It’s past time to fix Kentucky’s tax structure

FRANKFORT — Kentucky legislators began their annual session Tuesday in a snowstorm, and that was the least of their worries.

Much of Kentucky is still reeling from last week’s ice storm, which many are calling the biggest and most costly natural disaster in modern state history.

Worse still, the nation’s biggest economic crisis since the Great Depression has helped blow a $456 million hole in the state budget that must be filled by June 30.

To paraphrase our new president, Kentucky’s financial challenges are serious, they are many and they are real. As I stopped to chat with legislator after legislator, many just shook their heads and said there are no easy answers.

“It’s going to be ugly,” said Rep. Reginald Meeks, a Louisville Democrat. “But I look at it as an opportunity for us to show some leadership. The question is, are we going to continue to play politics as usual or do the heavy lifting it takes to improve the lives of Kentuckians in the future? We play politics at our peril.”

Kentucky’s part-time legislators are just like the rest of us: They’re reluctant to do anything unpleasant today that can be put off until tomorrow. But options for further procrastination are quickly disappearing.

Lawmakers face two big challenges. First, they must plug the hole in this fiscal year’s budget, because the constitution requires the budget to be balanced. That’s likely to require a lot of painful cuts to education and social services, as well as some higher taxes, most likely on cigarettes and alcohol.

Gov. Steve Beshear faces an uphill battle on his proposal to raise the state cigarette tax by 70 cents, to $1 a pack, which would raise $81.5 million this year and $144 million next year. The proposal has broad support among the public, education leaders, health advocates and the Kentucky Chamber of Commerce.

Studies consistently show that higher cigarette taxes lead to fewer smokers, which leads to a healthier population and lower long-term health care costs. It’s an economic no-brainer.

Still, some lawmakers are nervous, especially now that congressional Democrats are talking about raising the federal cigarette tax. They fear that poor people addicted to cigarettes will buy them anyway, no matter what the tax is, and that will hurt families.

But at some point Kentucky lawmakers must decide what they value: Education and health or cheap smokes.

Once the immediate crisis has passed, lawmakers must find a long-term fix for a tax system that doesn’t work in a 21st-century economy. They’ve known it doesn’t work since at least 2001, when an independent economist predicted the rising budget deficits the state has seen since the mid-1990s.

What’s the long-term fix? There are two competing visions, neither of which is likely to get much of a hearing until the 2010 regular session or a special session on tax reform.

One is being pushed by Rep. Bill Farmer, a Lexington Republican, who also thinks state spending needs to be scaled back.

Farmer has proposed removing virtually all sales tax exemptions, except on food, and taxing services used by individuals (as opposed to businesses), with the exception of medical care. He thinks that would raise enough revenue to allow the sales tax to be cut from 6 percent to 5 percent — and allow the state income tax to be eliminated.

Critics of Farmer’s approach say a system based on sales taxes would be too “regressive,” meaning it would hit poor people harder than those with higher incomes.

“We don’t have a progressive income tax system,” Farmer counters, noting that Kentucky’s 1950s-era income tax rate is capped at 6 percent for people making more than $8,000 a year, which is virtually everyone.

Jim Wayne, a Louisville Democrat, has a different approach. For the fourth year in a row, he filed a bill Tuesday that would make the state income tax more progressive — and more like the federal income tax system.

Wayne’s plan would raise taxes slightly on people earning more than $75,000 a year and provide a 15 percent earned income tax credit for low-income people. It also would restore the tax on estates worth more than $1 million and add sales tax to services used by wealthy people, such as limousine rides, charter air flights and country club fees.

“This is not a dramatic shift in income tax rates,” Wayne said. But even after the earned income tax credit returned about $90 million to the “working poor” it would increase state revenues by $250 million a year, he said.

No matter what approach lawmakers take, it’s clear they need to do something — and soon. Any change will involve political risk. But, as Wayne said, “The riskiest position is to not fix the system.”