Op-Ed: Principles Critical to Effective Tax Reform

By Jason Bailey
December 19, 2011

Published in the Lexington Herald-Leader, December 18, 2011.

In his inaugural address, Gov. Steve Beshear called on the state to build a “foundation for a better tomorrow” by restructuring Kentucky’s tax system in his second term.

His call for action is critically important. Because tax reform is complex and far-reaching, gubernatorial leadership is key.

But as this issue moves forward, we will need more than the will to act on tax reform. We will need the will to act on reforms that are in fact beneficial to the commonwealth. These days, some ideas presented under the banner of tax reform are limiting or even harmful to the goal of moving our state forward.

Tax restructuring plans must meet some basic principles:

Tax reform should result in more revenue.

Kentucky’s last debate on tax reform in the mid-2000s was restricted by the prevailing notion that any plan should be “revenue-neutral,” meaning changes to the tax code should result in no net new dollars. Revenue-neutral reforms sidestep the reason that the issue arises in the first place — inadequate state funds. That’s why Kentucky is already talking about tax reform again despite passing a revenue-neutral package in 2005.

The immediate need for more funds is clear. Ten rounds of budget cuts over the last few years have meant reductions of up to 30 percent in many critical state functions. Hardly a day goes by without news of how funding gaps are straining our essential systems, whether in child protective services, environmental protection or the judicial system.

Funding has also been a key missing piece of education reforms passed over the last 20 years, resulting in large tuition increases and limited access to early childhood education. We simply need a stronger base of funds from which to make core investments.

Tax reform should not increase inequality and poverty.

Some want to eliminate or reduce Kentucky’s individual and corporate income taxes and become more narrowly dependent on the sales tax. Such plans shift responsibility for paying taxes away from wealthy individuals and large corporations and over to low- and middle-income Kentuckians.

The Institute on Taxation and Economic Policy conducted an analysis for my organization on the impact of such a plan in Kentucky.

Its report shows that the poorest 60 percent of Kentuckians would see their taxes go up on average, while the highest-earning one percent of Kentuckians, who make more than $323,000 a year, would receive an average tax cut of $27,851.

Proponents say that such proposals will draw business and individuals to the state, but the economic evidence does not support these claims. The evidence does suggest, however, that a state is more attractive when it has good schools and a high quality of life.

Because eliminating income taxes makes the tax system less diverse, and because income taxes (particularly on higher-income people) are more responsive to economic growth than most other tax forms, such an overhaul can harm the state economy by reducing revenue for needed investments.

Tax reform should align our system with long-term revenue growth.

Holes in Kentucky’s tax system, such as a limited sales tax on services, make it unable to generate the revenue needed to even maintain current levels of services, much less increase them.

Meeting this third principle requires making the tax system more diverse, not less diverse. It means fewer loopholes and exemptions that unreasonably favor powerful groups or businesses, not more.

But when the tax code is opened up, it is inevitable that such interests will step forward to call for changes that benefit them but make the system less robust.

It is essential for leaders to resist such pressure and, as Beshear stressed in his inaugural address, put the long-run interest of Kentucky first.

Reforming the state’s tax system is perhaps the most important issue facing Kentucky. Funding limitations are a barrier to progress in countless areas of Kentucky life. Increased revenue alone is not sufficient to improve schools, health and the economy, but it is a necessary part of any real solutions.

Because tax reform is so important, and because a window of opportunity for addressing it comes along so rarely, we must do it right.

Jason Bailey is director of the Kentucky Center for Economic Policy.