Progressive or regressive?

The goal for the Blue Ribbon Commission is to suggest reforms that will create a tax system that meets these principles:

  • Fairness
  • Competitiveness
  • Simplicity and Compliance
  • Elasticity
  • Adequacy

The Blue Ribbon Commission on Tax Reform took steps toward formulating a set of recommendations to overhaul Kentucky’s tax system at a day-long meeting on Thursday, with both some hopeful actions and some discouraging discussions.

Commissioners spent several hours talking about changes in individual income taxes, and put together a package of suggested reforms. There was broad support for a state refundable Earned Income Tax Credit, and they ended up settling on a level at 15% of the federal EITC – exactly what KFTC has supported in the Kentucky Forward Plan!

“The EITC keeps a lot of people out of poverty, I’m glad they kept that,” said KFTC member Paul Schwartz of northern Kentucky who attended the meeting.

There also was general agreement that changes in the individual income taxes should result in an increase in revenue, though there was no sense is how much new revenue or agreement from what income levels it would come from.

Not so encouraging was when the discussion turned to making the system more progressive.

Jason Bailey of the Kentucky Center for Economic Policy explained that individual income taxes – as Kentucky’s largest single source of tax revenue – offers the best option for making Kentucky’s overall tax system more progressive (the second largest tax revenue source, the sales tax, is by its nature regressive). This could be achieved by having graduated tax rates – as income increases so does the tax rate.

Commissioners started with a proposal with rates being stepped up from 2% on the first $8,000 of income to 7% on income more than $60,000. However, some on the commission expressed support for a flat tax instead, possibly at 5%.

Greg Harkenrider (with the state budget office who has provided volumes of research on all the options being considered) very clearly stated that a flat tax would mean a tax increase for incomes less than $50,000 and a tax decrease for incomes greater than $50,000.

Yet that regressivity did not seem to matter to some. A straw vote had 7 supporting a flat rate and 5 for graduated rates (with some not voting).

In the end, the commission did not decide what tax rate structure to support, but asked staff to generate revenue numbers for various options and – at the insistence of Rep. Jim Wayne, Bailey and others – a distributional analysis of what the impact would be across various income levels.

“I like that they were concerned about how it’s going to affect lower income people,” said Schwartz. “I think the numbers are going to show that it [flat tax] shifts taxes to low and middle incomes.”

There was a strong push for lowering individual tax rates from what they are now (5.8% for income more than $8,000 but less than $75,000 and 6% for income more than $75,000). The reasoning for lowering rates was that more income would be taxed by disallowing 75% of itemized deductions and taxing public and private retirement income after the first $15,000 (currently the first $41,110 of retirement income per individual is exempt from state income taxes). They also agreed that the portion of Social Security income that is currently subject to federal taxation could also be taxed by the state.

Throughout the commission’s recent meeting have been a couple of recurring “themes” that KFTC members have found troubling.

”At the last [Oct. 23] meeting, I was disappointed with the first half of the meeting when they were mostly talking about how to help rich people,” said Linda Stettenbenz. “Then the conversation started to shift a little to talk about equity and revenue.

“In this meeting they talked a lot of about revenue and how important that was, but I still feel there is a missing piece, and that is the disparity of incomes and how proposals impact poor people and rich people differently. There is not really a lot of understanding about that.”

They are focused on job creation and revenue, but that is not the same as talking about do we value the lives of everyone in this state, that everyone has a roof over their heads and can afford heat in the winter. Is the economy about making more and more things, or is it about being people able to eat?”

Another troubling trend throughout all the commission’s meetings is the number of references and comparisons to other states, as if Kentucky could not do anything better than a neighbor. Many commissioners seem to have an anecdote about a person who, for example, works in Kentucky but lives just across the border in Tennessee in order to avoid state income taxes; or would cross into another state to buy something there if they could save a dollar in sales tax – as if the example is the norm and should drive the decision whether or not to accept a proposed change in Kentucky’s tax structure.

Bailey and Rep. Wayne pushed back, pointing out that if we invested in making Kentucky a great state with great schools and healthy communities then that would make people and businesses want to be here. Rep. Wayne pointed out that North Carolina has a top individual income tax rate of 7.5% and is one of the most economically advanced states in the South with excellent universities.


Corporate Taxes

Commissioners also considered more than a dozen proposed changes for corporate taxes, accepting some and rejecting others. Most had to do with the way income is calculated and reported, such as “single factor apportionment” and “destination sourcing,” and tax credits for research & development or “angel” investments in startup businesses. Those choices would result in both revenue gains and losses, with the cumulative impact not yet clear.

“There were some good proposals that would help level the playing field for small businesses,” said Jefferson County member Linda Stettenbenz.

Sales Taxes

There was agreement to expand the sales tax to some services – again something KFTC supports in the Kentucky Forward Bill. However, there was not agreement on what specific services should be taxed.

Rep. Jim Wayne pointed out that the sales tax is a very regressive tax, and that if it’s expanded to services they should target those services used primarily by upper income folks to help balance the overall tax structure. There was some pushback against this.

Instead of talking about what services to tax, the commission agreed to a set of principles by which another body (the governor or General Assembly) could decide what specific services fit these criteria.

Principles:

  • 10 or more states already tax the service
  • consumption based (sold to households rather than to businesses; consumed in households). Rep. Wayne pointed out there are certain things that other states tax that corporations or businesses pay, like janitorial taxes, that should not be eliminated by this principle;
  • clear sourcing in Kentucky (the transaction happens on Kentucky soil)
  • tied to the sale of a taxable tangible product (if a new muffler for your car is taxed, so should the labor to put it on)
  • inelastic demand services (like funerals)
  • sensitive to border states sales tax rates.


Also, the commission did not address the question of whether the sales tax rate should be changed.

The commission tentatively set it next meeting for Monday, November 19 from 10 a.m. to 5 p.m. in Frankfort. The commission has more about sales taxes to discuss as well as severance tax, property tax, local taxation issues, road fund issues and tax administration, and circling back to income taxes.

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