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Op-Ed: Principles for a Tax Reform Plan

This column originally ran in the Lexington Herald-Leader on April 21, 2017. It ran in the Courier-Journal on April 24, 2017.

With the 2017 Kentucky General Assembly in the books, Governor Bevin and the legislature will now turn their attention to a possible special session later this year that will focus on tax reform and pensions.

The need to clean up the tax code is among the biggest issues facing the Commonwealth. The growth of tax breaks increasingly undermines our ability to make the public investments that build thriving communities. But whether the governor’s plan moves us forward or actually sets the state back depends on its goals, assumptions and specifics.

For Kentucky to make progress, a tax plan must meet three principles:

1. Reform should not be a tax shift from the wealthy and corporations to low and middle-income Kentuckians.

Kentucky already has an upside-down tax system where the middle class and poor pay more of their income in taxes than do those at the top. And the state’s business taxes are comparatively low already and riddled with breaks that benefit large, profitable corporations.

However, there are serious concerns the governor’s plan may make the situation much worse due to a preference for a “consumption-based” tax system. That means less reliance on income taxes and greater reliance on sales taxes. Because those at the middle and bottom spend more of their income — out of necessity — than do the wealthy, a move towards sales taxes is a shift in who pays from those with more to those with less.

For example, a plan that shifts one-fourth of revenue collected now from income taxes to sales taxes would result in a tax increase for the bottom 60 percent of Kentuckians, according to an analysis by the Institute on Taxation and Economic Policy. In contrast, it would give an average tax cut of nearly $8,000 to the richest 1 percent.

Incomes at the top are soaring even while working families’ paychecks are stagnant. We cannot further squeeze everyday Kentuckians in order to finance more giveaways to the wealthy and powerful corporations.

2. A tax plan must raise more revenue.

There’s no sense talking about tax reform that is “revenue neutral,” meaning it raises no new money. Kentucky needs additional resources to invest in the things that grow our economy and improve well-being. That ranges from high-quality schools to affordable higher education, from a modern infrastructure to improved health. And we’ll need it to meet our obligations to the retirement of school teachers, public health nurses and other state employees.

To his credit, Governor Bevin has said he supports raising new revenue. If a plan doesn’t do so, it’s merely a shift in who pays taxes and a wasted opportunity to address the real issue.

3. New revenue should be real and sustainable over time.

The new revenue a plan expects to generate should be grounded in realistic assumptions. And it must be reliable over time to pay our debts and sustain public investments. That means it cannot depend on false claims about trickle down economic growth resulting from tax breaks to those at the top. Unfortunately the track record of economist Art Laffer is filled with such empty promises, and he is playing a role in coming up with a plan in Kentucky.

Kansas, whose shift to a consumption-based tax system Laffer helped design, has since seen a weak economy, massive budget cuts, three credit downgrades and a state Supreme Court ruling that school funding in unconstitutionally inadequate. And Kansas is not an isolated case: states like North Carolina, Ohio, Oklahoma and Louisiana shifted toward consumption-based tax systems in recent years and faced major revenue shortfalls as a result.

Especially because of soaring inequality in our economy, income taxes are the strongest revenue source states have. Reducing reliance on them in exchange for slower-growing consumption taxes results in less revenue over time. Even if a shift to a consumption-based system is designed to create a bump in new money at first, that revenue would fade away over a period of years and our budget would end up in even worse shape.

Any tax plan is not a good tax plan. The state needs reforms that strengthen the Commonwealth by ending tax breaks that benefit the few and powerful so we can better invest in the things that benefit us all.

It is critical for Kentucky leaders to establish clear boundaries for tax reform: if a plan doesn’t meet the three principles above, it is time to go back to the drawing board.

2017 Session a Step Backward for Kentucky Workers

The 2017 General Assembly has ended, but the full impact on workers of several harmful bills passed during the session will play out for years to come.

In the very first week of session in January, the legislature passed “Right to Work” (RTW, HB 1), making Kentucky the 28th state with such a law. The evidence does not support backers’ claims that RTW leads to job growth. Instead, what RTW does is lower wages for all workers in states – by an estimated $1,558 a year in 2015 dollars – and undermine workplace safety. It does so by removing the requirement that workers in unionized firms who aren’t members help defray the cost of the union’s mandatory representation and bargaining by paying reduced “core financial” dues. Without this requirement, some workers pay nothing and unions have fewer resources to represent the same number of workers.

Wages will also be reduced by the repeal of Kentucky’s prevailing wage law (HB 3) that first week of session. Prevailing wages support a skilled construction workforce and good-quality jobs by requiring that workers are compensated according to local industry standards. The argument for repeal – that the state can get public construction jobs done for less – is not backed by the evidence; according to research, better paid, better trained workers offset higher wages with other efficiencies including greater productivity. The real consequences of Kentucky’s prevailing wage repeal will include cutting construction worker income, training and benefits; losing jobs to lower paid workers from outside Kentucky and hurting the local economies where construction worker income circulates.

Another hit on wages comes from SB 6, which compromises public sector employees’ collective bargaining by getting rid of unions’ ability to automatically deduct dues from worker paychecks. Instead of being able to opt out of paying dues, workers will need to authorize deductions to opt in, creating an administrative barrier intended to reduce union resources.

A controversial bill referred to as the golf cart bill, HB 404, was also passed. It will permit commercial delivery companies like UPS to use utility vehicles for deliveries on public roads, subject to local government regulation. Advocates promoted the bill as a way to support efficient delivery, especially during peak season around the holidays. But savings for delivery companies will come at the cost of workers, whose safety will be compromised including as a result of hazardous seasonal weather, and for whom the associated jobs will likely be part-time, low-wage and lacking benefits.

At the same time the General Assembly worsened wages and conditions for workers in the 2017 session, the legislature made it easier for employers to avoid liability when workers’ rights are violated. SB 151, known as the franchisor bill, attempts to remove the possibility that large corporations that franchise would ever be held accountable when a franchisee in Kentucky is in violation of wage and hour, civil rights, workers compensation, unemployment insurance and health and safety laws. Though franchisors are rarely found to be “joint employers” in such cases, federal labor law allows for the possibility. More than 10 states have attempted to supersede this authority by passing similar, industry-backed legislation since a 2015 court case and a 2016 Department of Labor issuance reasserted the NLRB’s ability to find joint employment when the facts of a case support it. Besides having questionable legal standing, these franchisor bills send a dangerous message to franchisors that they can pressure franchisees to cut corners in order to increase profitability without facing the repercussions of potentially illegal cost-cutting measures.

Things could have been even worse in the 2017 session. An extremely draconian reduction in worker protections – SB 237 – was never posted to committee. HB 369, which would have let certain successor corporations off the hook for liability related to asbestos claims, was posted for passage in the House but never taken up for a vote. HB 296, which would have limited medical benefits for workers injured on the job to the advantage of employers and the profitable worker’s compensation insurance industry, died in committee.

But things could have been a lot better for workers, too. A number of bills that would have improved wages and working conditions for Kentuckians never saw the light of day.

  • ­­­­HB 456 would have adjusted the overtime threshold to protect more workers from unpaid work, recognizing that four decades of erosion in the threshold means that a person making poverty wages can be classified as exempt from overtime pay.
  • SB 33, HB 178 and HB 420 proposed to increase Kentucky’s regular and tipped minimum wages, adjusting for decades of erosion and the failure of worker wages to keep up with worker productivity; and HB 201 would have given localities the authority to set their own minimum wages.
  • HB 179 would have required equal pay for equal work, regardless of sex, race and national origin.
  • HB 303 would have improved economic security for families across the Commonwealth by providing the option of six weeks paid maternity leave to workers who have been employed for at least a year by an employer with at least 50 employees. Similarly, HB 260 and SB 172 would have extended provisions for “reasonable accommodations” to pregnant women and new moms – like extra bathroom breaks and the ability to carry a water bottle to the assembly line. Such accommodations would help moms who want and need to work stay employed and healthy.
  • HB 196 proposed to crack down on the practice of worker misclassification. In order to avoid responsibility for unemployment insurance and workers’ compensation, employers may classify workers as independent contractors instead of employees. This bill would have made it harder to misclassify workers in Kentucky’s construction industry.
  • HB 240 would have required that public construction jobs over $1 million go to contractors participating in apprenticeship (training) programs.

A strong economy is driven by jobs that pay workers family-supporting wages. Similarly, robust labor force participation depends in part on the availability of decent jobs. Instead of strengthening our laws to support job quality, this year’s General Assembly was a serious setback for Kentucky workers.

What Are Taxes For?

Across the commonwealth, Kentuckians are filing their taxes this week; and many are wondering if and how the Governor’s intention to do tax reform this year will impact what they pay in the future. The principles of good tax reform are clear (that it generates new revenue to invest in our communities in a fair and reliable way). Tax Day is a good time to remember what our contributions pay for, and why we should make sure that everyone is chipping in.

Through local, state and federal governments, tax dollars are pooled together and invested in schools and universities, roads and bridges, social services for vulnerable children and adults and other public services essential for shared prosperity and thriving communities across the Commonwealth.

In other words, taxes are a critical tool for doing important things together we cannot do alone. Here in Kentucky, state tax dollars go for:

Education: Early childhood education and childcare; K-12 education; higher education and need-based financial aid; adult education; worker training; vocational education; libraries; public television.

Health Care: Health insurance for people with disabilities, pregnant women, working poor families, and the elderly in nursing homes through Medicaid; public health; mental health services; disability services; substance use disorder services.

Human Services & Supports: Child and domestic violence protection; foster care and adoption; housing; nutrition assistance; support for low-income families; support for veterans; support for the elderly.

Infrastructure: Roads and bridges; water and sewer systems; public transit.

Environmental Protection: Land conservation; enforcement of laws protecting land, air and water; state parks; forest protection and management.

Public Safety & Justice: Court system; public defenders and prosecutors; state police; jails and prisons; disaster relief; consumer and worker safety protection.

Economic & Community Development: Small business development; tourism; job development; agricultural development; arts and culture.

Kentucky is projected to collect about $10.6 billion in revenue in its General Fund in Fiscal Year 2017. Forty-two percent of the General Fund is expected to come from the individual income tax; thirty-three percent from the sales tax; six percent from the property tax; eight percent from corporate taxes and the remaining from the coal severance tax, cigarette tax, lottery and other sources.

Over the current biennium, General Fund resources are allocated as follows:

Source: Office of the State Budget Director

For a closer look at how state tax dollars get appropriated to different budget areas, click here. And to see where federal tax dollars go, click here.

All these essential public services are why taxes matter and why we need good tax reform to address current underinvestment and ensure reliable funding in the future. Shifting our reliance from state income taxes to sales taxes, the current fad in other states, is not good reform: besides shifting our tax system even more onto middle and low income families, doing so would leave us with less revenue over time to build a thriving Commonwealth. That’s because sales taxes don’t grow as well as income taxes.

What’s good tax reform then? Here’s an example.

Paying taxes inspires aggravation in many, but we all benefit from the results. Taxes are one way we all roll up our sleeves and work together to make Kentucky an even better place to call home.

What Good Tax Reform Looks Like

Click here to view as a PDF.

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/.

Taxing Grocery Purchases Tough Sale

Commentary: Adding Sales Tax to Groceries Would Hurt Low-Income Families, Weaken Revenue Growth