Kentucky ended the 2017 fiscal year with $138.5 million less in General Fund revenue than economists predicted would be collected. The shortfall puts slightly more pressure on investments in our schools, universities and community colleges, health and human services and other building blocks of Kentucky communities. And its details reinforce the need to generate more revenue in ways that will work.
Total General Fund receipts in FY 2017 totaled $10.5 billion. Receipts did grow compared to FY 2016 by $138.9 million (1.3 percent), but the forecast predicted twice as much growth (2.7 percent). In general, year-over-year revenue growth is to be expected and has been the case historically in Kentucky, with total General Fund receipts growing 8 out of the last 10 years despite a major recession from which we’re still recovering.
A shortfall occurs when actual revenue does not meet the revenues estimated by the Consensus Forecasting Group. Those estimates are based on past revenue performance of the various taxes and fees levied by the commonwealth, and a review of general economic conditions in Kentucky and the nation. The estimates against which 2017 revenues are compared were made in late 2015. To put the shortfall in context, the amount actually generated is only 1.3 percent less than was predicted, which, given the length of time and number of factors considered, is pretty close. The governor has the ability to address the shortfall through a reduction plan that includes an already-ordered cut to agency spending of 1 percent, transfer of unspent funds and use of up to $59 million from the already-modest rainy day fund.
Even though the estimates were close and the deficit is not large, when considered in the context of Kentucky’s overall fiscal health, the shortfall underscores the inadequacy of our current tax structure to meet the needs of the commonwealth. We simply do not have the resources necessary to pay down the state’s unfunded pension liability, meaningfully respond to the opioid addiction or child protection crisis or recover from 16 rounds of budget cuts since 2007.
Kentucky’s main revenue sources – the individual income tax and the sales and use tax which comprise 41.9 percent and 33.2 percent, respectively, of total General Fund revenue in 2017 – both underperformed and contributed to the shortfall. The individual income tax was 0.4 percent below predictions and sales tax receipts were 1.5 percent lower than expected.
When comparing the overall strength of the individual income tax and the sales tax over time, it is important to note that since 2007, the individual income tax has grown by 44.5 percent while the sales tax has only grown 23.7 percent. The relative strength of the income tax showed up this year as well, as income tax receipts grew by 2.6 percent and generated $112 million more than the year before, while the sales tax grew by only 0.7 percent and generated $23 million more than 2016.
A major reason for the stronger growth in the income tax – which is more progressive (people with more income generally pay a larger share of their income in taxes than low- and middle-income people do) – is that it better aligns with the rapid income growth at the top in today’s increasingly unequal economy. The sales tax, on the other hand, asks more of middle and low-income people who have not seen their income or their purchasing power grow in decades. The sales tax also suffers from a relatively narrow base because it doesn’t generally apply to services, a faster growing sector of our economy.
Other revenue sources also contributed to lackluster overall growth in receipts: corporate income taxes, which are inherently volatile, fell 5.5 percent relative to 2016 and brought in 14.1 percent less than predicted. In fact, at $81.9 million less than was forecast, corporate income taxes were the largest nominal contributor to the shortfall. Factoring limited liability entity taxes (which businesses also pay) into corporate income taxes, these receipts grew by 1.8 percent compared to 2016 but underperformed estimates by 7.5 percent. Coal severance revenue fell for the 6th consecutive year to just a 1/3 of 2012 receipts, and cigarette taxes fell by 1.3 percent since last year.
Later this month, the state will close out the expenditure side of the budget and we will have an overall picture of where we stand fiscally. Later this year, in preparation for the 2018 budget session, the Consensus Forecasting Group will begin developing revenue estimates and agency heads will develop budget proposals for the 2018-2020 biennium. In addition to these processes moving forward, the governor has indicated that he plans to call a special session to address tax reform and pension reform – all further opportunities to examine Kentucky’s fiscal health.
As legislators consider the needs of the commonwealth and the ability of our tax code to generate sufficient revenues to meet them, the shortfall for 2017 should serve as a warning. Cutting income taxes for those at the top and shifting to heavier reliance on slower-growing sales taxes – which some Kentucky’s leaders are falsely promoting as a solution to not only budgetary but also economic woes – would deepen the fiscal challenges we face today. The real solution lies in cleaning up expensive special interest tax breaks that provide little to no benefit to the commonwealth. Real tax reform wouldn’t prevent shortfalls, but it would greatly improve the context in which they must be addressed.