By John Cheves
In 2012, having slashed $1.2 billion in state spending during his first term, Gov. Steve Beshear named two dozen people to a “blue-ribbon commission” to study Kentucky’s tax code and suggest reforms to help the state budget keep pace with demand for services.
Beshear said this report would not end up like eight previous reports on the tax code since 1995, which got stuck on shelves around Frankfort to be forgotten. Ignore the skeptics, he said at a February 2012 news conference.
“I would say to them to fasten their seat belts,” Beshear said. “Get ready for not just another study but for some proposals that I think can refashion Kentucky’s future.”
Twenty-one months later, there’s no need for a seat belt.
Led by Lt. Gov. Jerry Abramson, the commission spent 2012 listening to economists, taxation experts and hundreds of concerned citizens at statewide hearings. At year’s end, it gave Beshear a 453-page report with scores of recommendations, many controversial, such as taxing more of retirees’ pension incomes, taxing some services and raising the tax on a pack of cigarettes from 60 cents to $1.
Taken as a whole, the proposals would have added $659 million annually to the $9.5 billion General Fund that pays for schools, police, prisons, social services, parks, environmental protection and other public needs. In addition, the report would have introduced scrutiny to the $12.1 billion that Kentucky gives away every year in largely unexamined tax breaks, some dating back to the Great Depression.
Beshear thanked the commission for its work. Then the report joined its eight predecessors on shelves around Frankfort.
A handful of its ideas went into measures passed in the 2013 legislative session, such as changes in how chewing tobacco and snuff are taxed, yielding “an indeterminable impact” on revenue. The much-heralded state pension reform package partially relied on $95 million a year captured by halving one individual tax credit, closing some business tax loopholes and other minor alterations suggested in the report.
However, comprehensive tax reform — efforts to raise hundreds of millions of dollars in fresh revenue while rethinking who pays what and how — went nowhere in the General Assembly during 2013.
As the 2014 legislative session approaches in January, lawmakers say they don’t expect tax reform to be revived.
“To be honest with you, I don’t recall anyone being particularly enamored with it,” said Sen. Bob Leeper, a Paducah independent who is chairman of the Senate budget committee. “I’ve certainly not had any conversations with anyone about it lately.”
“I don’t know if comprehensive tax reform is doable right now, given the political climate,” said Leeper’s House budget committee counterpart, Rep. Rick Rand, D-Bedford.
The General Assembly this winter will face, on the one hand, scores of groups clamoring for more money after five years of budget cuts and, on the other, an electorate with its own financial worries that does not want to pay higher taxes, Rand said.
“People just don’t like new taxes, even if you explain the benefits to them, like better schools, new roads. It’s hard to get past that. The easiest thing for a political candidate to say is, ‘I will never raise your taxes, I will only lower them,'” Rand said.
‘Disappointing grab bag’
As Beshear appointed the commission, he said he wanted a tax code that was simple, fair, efficient, competitive and elastic, with taxes low enough for Kentucky to be an attractive place to do business, yet high enough to pay for the services people expect.
Some critics thought the panel’s report fell short of that ambitious goal. The nonpartisan Tax Foundation in Washington, D.C. called it a “disappointing grab bag” in a December 2012 critique.
“Some of the recommendations are timely and should be implemented, but overall, the report offers a grab-bag of provisions with little central theme,” the Tax Foundation wrote. “The recommendations would raise income and excise taxes, reduce corporate taxes (primarily for select in-state businesses) and maintain a costly business property tax system with few changes. The merits and implications of this approach are not explained in the report, let alone defended as the right policy.”
At present, the state’s General Fund relies on a 20th-century tax code. It gets nearly three-fourths of its money from individual income and sales taxes. However, tax collection isn’t keeping up with Kentuckians’ modest income growth.
Among other problems, more of people’s income is coming from government benefits and corporate fringe benefits, which aren’t taxable. Simultaneously, Kentucky has moved toward a largely untaxed service economy — lawyers, auto mechanics, accountants and the like.
By comparison, relatively little comes into the General Fund from taxes on corporations, property, tobacco, coal or other customary sources.
This tax structure — particularly the 6 percent sales tax that raises one-third of General Fund revenue — hits poor and middle-class families harder than rich families. By necessity, poor people tend to spend most of their money buying things, with little saved or invested. A 2003 study showed that the wealthiest Kentucky families paid 7.8 percent of their income in state and local taxes, compared to 9.8 percent for the poorest families and 10 percent or more for middle-class families.
More worrisome for lawmakers, state government’s average annual revenue growth shrank from 14 percent during the 1960s to 2 percent during the 2000s. Meanwhile, the state’s debt is climbing through bonds and unmet obligations to the state pension system. Wall Street analysts have noticed and downgraded Kentucky’s credit rating, making it more expensive to borrow money.
Unless taxes are raised or spending is slashed still further, Kentucky is on track to face a $1 billion annual deficit by the year 2020, University of Kentucky economists warned the tax-reform commission.
“Kentucky’s main revenue sources are growing slower than its economy,” the economists wrote in their own September 2012 report to the commission. “A continuation of this trend could seriously hinder Kentucky’s ability to deliver quality education, health and other public services.”
Some members of the tax-reform commission said they’re not ready to surrender their campaign.
“I’m still hopeful that we’re going to see something come out of it. Every group that I talk to knows that we’re going to have to have additional revenue to keep making progress in our state,” said Stu Silberman, executive director of the Prichard Committee for Academic Excellence, a schools advocacy group.
As part of their education, commission members learned about the painful impact of spending cuts — some as deep as 38 percent — across many state agencies since 2008 while debt service payments, Medicaid and prisons gobble up larger slices of the pie.
Among the effects:
■ Basic K-12 school funding froze, which is effectively a cut because student enrollment is increasing and prices are rising, as are mandatory pension and health care contributions for school employees. Meanwhile, state aid has dried up for textbook purchases, after-school tutoring programs, teacher training and other classroom assistance.
The erosion of state support means that Kentucky’s rich communities, with a stronger local tax base, can offer more to their kids than poor communities, which counted on state funding to close the gap. This year, a child in wealthy Anchorage in Jefferson County can expect $19,927 in school spending on her behalf while her country cousin in Barbourville in Knox County can expect only $8,362.
That sort of inequality was supposed to be eliminated by the Kentucky Education Reform Act of 1990.
■ The price for attending a public university jumped as the state reduced its support for higher education. At UK, for example, state funding dropped from about $325 million a year in 2008 to $284 million five years later, with tuition surging from $255 million a year to $339 million. For an in-state undergraduate, that means UK now costs more than $10,000 per year — up from about $7,000 in 2008.
■ State government’s roughly 32,000 employees (down from about 37,000 a decade ago) have not seen a pay raise in four years, while six days of unpaid furlough in Fiscal Year 2011 meant a 2.3 percent pay cut for that year.
■ Citing an $87 million shortfall, the Kentucky Department of Community Based Services said it would stop accepting applications for a program that pays relatives to care for abused or neglected children taken from their parents. When the announcement was made a year ago, more than 11,000 Kentucky children were cared for by relatives who received $300 a month to help cover expenses.
■ The state forfeited $11 million in matching federal funds for a rehabilitation-to-work program for the disabled, resulting in 8,900 fewer Kentuckians served.
■ Kentucky’s 59 public health departments struggled to deliver mandated services while their state funding declined. The departments reduced their business hours, laid off and furloughed employees and cut programs like immunization and diabetes education.
“We keep having these rallies in Frankfort to remind legislators that these aren’t just numbers on paper when they’re cutting services in the budget, these are real people with real lives who need our assistance,” said commission member Sheila Schuster, executive director at Action Advocacy Network, which represents the sick and mentally ill.
“But as soon as you mention the word ‘tax,’ the legislators say ‘Oh no, not me,'” Schuster said. “In an election year, it’s unlikely you’ll see a lot of them willing to stick out their necks.”
In 2014, all 100 House seats and 19 of the 38 Senate seats are up for grabs. Republicans control the Senate and are making a play for the House, where Democrats narrowly cling to a majority. The following year is the gubernatorial election.
“I think there are many areas that need more funding, that aren’t getting what they need, with education being an obvious one,” said Rep. Dwight Butler, R-Harned, a vice chairman of the House budget committee. “Politically, however, it would take a strong will to get anything done, and I don’t know who would take the lead.”
Another Republican on the House budget committee, Rep. Tommy Turner of Somerset, said he agreed with Butler’s assessment.
“Some people think you don’t need any more taxes, some people want to raise taxes on everything, and then there are a few in the middle who want to try and work out a compromise,” Turner said. “But it’s not easy. There aren’t many people in the middle anymore, and in an election year, that’s just going to get worse.”
In a prepared statement, Beshear recently said that tax reform isn’t necessarily dead.
“I remain interested in implementing comprehensive tax reform to help address the future needs of the commonwealth and remain hopeful that we will address the issue during the 2014 legislative session,” said Beshear, a Democrat halfway through his second and final term.
But reform won’t happen unless Beshear takes charge, speaking out around Kentucky and pressuring lawmakers in Frankfort, said Rep. Jim Wayne, D-Louisville.
Wayne, a commission member, unsuccessfully tried to pass a tax reform bill last winter, as he has for many years.
“The governor has some political capital right now, and my hope would be that he expends it to help people understand how essential tax reform is,” Wayne said. “Because if we don’t get it in the next session, the state budget is going to be an absolute disaster in terms of education, social services, environmental protection, infrastructure.”
“Everyone has been cut to the bone and is coming to us to say they need some funding restored,” Wayne said. “But we don’t have it to give them. We’re facing a financial crisis.”
Proposals from Gov. Steve Beshear’s ’12 tax-reform commission
Individual income tax: $474,980,000 gained in annual revenue by taxing more pension income, limiting itemized deductions, lowering the individual tax rate and enacting a state Earned Income Tax Credit for poor people
Corporate taxes: $104,000,000 lost in annual revenue by changing the income tax formula for multi-state firms, adding management fees to calculation of income taxes, and lowering the threshold that determines the minimum amount paid for limited liability corporations from $3 million to $1 million
Sales and excise taxes: $305,800,000 gained in annual revenue by broadening the sales tax to some services, increasing the tax on cigarettes to $1 per pack, imposing a 1 percent tax on residential and business utilities, and creating new tax breaks for the horse industry
Property taxes: $31,600,000 lost in annual revenue by creating new tax breaks for the bourbon industry, freezing the state property tax rate at 12 cents per $100 of value, and exempting inventory from state property tax
Severance taxes: $2,000,000 gained in annual revenue by eliminating the export credit under the minerals severance tax
Other taxes/issues: $6,000,000 gained in annual revenue by adding reviews every five years of all tax incentives and tax breaks to see if they’re worthwhile and imposing the pari-mutuel tax on advance deposit wagers made on live races held at Kentucky racetracks
Simplicity, compliance and tax administration: $5,920,000 gained in annual revenue by allowing non-renewal of professional licenses, driver’s licenses and vehicle registration for non-payment of taxes; updating use tax notification and compliance requirements for remote vendors; and extending the number of days to protest an assessment to at least 60 if not 90
Total General Fund impact: $659,100,000 gained in annual revenue