Tax Reform Discussion

Tax Reform Discussion

by My Old Ky Podcast

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.

Kentucky’s ACA Health Insurance Marketplace Is Not Falling Apart

Far from collapsing, the health insurance exchanges set up by the Affordable Care Act (ACA) are a way many Kentuckians are now able to buy health insurance. It will be important for the 81,155 Kentuckians who depend on that coverage for those in Washington to keep it stable rather than undermine it with administrative changes, threatened repeal of the ACA or even reckless public statements that cause insurance companies to question their participation.

Numbers from this year’s open enrollment show a functioning marketplace

Kentucky’s enrollment was lower this year than in past years, but several things contributed to the enrollment drop (including the switch from our state-based exchange Kynect to Healthcare.gov and the federal government pulling advertisements for healthcare.gov in the final weeks of open enrollment). And the drop is far from a so-called insurer “death spiral.” One indication of a death spiral would be an insurance pool with a disproportionately higher percentage of older enrollees. But data from healthcare.gov shows a fairly even mix:

  • 34 percent were under 35 years old
  • 34 percent were between 35 and 54
  • 32 percent were 55 and older

This data set does not provide any information on the health of the people who purchased insurance through the marketplace. It does, however, offer information on what kinds of policies people purchased, which indicate what people thought they could afford and what level of care they thought they would need (the higher level the plan, the more expensive it is and the more it will cover).

  • 843 people signed up for the lowest level of coverage, called “catastrophic” insurance.
  • 17,974, or 22 percent signed up for bronze level insurance.
  • 57,681 or 71 percent signed up for silver level insurance.
  • 4,657, or 6 percent signed up for gold level insurance. No one purchased platinum level insurance in Kentucky.

Normally, people choose higher quality plans (such as gold or platinum) if a higher level of care is believed to be needed. But since the vast majority of people chose lower “metal” plans this means either they didn’t feel like they could afford plans with greater coverage, or they were healthy enough not to need them.

The other indication of an insurer death spiral is exponentially increasing premiums over a short period of time. But in Kentucky, while premiums have risen, they have generally tracked with pre-ACA premium increases and have not grown sharply enough to suggest a collapsing market.

Sources: The Urban Institute & KCEP analysis of Healthcare.gov 2017 marketplace rate data.

Further, the Congressional Budget Office and Standard & Poor’s, both said the individual insurance policy market is stable and the American Academy of Actuaries wrote a letter to Congressional leadership urging them not to destabilize the market by repealing the ACA without a “viable replacement.” These organizations made explicit what the data show: the marketplaces are not unraveling.

Most Kentuckians in the marketplace are protected from unnecessarily expensive coverage

It is true that there were twice as many insurance companies participating in the marketplace in 2014 as there are today and that 59 of Kentucky’s 120 counties had only one insurance company (Anthem) offering plans this year.

While certainly not ideal, this is not as big of an issue as it seems. The portion of Kentucky’s population with only one insurer is 33 percent, with the remainder having 2 or 3 companies to choose from. Each of these insurers also offered multiple levels of coverage and some had multiple options within the same level of plan (HMO vs. PPO for example).

Source: KCEP analysis of 2017 Healthcare.gov data and 2015 Census Population Estimates.

Having only one insurer doesn’t mean there will be monopoly-driven, runaway premium hikes for two reasons. First, most customers get assistance paying for premiums, so for low-income Kentuckians especially, out of pocket costs for premiums are capped at a low level regardless of the amount of the premium. While insurance premiums vary based on numerous factors (county of residence, size of household, quality of insurance policy, insurance company, etc), the average premium in 2017 was $406 before subsidies—and actual costs were much lower:

  • Four in five people who purchased insurance received financial help paying for their premiums.
  • Those who got premium subsidies ended up paying an average of $144 per month.
  • Half of the Kentuckians who purchased insurance through the marketplace got further help paying for out-of-pocket costs like deductibles, co-pays and co-insurance (this is called Cost Sharing Reductions or CSRs).

Secondly, under the Affordable Care Act insurance companies are only allowed to keep 15-20 percent of their revenue for things like profit and administration. If they end the year with any more premium-generated revenue than that, they have to offer rebates to their enrollees. In fact since 2014 Kentuckians have received $33 million in rebates. This cap keeps insurers from capitalizing on monopolies by running up their profit margins.

Congress played a role in causing the decrease in number of insurers in the marketplace — in particular decisions it made affecting health insurance cooperatives and a federally administered funding stream — called risk corridor payments — that was designed to help all insurance companies participating in the exchanges through the initial years. The ACA supported the creation of cooperatives as an additional health insurance alternative that would be non-profit and owned by the people who purchase insurance from them, ideally reducing cost since they would not be profit-seeking. In 2015 Congress changed the rules and only paid out 12.6 percent of risk corridor payments, causing Kentucky’s health insurance cooperative to go under because its growth strategy relied on those funds in its early stage.

Healthcare reforms should build on our successes, not undo them

While the marketplace is stable and fears about its imminent collapse are overblown, improvements can be made. Kentucky’s overall uninsured rate has dropped to only 6.5 percent thanks to the ACA, but the percentage jumps to 15.4 percent for people who earn too much to qualify for assistance with paying premiums and don’t get coverage through work according to 2015 Census data. There are ways we can and should assist the people who were left out. Some options that should be considered include:

  • Increasing the income eligibility limit for people receiving help paying premiums from its current level of 400 percent of poverty to 500 percent or even higher.
  • Allow people aged 55 to 64 to be able to “buy-in” to Medicare early.
  • Introduce a “public option,” which is a government sponsored insurance program, into the exchanges.
  • Bring back the risk corridor funding that help financially support new insurance programs like the co-ops while they were getting started.
  • Offer a public re-insurance program for insurance companies that end up paying out more in claims than they bring in through premiums.

The real threat to the marketplaces is not looming collapse on their own, but that they will be deliberately destabilized over time through executive action or undermined by threatened repeal of the ACA.

 

New Law Will Increase Sentences for Low-Level Heroin Dealers in Kentucky, a Break From Recent Criminal Justice Reform

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.”