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.

Five Takeaways from Kentucky’s Year-End Revenue Results

Revenue receipts are in for June 2016, the final month of Kentucky’s last Fiscal Year (FY), showing modestly strong General Fund growth of 3.7 percent since 2015. Here are five big takeaways:

Revenue Growth Itself Isn’t Remarkable as It Almost Always Grows from Year to Year

Kentucky collected $372 million more in FY 2016 than in FY 2015. And while this increase shows Kentucky’s economy is growing – with people earning and spending more, thus paying more income and sales taxes, for example – it is the norm for our economy, and therefore revenue, to grow.

revenue growth

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

After the Great Recession, revenue dropped two times in FYs 09 and 10, but in the 6 years since, has grown every year — 3 times at a rate higher than in FY 16. Over the last 20 years, revenue has declined only 3 times, and has grown at a higher rate than in FY 16 8 times.

Whether revenue is growing enough is a different matter (one we can say more about in August when the state publishes quarterly economic data). For a long time in Kentucky, revenue growth has not been keeping up with economic growth, meaning our ability to sustain a certain level of crucial investments is eroding. And given Kentucky’s large pension liabilities and pressure to reinvest in education, human services and other areas, the gap between what we are generating and what we need is substantial.

It Is Unclear at this Point Whether We’ll Have a Surplus

It will be another month before state officials reconcile expenditures with revenue and announce if there was a surplus in FY 16. This process will account for necessary governmental expenses – unbudgeted expenditures such as natural disasters like the recent flooding in western Kentucky – as well as how much was actually spent by various agencies of state government compared to what was budgeted. Governor Bevin announced cuts of 4.5 percent for many parts of state government in FY 2016 and 2 percent for higher education.

Relative to the original forecast on which the 2016 budget was built, revenue collections were $292 million higher than expected (or 2.9 percent). Part of that difference can be attributed to improvement in our economy since January  2014 when the forecast was created, and some is due to the difficulty of predicting receipts two years out.

Compared to the official revised forecast from January of this year, revenue was just $49 million higher (0.5 percent) – a small difference in the context of a $10.3 billion General Fund.

Strong Revenue Growth is Needed to Address a Deepening Structural Deficit

Experts have predicted that if Kentucky does not address the holes in our tax code – especially the billions in tax breaks inserted into our tax laws by powerful interests – we face a structural deficit that could grow to $1 billion by 2020. That means a growing challenge in finding the money we need to invest in public schools, affordable colleges and universities, health and human services, and other services essential for thriving communities. The most recent two-year budget reflects this growing crisis, which pitted our pension liabilities against higher education, services for vulnerable Kentuckians and many other areas that received their 16th round of budget cuts since 2008.

Kentucky’s Individual Income Tax is Crucial to the State’s Ability to Improve

Sales and use tax growth outpaced individual income tax growth (IIT) by 0.8 percentage points in 2016 compared to 2015. But looking back over the years since the recession, the IIT has grown 41 percent or $1.2 billion while the sales tax has grown 23 percent or $645 million. Over the long term, income taxes grow more than sales taxes do.

income growth

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

The kind of tax reform Kentucky needs strengthens both income and sales taxes and resists jumping onto the income-tax cutting bandwagon that has been popular (and devastating) in other states. Cutting income taxes would weaken the strongest source of revenue growth we have to invest. The idea that shifting to a more sales-tax reliant system would make up for these losses is misguided: not only does it increase income inequality by asking even less of those at the top and more of everyone else, but it also ignores the problem that, in the context of growing income inequality, sales tax-reliant states struggle to generate enough revenue. That’s because a shrinking middle class means weakening demand for the purchases that generate sales taxes.

The Road Fund is Hurting Because Lawmakers Took Too Long to Raise the Gas Tax Floor

Despite action in the 2015 session of the General Assembly to raise the gas tax floor and adjust the rate setting process going forward, Kentucky roads and bridges – and therefore our motorists and economy – were not sufficiently protected from falling gas prices over recent years. With the tax based on the wholesale price of gasoline, declining global oil prices have impacted Kentucky revenue. Even though the Road Fund’s second biggest source of revenue, the motor vehicle usage tax, grew by 11.9 percent or $52 million in 2016, the entire fund shrank by 2.9 percent or $44 million to $1.5 billion. The gas tax itself shrank $100 million in FY 2016.

Budget Agreement Affirms Deep Cuts, Higher Pension Contributions

To view this report as a PDF, click here.

The budget passed by the General Assembly maintains the governor’s proposed cuts of 9 percent to many parts of government over the biennium and contains a 4.5 percent cut to higher education and flat-funding for K-12 schools. It uses savings from these cuts along with one-time monies to contribute $1.16 billion above base funding over the two years directly to the state’s underfunded pension systems and put $125 million in a “permanent” pension fund.

The state’s spending plan will be finalized once the governor decides what he will veto and pending the outcome of a court case challenging the governor’s decision to make 4.5 percent cuts to public universities and community colleges in the current fiscal year. Those decisions will also affect how much ends up in the rainy day fund and other areas.

Contains 4.5 percent Cuts to Higher Education and Cuts to Other Areas

A major point of contention between the two chambers’ budgets concerned higher education, which the Senate budget cut by 9 percent and the House budget did not cut. In the final agreement, higher education is cut by 4.5 percent. The budget also begins allocating a portion of the funding for higher education institutions to a performance-based formula, beginning with 5 percent of their appropriations in 2018. A working group is charged with developing the formula by December of this year.

As the graph below shows, with this cut higher education funding will be reduced by 31 percent between 2008 and 2018 once inflation is taken into account, with 5 percent of these funds at risk because of performance-based funding. Already, Kentucky ranked 11th-worst among the states for its cuts to higher education since 2008 1.

budget 1

Source: KCEP analysis of Office of the State Budget Director, Bureau of Labor Statistics data. Does not include the governor’s 4.5 percent cut for 2016.

The budget agreement does contain significant new investments in college affordability programs. It includes $55 million more for the need-based lottery funded scholarship programs — the College Access Program and the Kentucky Tuition Grant program — over the biennium than was included in the last two year budget. That puts funding for those programs up to the amount intended by law (dollars have been diverted from these programs in recent budgets) 2. This increase would help an estimated 30,000 students. The final budget also includes $25.3 million over the biennium for the Work Ready Kentucky Scholarship program, a new initiative that provides free tuition to traditional age students enrolled in associate’s degree programs at the state’s community colleges, public universities and private colleges. And the budget includes $15 million over the biennium for dual credit merit-based scholarships for high school students enrolled in college classes, a priority of the Senate.

The budget does not include cuts to the non-SEEK portions of P-12 education, which the governor’s budget and the Senate budget each cut by nine percent. That means funding for Learning and Results Services (LARS) areas like preschool, extended school services, teacher professional development and instructional resources are frozen at their 2016 funding levels for 2017 and 2018. The plan does expand eligibility for preschool from 160 percent to 200 percent of the federal poverty level. It also includes an additional $10.6 million each year to expand eligibility for child care assistance from 150 percent to 160 percent of the poverty level.

The budget would essentially freeze funding for SEEK, the core funding formula for schools and the largest General Fund expenditure. That would make SEEK funding 12.2 percent below its 2008 level once inflation is taken into account. In a recent report, Kentucky ranked 6th-worst among states in cuts to its core funding formula with a 10.6 percent cut since 2008 3.

The budget cuts the constitutional offices (Attorney General, Secretary of State, Auditor, Treasurer, Agriculture) by 3.375 percent. Kentucky Educational Television was not cut. The final judicial branch budget removes cuts that had been included in earlier versions of the budget and helps address the structural imbalance in the branch’s budget through supplemental dollars contained in a separate bill.

Like previous versions of the budget, the plan includes approximately nine percent cuts to other areas including behavioral health, community based services (besides child care and non-parental relative placement), Aging and Independent Living, Kentucky Arts Council, Educational Professional Standards Board, Energy Development and Independence and the Kentucky Nature Preserves Commission.

Both the House and the governor had included funding for 44 new public defender positions to help with caseloads, but that money is not included in the final plan. The budget sends 60 percent of coal severance tax money back to coal counties through a variety of programs and local revenue sharing, up from the approximately 50 percent that is sent back currently. As in previous versions of the budget, there are again no raises for employees in the budget other than selected salary increases for a few occupations such as social workers and state police.

The final budget includes $635 million in fund transfers over the biennium, similar to the $634 million in the Senate plan, $638 million in the House budget and $611 million in the governor’s plan. That includes $500 million transferred out of the Public Employees’ Health Insurance Trust Fund.

The budget includes $582 million in bonds for capital projects compared to $415 million in the Senate and $384 million in the House (these numbers don’t include agency bonds). The final capital budget includes $100 million for a workforce development construction pool, which the House had not included in its budget but that the governor had proposed.

Makes Over $1 Billion in Contributions to Pensions while Setting Aside Money in Permanent Fund

The final budget makes much larger pension contributions than have been made in previous sessions, and more than what the governor had original proposed. The plan contributes an additional $1.16 billion over the biennium, compared to $845.5 million in the governor’s original proposal.

One difference between previous versions of the budget was the mix of pension funding between the Kentucky Teachers’ Retirement System (KTRS) and Kentucky Retirement Systems (KRS). The final budget contains a blend between what the House and Senate had proposed (see graph below for how the plans compare). It includes an amount close to 100 percent of the actuarially required contribution (ARC) for KTRS and $185.8 million above the ARC for KRS over the biennium.

pension contributions

Source: KCEP analysis of HB 303.

Another point of difference among the plans concerned how much is left in the rainy day fund at the end of the period and how much was deposited in a permanent fund that the governor said was intended to be distributed to pension plans following a performance audit. The final budget puts aside less money than the Senate and governor proposed. It appropriates $125 million to that permanent fund compared to $250 million in the Senate budget, $500 million in the governor’s plan and $0 in the House budget. The budget leaves $175 million in the rainy day fund according to Senator McDaniel (balance is not included in the budget documents) compared to $371.5 million in the Senate budget, $283 million in the House plan and $524 million in the governor’s budget (see graph below). The final amount in the rainy day fund, however, will be contingent on the outcome of the court case on higher education funding this year and on what items the governor vetoes.

budget 3

Source: KCEP analysis of HB 303, Sen. McDaniel comments from the floor.

What’s Next

The budget is now in the governor’s hands, and he can either veto it outright (which would require calling a special session to enact a new budget) or line item veto particular language and funding items. If he vetoes language in particular budget areas, it would give the governor or specific agencies more flexibility in how monies are spent. The governor’s vetoes cannot be overridden by the legislature.

Line item vetoes of any entire budget units would increase the General Fund’s undesignated balance and those monies are allocated according to what’s called the General Fund surplus expenditure plan (if language is not vetoed for that process). The plan says monies must go first to necessary governmental expenses like natural disasters. Then in 2017 the remainder is split evenly between the state’s rainy day fund and the permanent pension fund. In 2018 the remainder is split with half going to the state’s rainy day fund, 25 percent to KTRS and 25 percent to KERS.

Brief updated to reflect additional appropriations in House Bill 10.

  1.  Michael Mitchell, et al., “Years of Cuts Threaten to Put College Out of Reach for More Students,” Center on Budget and Policy Priorities, May 13, 2015, http://www.cbpp.org/research/years-of-cuts-threaten-to-put-college-out-of-reach-for-more-students.
  2. Dustin Pugel, “Fact Sheet: Need-Based Financial Aid Dollars Being Diverted to General Fund,” Kentucky Center for Economic Policy, February 23, 2016, http://kypolicy.org/need-based-financial-aid-dollars-being-diverted-to-general-fund/.
  3. Michael Leachman, et al., “Most States Have Cut School Funding, and Some Continue Cutting,” Center on Budget and Policy Priorities, January 25, 2016, http://www.cbpp.org/research/state-budget-and-tax/most-states-have-cut-school-funding-and-some-continue-cutting.

Senate Budget Maintains Governor’s Deep Budget Cuts, Increases Pension Contributions by Reducing Governor’s Set-Aside Funds

To view in PDF format, click here.

The Senate budget maintains the governor’s dramatic proposed cuts of nine percent to postsecondary education, parts of P-12 education and a wide range of services affecting health, quality of life and vulnerable Kentuckians. Its primary difference from the governor’s plan is to leave less money in the rainy day fund and a proposed permanent fund while increasing direct funding for pensions.

The Senate budget is similar to the House plan when it comes to total pension funding. The main difference between the two is the Senate still leaves $336 million more in the rainy day fund and permanent fund combined at the end of the biennium than the House, which uses those monies to reduce budget cuts in education and other areas.

Maintains the Governor’s Deep Budget Cuts to Higher Education and Many Other Areas

The Senate budget includes the governor’s budget cuts of 9 percent (4.5 percent this year) to many parts of state government with few modifications.

It includes 9 percent cuts to higher education institutions, which would mean funding for universities and community colleges will have been reduced by 35 percent between 2008 and 2018 once inflation is taken into account. In 2018 it puts 25 percent of higher education funding into a new performance-based system in which institutions must compete against each other for their portion of those funds (Kentucky State University is excluded).

The Senate budget does not include $57 million the House had proposed for need-based lottery-funded scholarship programs — the College Access Program and the Kentucky Tuition Grant program — which have had dollars diverted from them in recent budgets 1. The Senate also doesn’t fund the Work Ready scholarship proposed by the House that fills the gap in providing free tuition to traditional age students at the state’s community colleges. Instead, the Senate plan puts $58.9 million over the biennium into Kentucky Educational Excellence Scholarships (KEES), which are based on grades, for high school students who are dually enrolled in college credit or technical programs.

The Senate goes along with the governor’s budget in including nine percent cuts to the non-SEEK portions of P-12 education, which the House budget had not cut. Within Learning and Results Services, that means cuts of nine percent to areas like preschool, extended school services, teacher professional development and instructional resources. Family resource and youth services centers are cut by 6.3 percent, paid for by defunding a few programs including dropout prevention and the visually impaired preschool services program.

The Senate budget does not expand eligibility for preschool from 160 percent to 200 percent of the poverty level, as in the House plan. Like the House, the Senate would essentially freeze funding for SEEK, the core funding formula for schools.

The Senate cuts other areas as the governor proposed that the House had exempted from cuts, including constitutional offices (Attorney General, Secretary of State, Auditor, Treasurer, Agriculture), Kentucky Educational Television, Office for the Blind, Libraries and Archives, Board of Elections, Registry of Election Finance, Kentucky Center for the Arts, Commission on Human Rights, Commission on Women and the Executive Branch Ethics Commission.

Like the House and the governor, the Senate includes approximately nine percent cuts to other areas including behavioral health, community-based services, environmental protection, public health, aging and independent living, Kentucky Arts Council, Educational Professional Standards Board, natural resources, energy development and independence and the Kentucky Nature Preserves Commission 2.

The Senate budget deletes the House’s proposed additional $10.6 million each year to expand eligibility for child care assistance from 150 percent to 160 percent of the poverty level. The Senate also deletes an authorization included in the House budget of up to $10.5 million over the biennium for the fund that provides care for the uninsured at University of Louisville Hospital, as well as monies for colon, breast and cervical cancer screening 3.

The Senate budget eliminates funding for 44 new public defender positions both the House and governor had included to help with caseloads. As in the House budget and the governor’s proposal, there are again no raises for employees in the budget other than selected raises for a few occupations such as social workers and state police.

Contributes Similar Overall Amount to Pensions as House

The Senate agreed with the House in making significantly larger contributions to employee pensions than the governor proposed, with a contribution of $1.195 billion over the biennium compared to $1.123 billion in the House plan. That compares to $845.5 million in what the governor proposed.

The Senate somewhat changed the mix of funding to the pension plans compared to the House. The House included the full actuarially required contribution (ARC) to the Kentucky Teachers’ Retirement System (KTRS) over the biennium, while the Senate plan includes 88 percent of the KTRS ARC. The Senate plan puts over three times the amount the House does in additional dollars above the ARC to the Kentucky Employees’ Retirement System (KERS) (see graph below, which does not include base funding for the systems).

senate budget 1

Source: KCEP analysis of HB 303 SCS.

The Senate also leaves $250 million in a permanent fund compared to $500 million in the governor’s plan and $0 in the House budget 4. The Senate leaves a rainy day fund balance of $371.5 million at the end of the biennium compared to $283 million in the House plan and $524 million in the governor’s budget (see graph below) 5. In total, The Senate leaves $336 million more in idle funds at the end of the budget period than does the House.

senate budget 2

Source: KCEP analysis of HB 303 SCS.

The Senate’s budget is built with $634 million in fund transfers over the biennium, compared to $638 million in the House budget and $611 million in transfers contained in the governor’s plan. The Senate budget includes $580 million in new debt for capital projects compared to $549 million in the House plan and $625 million in the governor’s budget. In the Senate, that includes $50 million for a workforce development construction pool, which the House had not included in its budget but for which the governor had proposed $100 million. The Senate budget does not allow postsecondary institutions to issue debt on unauthorized, self-funded capital projects over $600,000, as the House had allowed.

Other Important Differences

  • The Senate maintains that approximately half of coal severance money will continue going to the General Fund, with half going back to counties through a variety of programs and local revenue sharing. It includes no specific local projects as the House included. The House budget begins to shift more coal severance tax dollars back to counties and local spending, with a plan to make that transition complete over four years. Some of the programs previously funded with coal severance dollars, like Operation Unite and the SOAR initiative, are funded through other parts of the House budget.
  • The Senate budget repeals prevailing wage on public construction projects, while the House budget does not.
  • While the House had required specific funding amounts for certain programs within some of Cabinets, the Senate restores the discretion to the Executive Branch the governor had proposed.

 

  1.  Dustin Pugel, “Fact Sheet: Need-Based Financial Aid Dollars Being Diverted to General Fund,” Kentucky Center for Economic Policy, February 23, 2016, http://kypolicy.org/need-based-financial-aid-dollars-being-diverted-to-general-fund/.
  2.  Anna Baumann, “House Budget Does Not Restore Many Crucial Services for Vulnerable Kentuckians,” Kentucky Center for Economic Policy, March 18, 2016, http://kypolicy.org/house-budget-not-restore-many-crucial-services-vulnerable-kentuckians/.
  3.  Jason Bailey, “Uninsured Costs at U of L Hospital Have Dropped Dramatically Because of Medicaid Expansion and Kynect, But Could Go Up with Changes,” Kentucky Center for Economic Policy, March 22, 2016, http://kypolicy.org/uninsured-costs-u-l-hospital-dropped-dramatically-medicaid-expansion-kynect-go-changes/.
  4.  Jason Bailey, “Why the House Budget Approach Is Better than a Big Set Aside of Idle Funds,” Kentucky Center for Economic Policy, March 18, 2016, http://kypolicy.org/house-budget-approach-better-big-set-aside-idle-funds/.
  5.  The House budget also includes some items in its budget as necessary governmental expenses that will reduce the final amount in the rainy day fund.

House Budget Uses Set-Aside Money to Reduce Cuts and Fully Fund Teachers’ Pensions

To view this in PDF form, click here.

The House budget reduces proposed cuts to education and selected other areas and provides additional money to fully fund the actuarially required contribution to the Kentucky Teachers’ Retirement System. It does that by using resources the governor set aside in his budget for a $500 million permanent fund and for extra contributions to the state’s rainy day fund.

How the Budget is Built

The budget begins with revenue growth of 3.2 percent in 2017 and 2.4 percent in 2018 and relies on revenues for 2016 that are currently expected to end the year $243 million above what was originally forecast.

In addition to those monies, the House budget transfers $638 million from a variety of funds across state government over the biennium, including $500 million from the Public Employees’ Health Insurance Trust Fund 1. That’s slightly more than the $611 million in transfers contained in the governor’s plan and much higher than the average of $340 million over the last eight biennia.

The budget uses those resources for the spending outlined below as well as an additional contribution of $74 million to the rainy day fund, growing its balance to $283 million. That contribution is $241 million less than the governor’s plan added to the rainy day fund, which would have brought the fund to a balance of $524 million. The House budget also includes less new debt for capital projects than the governor’s budget, $549 million compared to $625 million in the governor’s budget.

Fully Funds Pensions Now, Doesn’t Create New Permanent Fund

The House plan, unlike the governor’s proposal, provides the full actuarially required contribution to the Kentucky Teachers’ Retirement System (KTRS). The governor’s budget included only two-thirds of the required contribution to KTRS, meaning that the House plan puts $345 million more into the pension system over the biennium. The House does not propose issuing a bond to make these additional contributions, but instead does so through General Fund appropriations.

Like the governor’s plan, the House plan includes the actuarially required contribution to the Kentucky Employees Retirement System (KERS) plus an additional $90 million over the biennium above that amount because of concerns about the risk that plan faces without more money. The House budget does not include another $67 million in additional funding to KERS that was part of the governor’s budget.

The House plan also does not include the governor’s proposed permanent fund, a set-aside of $500 million that he said was intended to be used for pensions in future years. The source of that funding in the governor’s plan, the $500 million from the employees’ health insurance trust fund, is instead used to help fund the pension plans directly.

Removes Governor’s Cuts to P-12, Higher Education and a Few Other Areas

The House plan eliminates proposed cuts in the governor’s budget of nine percent next year in P-12 education, higher education and a few other areas.

The governor’s budget did not shield from those cuts the Learning and Results Services part of the education budget that includes programs like Family Resource and Youth Service Centers, textbooks and afterschool programs. The House budget instead freezes funding to these programs at 2016 levels over the next two years. It also expands eligibility for public preschool from 160 percent to 200 percent of the federal poverty level.

In higher education, the House plan eliminates the proposed nine percent cuts to the universities. It also eliminates the provision in the governor’s plan that made one-third of university funding subject to performance in 2018 and instead proposes a new work group to develop a comprehensive funding model for the institutions.

The budget funds the House’s proposed new Work Ready scholarship program that fills the gap in providing free tuition to traditional age students at the state’s community colleges, at a cost of $33 million over two years. It also provides $57 million more than in the governor’s budget over the biennium for the need-based, lottery-funded scholarship programs — the College Access Program and the Kentucky Tuition Grant program — which have had dollars diverted from them in recent budgets. The House budget does not fund the governor’s proposed new workforce scholarship program and doesn’t include the proposed $100 million in bonding for workforce training.

Outside of education, the House budget deletes cuts in a few other areas, including the constitutional offices (Attorney General, Secretary of State, Auditor, Treasurer, Agriculture), Kentucky Educational Television, Office for the Blind, Vocational Rehabilitation, Property Valuation Administrators, Commission on Human Rights, Commission on Women, the Executive Branch Ethics Commission and Military Affairs. The budget increases eligibility for child care assistance from 150 percent to 160 percent of the poverty level.

Maintains Cuts to Many Vital Services

Despite this easing of reductions, cuts of nine percent remain for many agencies and programs across state government, including agencies addressing health, family services, environmental protection, and tourism, arts and heritage. Funding for many of these investments has been reduced 15 to 50 percent since 2008, once inflation is taken into account 2.

It’s also important to remember that flat funding of programs and services is a cut after inflation. For example, like the governor’s budget the House budget essentially freezes funding for SEEK, the core funding formula for schools. That would make SEEK funding 12 percent below 2008 dollars in 2018 once inflation is taken into account.

Kentucky already ranks sixth-worst among states in cuts to its core formula funding with a 10.6 percent cut since 2008 after inflation3. Also, our inflation-adjusted cuts to higher education rank among the worst in the country 4.

As in the governor’s proposal, there are again no raises for employees in the budget other than selected raises for a few occupations such as social workers and state police.

Makes Other Significant Changes

Other elements of the House budget include:

  • It begins to shift more coal severance tax dollars back to counties and local spending, with a plan to make that transition complete over four years. Some of the programs previously funded with coal severance dollars, like Operation Unite and the SOAR initiative, are funded through other parts of the budget.
  • Budget does not repeal prevailing wage as the governor’s budget proposed, and neither did the House minority budget released today.
  • Budget is accompanied by a revenue bill that includes tax breaks for animal pharmaceuticals, 529 college savings accounts and beekeeping as well as some nominal additional revenue measures.
  1. Jason Bailey, “Shifting Health Costs to Employees Has Become Way State Plugs Budget,” Kentucky Center for Economic Policy, January 28, 2016, http://kypolicy.org/shifting-health-costs-employees-become-way-state-plugs-budget/.
  2. Ashley Spalding, et al., “Investing in Kentucky’s Future: A Preview of the 2016-2018 Kentucky State Budget,” Kentucky Center for Economic Policy, January 4, 2016, http://kypolicy.org/investing-in-kentuckys-future-a-preview-of-the-2016-2018-kentucky-state-budget/.
  3. Michael Leachman, et al., “Most States Have Cut School Funding and Some Continue Cutting,” Center on Budget and Policy Priorities, January 25, 2016, http://www.cbpp.org/research/state-budget-and-tax/most-states-have-cut-school-funding-and-some-continue-cutting.
  4. Michael Mitchell, et al., “Years of Cuts Threaten to Put College Out of Reach for More Students, “Center on Budget and Policy Priorities, May 13, 2015, http://www.cbpp.org/research/years-of-cuts-threaten-to-put-college-out-of-reach-for-more-students.

Revenue Options that Strengthen the Commonwealth

Kentucky has good options to fairly generate new revenue and put an end to year after year of deep cuts to vital public investments, as outlined in a report by the Kentucky Center for Economic Policy (KCEP).revenue options

The report, “Revenue Options that Strengthen the Commonwealth,” identifies more than 30 options to clean up Kentucky’s tax code, raise new revenue and restore and sustain critical investments in schools, higher education, health and more. These options and others are an alternative to even deeper cuts to public investments.

The options include limiting income tax breaks for high earners, expanding the sales tax base to include services and closing special interest loopholes that are draining resources from the state budget. The report also suggests reforms to help the struggling Road Fund.

You can view the report here.

Investing in Kentucky’s Future: A Preview of the 2016-2018 Kentucky State Budget

A comprehensive preview of the upcoming two-year Kentucky state budget confirms both a massive funding gap facing the state for the next two years and a need for reinvestment in many areas post-recession.

Authored by the Kentucky Center for Economic Policy (KCEP), the report notes that expected growth in state revenue the first year of the new budget will be at least $500 million less than basic new costs the state will face in pensions, corrections, Medicaid and school population growth alone. More resources will need to be found if Kentucky hopes to roll back cuts to services harmed by 15 rounds of reductions since 2007 or make new investments that could move the state forward.

With a more than $10 billion budget, one way to get back to building thriving communities with strong schools, roads and other necessities is to look at the more than $12 billion the state is giving away in tax breaks.

The 37-page report is broken into two parts – the first section dealing with Kentucky’s budgetary needs and challenges and the second with the state’s broken revenue system. A copy of the report can be found here.

Reinstating Kentucky’s Tax on Extreme Wealth a Part of Making State Taxes Fair and Adequate

To view this brief in PDF form, click here. 

Kentucky loses an estimated $25 million a year because state lawmakers haven’t yet taken steps to recoup lost revenue from federal estate tax changes that essentially eliminated the state’s estate tax in the 2000s 1. Recognizing estate taxes generate revenue and make taxes fairer, many states have either decoupled from the federal changes or enacted their own, separate estate taxes.

Legislation to sever the connection between Kentucky’s estate tax and federal law has been proposed. For instance, during the 2015 legislative session House Bill 132 called for Kentucky to collect estate taxes “under the federal tax law as it was in effect on January 1, 2003,” prior to the repeal of the federal estate tax credit for states.

Restoring Kentucky’s estate tax — a move that would affect only the largest, wealthiest estates — would generate needed resources for state priorities like public education and health that benefit all Kentuckians. Asking a little more of those who can best afford to pay and who receive many of the biggest breaks from Kentucky’s tax code would also push back against the way our state and local taxes make income inequality worse overall.

Taxes on Inherited Wealth Perform Important Functions

Estate taxes have several purposes: to generate revenue for public investments, provide a backstop to income tax losses through unrealized capital gains and address the concentration of wealth that threatens widespread prosperity and broad economic growth.

The federal estate tax is applied to the value of large transfers of money and property made from one generation to the next 2. With inequality at levels not seen in this country in almost 100 years, an estate tax is especially important today. It is an avenue for those who have profited above all others from public investments in the economy to pay their fair share toward the good schools, health care and other services that are necessary for new generations of hard-working people to achieve the American dream.

Structurally, the estate tax is applied to the market value, at the time of death or up to six months later, of such assets as real estate, trusts, cash, stocks, bonds, businesses, pensions, life insurance policies and the value of taxable gifts made over one’s lifetime. Once exemptions and deductions for transfers between spouses, gifts to charitable organizations, debts and administrative costs are accounted for, only the very wealthiest Americans owe federal estate taxes 3. In fact, the nationwide share of estates subject to the tax was at an historical low of 0.15 percent in 2012, the most recent year for which data are available. The share of Kentuckians owing federal estate taxes was even lower — just 0.1 percent of all the state’s estates (see table below). As federal law stands today, the first $5.43 million of an estate is totally exempt from the tax and that number is adjusted each year for inflation.

Estate Table 1

Source: Citizens for Tax Justice

Most states levied estate and inheritance taxes prior to establishment of the federal estate tax in 1916. Kentucky’s inheritance tax, for example, was enacted in 1906. These taxes on the very wealthy helped in a small way to counterbalance states’ heavy reliance on “regressive” sales taxes — meaning the lower a family’s income, the larger share of it they pay in sales taxes.

In order to provide for more uniform estate taxation by states, a state credit against the federal tax for state estate and inheritance taxes was added to the federal estate tax in 1926 4. Under the law, states that levied an estate tax equal to the amount of the credit did not increase the total (federal and state) tax bill. Rather, states picked up a share of federal estate tax collections, as Kentucky began doing in 1926 5. When the credit was phased out in 2005 under the 2001 federal tax cuts and replaced with a deduction, states lost the ability to automatically pick up a portion of federal estate tax liability and many were left with no estate taxation at all. In 2012, the repeal of the credit was made permanent.

Since then, three states have established their own estate taxes separate from the federal tax and 11 states and the District of Columbia have “decoupled” from the repeal of the state credit, allowing them to keep an estate tax that is the same or similar to the prior tax 6.

Kentucky currently does not have an estate tax, but has retained its other tax on the generational transfer of wealth — the inheritance tax. Distinct from the estate tax which is paid on the net value of the taxable estate, inheritance taxes are assessed against the value received by each beneficiary, with exemptions based on one’s relationship to the estate. Spouses, parents, children, grandchildren and siblings became completely exempt from the inheritance tax in 1998 7. Beforehand, they were entitled to exemptions ranging from $5,000 to $20,000 and paid from two percent on inheritances valued up to $20,000 to ten percent on inheritances exceeding $500,000. More distant relatives still pay from four percent on inheritances valued at less than $10,000 to 16 percent on those with value exceeding $60,000, with exemptions ranging from $500 to $1,000 8.

Before the federal pickup credit was repealed, Kentucky’s estate taxes were equal to the difference between the inheritance tax and the federal estate tax credit 9. In other words, the amount someone paid in inheritance taxes reduced the amount he or she paid in state estate taxes.

Estate and Inheritance Tax Erosion Means Less Revenue, Raised Less Equitably

Today the inheritance tax in Kentucky is a small but important source of General Fund revenue, generating $51 million in 2015 10. To put that amount into context, Kentucky budgeted $48 million General Fund dollars in 2015 for its child care assistance program which helps low-income, working families pay for child care 11.

Yet in the past, taxes on inherited wealth have provided more resources for investments in education, health and other areas that help create and support the middle class. Accounting for inflation, Kentucky estate and inheritance taxes shrunk 59 percent between 2001 and 2014 12. Along with the elimination of the estate tax, an enhanced exemption from the inheritance tax for siblings in 1995 and the phase-out of inheritance taxes on close relatives by 1998 have reduced collections.

Since the late 1990s, inheritance and estate taxes have declined and flattened as a share of General Fund revenue (see below). If these taxes generated the same share of state revenue they did in 1997, Kentucky would have collected $168 million in 2015, compared to $51 million in actual receipts — a much-needed $117 million difference to help address public needs.

Estate Tax Graph 1

Source: KCEP analysis of June Monthly Tax Receipts Reports, Office of the State Budget Director

The loss in state revenue resulting from changes to estate and inheritance taxes can be dealt with in two ways. The money can be made up on the spending side by reducing investments in important public services and other fiscal maneuvering and on the revenue side by raising taxes that fall less heavily on the wealthiest households. Both are used in practice.

Today in Kentucky, low-income and middle class families pay a larger share of their income in state and local taxes than the wealthiest do, as shown in the graph below. For example, Kentuckians whose average annual income is $23,000 pay 10.6 percent of family income in taxes, while those averaging $839,500 a year or more – the top 1 percent — pay just 6.0 percent 13. That means, on average, the wealthiest Kentuckians are bringing home 37 times more income but paying just over half, percentagewise, what low-income residents do in state and local taxes 14. Restoring the estate tax would help offset that unfairness.

Estate Tax Graph 2

Source: Institute of Taxation and Economic Policy

Inequality is a Growing Problem in Kentucky, One that Estate Taxes Can Help Address

A tax system where the wealthiest people pay the lowest percentage of their income in taxes could be described as upside-down. This has serious implications. As more and more struggle to make ends meet while a relatively tiny sliver of the population sees its income grow dramatically (as the graph below shows), the imbalance threatens our state budget as well as economic growth.

In the three decades leading up to the Great Recession, those whose income put them in the top one percent of all Kentuckians took home nearly half of state income growth. In 2011, the top one percent made 17 times as much as everyone else15. With such a disproportionate share of growth in the economy going to the wealthiest, it would be a common-sense policy decision to make it so that taxes paid by those at the top on inherited wealth should at least keep pace with economic growth. But in Kentucky these taxes have decreased as a share of personal income to 0.03 percent, down from about 0.1 percent where they hovered from the late 1970s through the 1990s 16.

Estate Tax Graph 3

Source: EARN Analysis of state-level IRS data, Piketty and Saez 2012

With inequality rising to levels not seen since the Great Depression, it’s important that states and the federal government recommit to addressing the concentration of wealth in the hands of a relative few. A growing body of research explores and explains how increasing inequality hurts the economy, including by decreasing educational opportunities and income mobility 17. Another major concern is that with the financial means to influence policy comes the power to keep dollars flowing in the direction that benefits those interests.

Many state and federal policies are needed to address inequality, including tax reform that calls upon those at the very top to pay their fair share toward investments in a stronger economy 18. Federal estate tax exemptions have skyrocketed to $5.43 million per spouse today from around $600,000 in the 1990s. Today, fewer than two of every 1,000 estates owe any estate tax 19. Furthermore, with exemption rates tied to inflation, wealthy estates get protection even as the minimum wage and other supports for average working people erode 20.

Common Arguments against Estate Taxes Are Unfounded

Those who support maintaining or even expanding this special treatment for the ultra-wealthy make the unsubstantiated claim that estate taxes force family farms and small businesses to liquidate assets. There are many reasons this is an extremely rare occurrence. To begin with, high exemptions mean that very few farms and businesses even file estate taxes. In 2012, just one tenth of one percent of Kentucky estates (29, total) owed even a dollar in federal estate taxes 21. The likelihood that federal estate taxes affect these inheritors is further reduced by laws allowing family farms to be assessed at their agricultural rather than “best use” market value and a “qualified family-owned business-interest deduction.” 22 In rare cases where estate taxes are owed, another federal provision allows many businesses to spread payments over 15 years.

The fact is that the large majority of estates’ wealth goes to the intended beneficiaries — not taxes. For the 0.1 percent of taxable estates that owed any estate tax in the U.S. in 2011, more than 80 cents of every dollar went to heirs and charities.

Estate Tax Graph 4

Source: Citizens for Tax Justice analysis of IRS data on taxable estates of Americans who died in 2011.

Another anecdotal argument in favor of special treatment for transferred wealth is that estate taxes cause residents to leave states that have them. In reality though, fewer than two out of every 100 Americans move from one state to another each year and when they do the most common reasons are for a job, family considerations, weather and lower housing costs — not taxes 23. Related more specifically to the myth that higher taxes cause the wealthy to flee, under that logic, states with comparatively high income taxes should see big population losses as well. But actual practices show otherwise. For instance, from 2005 to 2011, California – a state with relatively high state income taxes – saw more people with incomes greater than $200,000 a year move into the state than move out 24. Even stronger evidence against the tax-flight myth comes from New Jersey, which increased its top income tax rate in 2004 by 2.6 percentage points to 8.97 percent — one of the highest rates in the nation. Because it affected households with taxable income greater than $500,000, the impact of this tax increase serves as a good proxy for estate taxes since they also affect only the very wealthy. Statistical analysis of trends after New Jersey’s tax increase confirm that rich people have the same “non-response” to state tax changes as the general population. 25

Kentucky Should Restore the Estate Tax

Following lawmakers in 11 other states and the District of Columbia, the General Assembly can restore Kentucky’s estate tax by referencing a date in the statutes prior to the federal repeal of the pickup tax credit for states. Rep. Jim Wayne’s 2015 bill proposed linking it to “federal tax law as it was in effect on January 1, 2003, and without any of the scheduled increases” that took effect under the 2001 federal tax cuts. In 2003, the exemption rate was set at $1 million, meaning estates smaller than $1 million were exempt as well as the first million of estates larger than the threshold. At full implementation, the bill would have generated an estimated additional $25 million for the state’s General Fund.

To reduce any impact on family businesses, Kentucky could piggyback on the previously mentioned federal law that provides an additional exemption on top of the standard amount. Kentucky already assesses inherited farm land at its agricultural value and allows taxes to be paid in up to ten annual installments if the net amount exceeds $5,000 26.

States that base their estate tax on the previous federal credit have a maximum state estate tax rate of 16 percent and can either tie their exemption to the current federal level ($5.43 million per spouse) or create their own lower exemption. Alternatively, three states have separate estate taxes not tied to the federal pick up tax. A new state tax would be partially offset because it would be deductible from federal estate taxes.

state estate and inheritance taxes

 

Source: Center on Budget and Policy Priorities, Institute on Taxation and Economic Policy
*Maryland and New Jersey levy a pickup tax and a separate inheritance tax.

Conclusion

Kentuckians are rightly concerned about the struggles of everyday working people at a time when the wealthiest few are enjoying more and more of today’s economic growth. A tax system that fails to generate enough resources to meet growing needs at the same time it gives big breaks to those who arguably need them the least only makes the situation worse. Restoring Kentucky’s estate tax would be an important step in the right direction.

  1. Representative Jim Wayne, “House Bill 132,” Kentucky General Assembly, 2015, http://www.lrc.ky.gov/record/15RS/HB132.htm. John Scott, “Issues Confronting the 2012 Kentucky General Assembly: Estate Taxes,” Legislative Research Commission, November, 2011, http://www.lrc.ky.gov/lrcpubs/IB236.pdf.
  2. Joseph Cordes, Robert Ebel and Jane Gravelle, “The Encyclopedia of Taxation and Tax Policy, Second Edition,” The Urban Institute Press, 2005.
  3. Steve Wamhoff, “State-by-state Estate Tax Figures Show Why Congress Should Enact Senator Sanders’ Responsible Estate Tax Act,” Citizens for Tax Justice, September 22, 2014, http://ctj.org/pdf/estatetax2014.pdf.
  4. Institute on Taxation and Economic Policy (ITEP), “State Estate and Inheritance Taxes,” July 2014, http://www.itep.org/pdf/estatetax2014.pdf.
  5. Jeffrey Cooper, “Interstate Competition and State Death Taxes: A Modern Crisis in Historical Perspective,” Pepperdine Law Review 33 (4), 2006, http://digitalcommons.pepperdine.edu/cgi/viewcontent.cgi?article=1219&context=plr.
  6. ITEP, “State Estate and Inheritance Taxes.” The current total of states with a separate pickup tax is 11, as North Carolina eliminated the tax in 2013. Three additional states have enacted their own estate taxes.
  7. Governor’s Office for Economic Analysis, “Tax Expenditure Analysis: 2014-2016,”April 30, 2014, http://osbd.ky.gov/Publications/Documents/Special%20Reports/Tax%20Expenditure%20Analysis%20Fiscal%20Years%202014-2016.pdf.
  8. Kentucky Revised Statutes (KRS) 140.070, “Inheritance Tax Rates,” http://www.lrc.ky.gov/Statutes/statute.aspx?id=28983
  9. The credit was replaced with a deduction, meaning that taxpayers may deduct any state-level estate taxes paid from the value of their estate for federal estate tax purposes, therefore receiving a partial reduction in net taxes paid equal to the value of the state taxes paid times the federal tax rate. ITEP, “State Estate and Inheritance Taxes.”
  10. Office of the State Budget Director, “Monthly Tax Receipts; June 2015,” http://osbd.ky.gov/Publications/Tax%20Receipt%20Reports%20%20Fiscal%20Year%202015/1506TaxReceipt.pdf. The State Budget Director estimates that inheritance tax exemptions will reduce collections by $55 million in 2016. Furthermore, the five percent discount applied to the tax if it is paid in full within nine months after death, and the exemption for gifts made to “educational, religious, charitable or certain governmental organizations”—will further reduce inheritance tax collections by about $1 million and $12 million in 2016, respectively. Governor’s Office for Economic Analysis, “Tax Expenditure Analysis: 2014-2016.”
  11. Office of the State Budget Director, Budget of the Commonwealth, 2014-2016. http://osbd.ky.gov/Documents/Most%20Recent%20Publications/Operating%20Budget%20-%20Volume%20I%20%28Full%20Version%29.pdf.
  12. Office of the State Budget Director, “Monthly Tax Receipts Reports.”
  13. ITEP, “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States,” Fourth Edition, January 2013, http://www.itep.org/pdf/whopaysreport.pdf.
  14. Kentucky adheres to other federal laws that shelter transferred wealth from taxation—or in other words, which give preferential tax treatment to very wealthy families: when an asset that has appreciated in value is given as a gift during a donor’s lifetime, the capital gains are not taxed, a practice will cost Kentucky about $14 million in the budget year 2016. When property that has appreciated in value is transferred at a donor’s death, the recipients value “basis” is the current market value, meaning that the capital gains will never be taxed. Kentucky will lose an estimated $81 million in this budget year 2016 to this practice. The federal government recoups some of this loss through the estate tax but Kentucky does not have an estate tax. Governor’s Office for Economic Analysis, “Tax Expenditure Analysis: 2014-2016.”
  15. Estelle Sommeiller and Mark Price, “The Increasingly Unequal States of America; Income Inequality by State, 1917 to 2011,” Economic Analysis and Research Network (EARN), February 19, 2014, http://s2.epi.org/files/2014/Income-Inequality-by-State-Final.pdf.
  16. Author’s analysis of data from the Bureau of Economic Analysis, The Office of the State Budget Director and the State and Local Government Finance Data Query System.
  17. Jared Bernstein, “The Impact of Inequality on Growth,” December 2013, The Center for American Progress, http://cdn.americanprogress.org/wp-content/uploads/2013/12/BerensteinInequality.pdf. Jonathan D. Ostry, Andrew Berg and Charalambos Tsangarides, “Redistribution, Inequality, and Growth,” IMF Staff Discussion Note, International Monetary Fund, February 2014, http://www.imf.org/external/pubs/ft/sdn/2014/sdn1402.pdf. Joe Maguire, “How Increasing Income Inequality is Dampening U.S. Economic Growth, And Possible Was to Change the Tide,” Standard and Poor Global Credit Portal, August 6, 2014, https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1351366&SctArtId=255732&from=CM&nsl_code=LIME&sourceObjectId=8741033&sourceRevId=1&fee_ind=N&exp_date=20240804-19:41:13#ContactInfo.
  18. Senator Bernie Sanders has proposed the “Responsible Estate Tax Act” which would reduce the exemption to its level in 2009, $3.5 million per spouse, have a graduated rate structure from 40 to 55 percent, and result in about 0.3 percent of estates being liable. President Obama has also recommended reinstating the 2009 exemption, but his plan proposes a flat rate of 45 percent. Steve Wamhoff, “State-by-State Estate Tax Figures Show Why Congress Should Enact Senator Sanders’ Responsible Estate Tax Act.”
  19. ITEP, “State Estate and Inheritance Taxes.”
  20. Robert Greenstein from the Center on Budget and Policy Priorities points out that at the same time as estate tax changes benefitting millionaires were made permanent in 2013 fiscal cliff negotiations, 2009 improvements to the Child Tax Credit and Earned Income Tax Credit were scheduled to expire in 2017. “Disparate Treatment: Permanent, Million-Dollar Estate-Tax Breaks for Wealthy Heirs vs Temporary Tax Credit Improvements for Low-Income Working Families,” January 4, 2013, http://www.offthechartsblog.org/disparate-treatment-permanent-million-dollar-estate-tax-breaks-for-wealthy-heirs-vs-temporary-tax-credit-improvements-for-low-income-working-families/.
  21. Steve Wamhoff, “State-by-state Estate Tax Figures Show Why Congress Should Enact Senator Sanders’ Responsible Estate Tax Act.”
  22. Congressional Budget Office, “Effects of the Federal Estate Tax on Farms and Small Businesses,” July 2005, http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/65xx/doc6512/07-06-estatetax.pdf. Based on federal estate tax returns for 2000, the CBO found that, nationwide, if the exemption rate for that year had been set at $3.5 million, all but 41 family-owned businesses and 13 family farms would have had the liquid assets necessary to pay their estate taxes. At the current and inflation-indexed exemption of $5.43 million, the numbers are likely to be smaller still.
  23. Robert Tannenwald, Jon Shure and Nicholas Johnson, “Tax Flight is a Myth: Higher State Taxes Bring More Revenue, Not More Migration,” Center on Budget and Policy Priorities, August 4, 2011, http://www.cbpp.org/cms/?fa=view&id=3556.
  24. 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/cms/?fa=view&id=4141.
  25. Cristobal Young and Charles Varner, “Millionaire Migration and State Taxation of Top Incomes: Evidence from a Natural Experiment,” National Tax Journal, June 2011, 64(2), http://web.stanford.edu/~cy10/public/Millionaire_Migration.pdf.
  26. KRS 140.310, KRS 140.222 http://www.lrc.ky.gov/statutes/chapter.aspx?id=37672.