The new plan from the Governor’s Blue Ribbon Tax Reform Commission rightly puts the first priority on raising needed revenue to address Kentucky’s budget challenges. The commission finalized a package that raises approximately $659 million in the first year and closes various holes in the tax code that are limiting the pace of state revenue growth.
The most important changes involve strengthening the individual income tax. After much debate, the commission made the right decision in choosing to maintain a graduated income tax after pressure from some commissioners to move to a flat tax. While the commission’s proposal reduces income tax rates slightly, it also makes them somewhat more graduated and raises $475 million more from the income tax alone.
The plan raises revenue in part by putting a cap on itemized deductions of $17,500 that will particularly limit deductions for higher-income people while protecting many middle-income Kentuckians. The recommendations also include a proposal to lower the income tax exclusion on retirement income from its current $41,110 to $30,000, and to phase out that exclusion entirely for those with more than $60,000 in total annual income. Both of those changes will make the income tax somewhat more progressive while lessening restrictions on income tax growth.
Also, very importantly, the commission recommended a refundable earned income tax credit (EITC) at 15 percent of the federal credit. The EITC is a proven policy that helps lift working families out of poverty. An EITC will also help address the unfairness of the state tax system.
Other important recommendations include expanding the sales tax to include some services, particularly luxury services; removing the restrictions that House Bill 44 sets on property tax growth at the state and school district levels; and raising the cigarette tax to $1 a pack (along with an increase in other tobacco taxes) to improve health. The commission proposed creating a one percent state-wide utility tax on both businesses and residences that would be earmarked to school funding.
The biggest problem with the final recommendations is the inclusion of about $110 million in unneeded corporate tax cuts that comes from a proposal to move to a single sales factor formula in calculating corporate income taxes, which we have critiqued here. That $110 million price tax is an increase from the $65 million estimate that commissioners received from consultants a few months ago. Single sales factor would be a big tax windfall to a minority of large corporations, and there is no guarantee or requirement that those companies will grow jobs or increase investment in Kentucky because of the tax cuts.
These cuts were passed despite information shared with the commission showing that Kentucky’s business taxes are already low compared to other states, and despite a lack of evidence demonstrating that business tax cuts are a cost-effective way to create jobs. The recommendations would wipe out more than one-fourth of Kentucky’s corporate income taxes.
The commission also missed on other opportunities, including turning down a proposal to establish sunsetting (expiration) dates on tax expenditures. It recommended instead to simply review such expenditures at least once every five years. But sunsetting dates are growing in popularity among states because they pressure decision makers to better prioritize budgeted programs and tax expenditures, both of which are essentially an appropriation of funds. Virginia recently passed legislation requiring that all new tax expenditures sunset at least once every five years.
The recommendations can and should be improved as they move forward, particularly through changes that assure corporations pay their fair share for the investments in education, infrastructure and other public services from which they benefit. But there are a number of very strong elements in the commission’s plan that should be preserved, including the emphasis on creating substantial new revenue and the ideas to strengthen the state income tax.
*Blog updated to reflect final revenue estimates