combined impact of the tax increases and tax cuts in Governor Beshear’s reform proposal would not help improve the regressive nature of Kentucky’s tax system, according to analysis of the plan released today by the Institute on Taxation and Economic Policy (ITEP). The plan would basically maintain the existing distribution of taxes for individuals, in which low- and middle-income Kentuckians pay a higher share of their income in taxes than the wealthy.
Governor Beshear has released his tax reform proposal, and analysis and debate over the plan has begun. It’s important that this discussion keep in mind three principles that are needed in a tax reform plan in order to move Kentucky forward:
- First, tax reform should generate significant new revenue now to allow Kentucky to begin reinvesting in our needs.
- Second, it should increase tax fairness based on ability to pay and should not be a tax shift from high income individuals and businesses to low- and middle-income Kentuckians.
- Third, it should help Kentucky sustain its budget in the future by strengthening long-term revenue growth.
By Jack Brammer and Janet Patton
Many of the proposals in Governor Beshear’s tax plan come from his Blue Ribbon Commission on Tax Reform. But his plan is also different—it leaves measures out that were included in the commission’s recommendations while adding some new proposals. Here’s a rundown of major changes between the commission’s recommendations and the governor’s plan.
Raises Less New Money Overall
One big difference between the commission recommendations and the governor’s plan has to do with the amount of revenue raised. The commission’s final report includes ideas that together would create a net $659 million in new revenue. The governor’s plan, in contrast, raises only $210 million upon full implementation.
One of the five principles that the commission used to guide its tax reform proposal was adequacy. A considerable amount of public testimony and some commission discussion concerned the many needs in the state budget in areas like education and health. That’s why the commission generated a plan that raised more new revenue to begin reinvesting in Kentucky after 13 rounds of budget cuts that have sliced $1.6 billion out of state spending.
Eliminates or Weakens Some Revenue-Raising and Progressive Measures
A major way the governor’s tax plan raises less money than the commission’s plan is that it leaves out or weakens some revenue-raising measures that the commission included. Most notably, it leaves out the limit on itemized deductions for higher income people that would have raised $350 million by capping deductions at $17,500. That limit would only have affected high earners. Four of Kentucky’s surrounding states don’t allow itemized deductions at all.
The governor’s plan also drops a proposed utility gross receipts tax of 1 percent that would have raised $102 million. And while it keeps a measure that phases out the exclusion of retirement income from the income tax for wealthier people, it starts the phase out at a higher level of income than the commission had proposed. That means it raises approximately $310 million less than the commission’s plan.
The governor’s plan does not include the commission’s proposal to lower the threshold of minimum gross receipts by which businesses organized as limited liability entities must pay the limited liability entity tax. The commission proposed to lower that threshold from $3 million to $1 million, which would have raised $13 million. The reason to lower the threshold is that 82 percent of limited liability entities don’t pay the tax at all—paying a $175 fee instead—because their receipts are below $3 million.
Nor does the governor’s plan address House Bill 44, the law passed in the 1970s that limits property tax growth. At the state level, the limit has driven down the property tax rate on real estate from 31.5 cents per $100 in 1979 to 12.2 cents today, meaning over $500 million in lost revenue this year. The commission had proposed to freeze the state property tax rate at 12 cents, which would prevent future cuts.
The governor’s plan includes a refundable Earned Income Tax Credit, as the commission recommended. But it reduces the size of the credit from 15 percent of the federal credit to 7.5 percent. That reduces the size of the average credit Kentucky families will receive from $345 to $173.
Adds More Business Tax Cuts
On top of business tax cuts recommended by the commission, the governor’s plan adds a sales tax exemption on pharmaceuticals for livestock, doubles the New Markets tax credit and reduces the wholesale tax on beer, wine and distilled spirits. In total, the plan includes 12 business tax cuts that total $234 million in lost revenue, including breaks for the bourbon and horse industry and cuts in business property taxes. At the same time, it drops a commission proposal that the state’s tax incentive programs and other tax expenditures be subject to a formal review at least once every five years.
The estimated cost of the largest business tax cut in both plans—a shift to calculating corporate income taxes owed based solely on sales in Kentucky—has grown. While the commission’s final report estimated a cost of $110 million, the governor’s plan puts the cost at $154 million. That proposal alone eliminates about one-third of Kentucky’s corporate income taxes.
In addition to leaving out the proposal to raise more in limited liability entity taxes mentioned above, the governor’s plan also omitted a measure that would have eliminated a tax break called the “domestic production deduction.” That’s a break that exists only because of a federal law change which 22 states have chosen not to follow. The deduction provides no incentive for companies to locate in Kentucky as opposed to another state, and that’s why the commission had proposed eliminating it to gain $4 million.
Expands the Sales Tax to More Services
The commission proposed raising only $106 million through an initial expansion of the sales tax to services. The commission didn’t specify particular services, but the revenue estimate was based on legislation introduced previously in the General Assembly. The governor’s broader expansion would raise $280 million by including additional new services in the sales tax.
$143 million of that revenue is from taxing the labor on installation, repair and maintenance services—including machinery and equipment, auto repair, and computer hardware and software. $35 million is from recreational activities including fitness clubs and golf courses. And $102 million is from a variety of commercial, residential and personal services including landscaping, janitorial services and laundry services.