The House’s top priority (HB 1) in the 2023 legislative session is a bill to continue reducing the state’s income tax, the source of nearly half of state revenue. Lawmakers say they will have plenty of money in the future to cover the cost of dropping from a 5% to a 4% income tax rate, despite the resulting loss of $1.1 billion annually even after taking the new sales taxes on services into account.
But the House’s second priority (HB 2), a bill to provide the additional $16.6 million required to build a long-needed veterans nursing home in Bowling Green, is an example of why HB 1 won’t work.
When costs go up, so must tax revenue
The veterans nursing home needs the extra $16.6 million because inflation has increased construction costs far above what was originally anticipated. The state and federal governments initially appropriated $30 million for the project based on a 2015 cost projection. But as the Bowling Green Daily News reported, “that was before supply chains and materials cost led to what the U. S. Census Bureau calculates is a 23% jump in construction costs from 2019 until 2021.” The bids for the project approached a much higher $50 million, and the state must now come up with an extra $16.6 million for the nursing home to move forward.
HB 2 passed the House by a vote of 98-0 and it is expected to pass the Senate when lawmakers return in February. But this necessary increase in appropriations is just a small step toward a much wider budget reckoning. Inflation makes things cost more, and if you want to provide at least the same services as you have in the past you must increase the amount of money you allocate.
However, the legislature has done too little to recognize the need for bigger appropriations to cover inflation in recent years. State spending on base funding for P-12 schools in the most recent budget is 27% less than 2008 in real dollars; higher education funding is 26% less. State retirees have not received a cost of living adjustment since 2011, reducing the real value of their pensions by 24%.
These funding reductions have led to serious problems attracting and retaining employees. Average teacher pay has fallen 14.7% since 2008 in inflation-adjusted dollars, leading to a severe teacher shortage. An unwillingness to raise pay has created other staff shortages that have contributed to horrific crises, from too-few social workers to deal with nation-leading child abuse levels to an understaffed juvenile legal system that has resulted in violence and mistreatment.
Now, with recent inflation higher than it has been in 40 years, the need to catch up on spending levels is even more important. In addition to the higher cost of attracting and retaining employees and the increased cost of construction, the state must pay more for equipment and supplies. And as the Federal Reserve raises interest rates, it will cost more for the state to borrow for capital projects — meaning higher interest payments in future years. That’s especially important because of the legislature’s little-known increased use of debt in the most recent budget despite record cash on hand.
Kentucky has record resources, but is not using them to pay true costs
The state currently has billions of dollars in revenues in its Budget Reserve Trust Fund (BRTF) due to the economic effects of federal pandemic aid and because higher prices have resulted in greater sales tax, income tax and other receipts. But the budget the legislature passed in 2022 did not take into account higher costs in many areas of government. The General Assembly did include an 8% raise for state employees in the new budget, but that was after not providing raises for 10 of the 12 previous years. An 8% raise is only enough for state employees to tread water when inflation is running just as high, and does not make up ground lost in the past. The General Assembly did not increase the state portion of education funding enough to prevent average teacher pay from declining 5.3% this year after taking inflation into account.
Importantly, one area with significant investment in the 2022-2024 budget is capital construction projects for needs similar to the Bowling Green nursing home. Most of this construction was at the state’s universities and community colleges, and also included items ranging from state park renovations to P-12 school construction, State Fair property improvements and renovating the state Capitol. However, the state borrowed a significant amount of money for these projects rather than using more of the ample cash available due to those state budget surpluses, as the governor’s plan had proposed. The legislature authorized a record $3.8 billion in borrowing, which far exceeds prior years, as shown below.
Why did the legislature borrow so much for these capital projects rather than just using more of the billions in surplus cash that was available? Paying with cash would have increased state appropriations and reduced the amount set aside in the BRTF. That easily could prevent the state from triggering the conditions the legislature had created in last year’s House Bill 8 that they say allow them to make permanent cuts to the state income tax rate. Borrowing rather than spending gives the illusion that income tax cuts are “affordable” by getting around the formula the legislature had just created.
Borrowing also makes costs for these projects much higher than cash financing by forcing the state to pay avoidable bond issuance costs and interest costs on the payments each year. And, as mentioned earlier, interest rates are rising because of the Fed’s response to inflation. The legislature will have to pay off these significant bonds in future years while trying to meet other obligations — and with HB 1’s cut in the income tax rate they will have substantially less in tax revenue available to do so.
State needs responsible budgeting
Being serious about funding necessary services requires recognizing their true cost, and acknowledging that those costs have gone up. HB 2 is a first step in that direction. But as the shift from spending to borrowing on capital construction in the most recent budget shows, the General Assembly appears to be going out of its way to avoid fully facing its cost needs in order to pass huge and permanent tax cuts instead. We will face more pain from this decision.