Three Steps to Passing a Better Budget for Kentucky
March 12, 2020
The budget passed by the House mostly avoids another round of damaging cuts to programs and services that have been common since the Great Recession (with a few important exceptions, like the elimination of direct aid to libraries). However, because it is based on the worst revenue forecast in 25 years and is not accompanied by significant revenue raisers, there simply isn’t enough revenue to support the level of investment necessary to move the commonwealth forward.
Furthermore, there will likely be additional fiscal strain in Kentucky related to the quickly escalating COVID-19 pandemic, including the increased risk of a recession. Kentucky’s rainy day fund will be only 3.3% of revenue under the House budget two years from now, one of the poorest-funded in the country; the median state rainy day fund was at 11.1% of revenue as of 2018.
As the Senate advances its proposal and negotiations across chambers take place to work out differences, all revenue options should be carefully and seriously considered, no new tax breaks should be passed, and measures should be put into place that protect investments going forward.
One: Pass revenue raising measures
New revenue is necessary. In a comprehensive budget preview published in January, we documented the impact of more than a decade of budget cuts on schools, college affordability, child protective services, supports for Kentuckians with disabilities and more. These challenges have been described at length in budget review subcommittee meetings over the last couple of months. [i] In addition, the likely additional strains on the public health system and on public services more broadly due to coronavirus and the subsequent economic fallout, and the likelihood of less revenue coming in as a result, heightens the need for action.
Given the short time left in the session, and the lack of movement on comprehensive proposals that would raise adequate revenue to robustly address these challenges, at a minimum the legislature should act on several bills and ideas that have been introduced that would generate much-needed revenue and add other commonsense ideas.
- Address the under-taxation of “instant racing” slot machines and advanced deposit account wagering – HB 607, filed by Representative King, imposes a 1.5% surtax on the rapidly-proliferating “instant racing” slot machines and a 2.5% surtax on wagers made through advanced deposit account wagering (ADW), with all proceeds from the surtaxes being deposited in the General Fund. These two forms of betting are growing quickly, and the current tax rates are very low compared to other states and to wagering at a comparable level in Kentucky. In addition, a majority of the revenues from the taxes imposed on both forms of betting are funneled back to the industry to support breeding and purses. The state racing commission has approved the installation of close to 10,000 new machines across the state over the next few years, presenting significant new opportunities to generate revenues for our General Fund while continuing to provide strong support for the horse industry. If passed, HB 607 could generate $60-80 million in new revenues annually for the General Fund, with likely additional growth as more machines are placed in service. HB 607 has been referred to the Licensing, Occupations, and Administrative Regulations Committee.
- Increase the tax on other tobacco products, including vaping, to match the cigarette tax increase passed in 2018 – HB 32, introduced by Representative Miller, increases the tax imposed against tobacco products other than cigarettes, including vaping products, to a level comparable to the cigarette tax increase enacted in 2018. Historically, taxes on all forms of tobacco have been increased simultaneously. However, that did not happen in 2018 and this proposal remedies that. The LRC fiscal note projects new revenues of $22.6 million in fiscal year 2021 and $27.3 million in fiscal year 2022 from this proposal, and the House assumes these revenues in the budget that it passed last week. The proposal has passed the House and has been referred to the Senate Appropriations and Revenue Committee for consideration.
- Raise the cigarette tax – The governor included an increase in Kentucky’s low cigarette tax in his budget proposal. Increasing the tax makes sense as a health measure to help deter youth smoking and will help in the short term as a temporary revenue raising measure. Kentucky’s $1.10 per pack is 36th among states and below the national average of $1.81 per pack. The governor proposed increasing it by 10 cents a pack, but as long as the state is raising the tax it should do so by at least 50 cents, which would raise approximately $100 million. Raising the cigarette tax rate by 50 cents and the other tobacco tax rate commensurate would generate additional revenue.
- Regulate and tax sports betting and fantasy sports – Although it will not raise much revenue, HB 137, sponsored by Representative Koenig, will regulate and tax activities that residents of Kentucky already engage in through programs and opportunities available in other states. This bill passed out of committee in the House, and is on the floor for consideration by the entire body with 18 floor amendments filed. If passed, revenues from this proposal are likely to be less than $10 million annually due to market saturation and the limited deployment of sports betting (no fiscal note exists on the bill).
- Provide additional support for state parks infrastructure – HB 601, sponsored by Representative Donohue, imposes a 1% surtax on the existing 1% transient room tax. This would provide a much-needed, consistent funding source to support state parks infrastructure. Based on receipts from the existing tax, this levy could generate up to $14 million a year. The bill has been referred to the House Appropriations and Revenue Committee.
- Require federally documented vessels to register in Kentucky – Under current law, boats that are federally documented are not required to register separately in Kentucky, making the payment of required annual property taxes on these boats difficult to enforce. HB 418, filed by Representative Tipton, would require federally documented vessels to be registered in Kentucky. This bill will likely not raise much new revenue, but it will treat all boat owners fairly and will help to ensure that cities, counties, school districts and the state will receive the property taxes due. The bill has been referred to the House Tourism and Outdoor Recreation Committee.
- Update the Limited Liability Entity minimum fee to take inflation into account– The governor also proposed raising the limited liability entity (LLE) minimum tax from its current $175 to $225. LLEs are businesses that are not organized as corporations, but that receive the same legal protections. It is wrong to assume they are all “small businesses” because many large corporations organize as LLEs or have LLE subsidiaries. According to one estimate, 82% of LLEs only pay the minimum fee because the tax exemption from paying the full LLE tax is so generous. The $175 fee was not indexed for inflation when it was created in 2006, and $225 simply makes the inflation adjustment over that time period. It would raise $8.2 million annually.
- Consider a temporary emergency surcharge on high earners – Though not on the table currently, Kentucky should create a temporary income tax surcharge on high earners to generate needed short-term revenues to both address immediate costs associated with coronavirus demands, a possible need for additional services in light of an economic downturn and in recognition of the resulting drop in revenues. A high-income surcharge applying, for example, to incomes above $150,000 would avoid affecting working families struggling to get by. It could be designed to go away in a short period of time (for example, 1-2 years) based on the state’s unemployment rate.
More commonsense revenue ideas are available in our Revenue Options report and in HB 416 sponsored by Representative Willner. It is a comprehensive proposal to clean up General Fund tax breaks that raises over $1 billion annually in new revenue, while holding the bottom 80% of Kentuckians harmless and asking more from the wealthiest Kentuckians. And even though HB 416 cleans up many tax breaks the wealthy benefit from, the top 20% would still pay less in state and federal income taxes combined than they did three years ago before significant new tax cuts were passed.
In addition to the proposals that would provide new revenues for the General Fund, the General Assembly should also pass HB 580 sponsored by Representative Santoro – a comprehensive proposal that is expected to generate $483 million annually to help support maintenance of our transportation infrastructure at the state, county and city levels. This bill has been referred to the House Appropriations and Revenue Committee.
Two: Oppose new tax breaks or expansions of existing ones
There have been more than 50 bills filed during the 2020 legislative session seeking to amend our tax code to provide additional exemptions, expansions, credits, carve-outs or special treatment for a particular industry or cause. While none of these proposals appear to be moving forward currently, we are at the point in the session where legislators are considering the budget, and where negotiations between the House and the Senate will soon begin. It was during this period in both 2018 and 2019 that many costly tax breaks and tax cuts, most of which were not previously proposed or discussed during the legislative committee process, were inserted into bills that moved quickly through the legislative process without adequate transparency or accountability to the public.
Legislators should not enact new tax breaks, or expand existing tax breaks, because we cannot afford them. We also encourage the continued suspension or repeal of the angel investor tax credit program (currently suspended until January of 2021) which provides an overly generous and poorly targeted subsidy for wealthy investors.
Three: Pass measures that will support the regular and systemic clean-up of existing tax breaks
Finally, legislators should pass measures that will provide more fiscal transparency both for legislation being considered by the General Assembly and tax breaks that are already on the books so they have adequate information to make fiscally responsible decisions about the budget in the future. Legislators from both parties have filed four bills this session (HB 63, HB 413, HB 422 and HB 533) that seek to provide more transparency, greater oversight and better information about the impact of proposed and enacted legislation on state revenues. The growing, bipartisan interest in such accountability measures may not be enough to improve the 2020-2022 Budget of the Commonwealth, but should be acted on now as a key part of making better decisions about Kentucky’s budget in the future.
[i] For instance, in testimony to the House Budget Review Subcommittee on General Government on February 11, 2020, it was reported that there is a waiting list of 218 veterans who need care in state-operated veteran’s nursing homes. Even though there are enough beds to serve everyone, facilities are under-staffed due to insufficient resources and low levels of pay. The inability to offer competitive salaries is a problem that exists across state government resulting high turnover, heavy workloads, and the inability to fill vacant positions and provide services.