Economists recommend directions for tax reform

FRANKFORT — This is the time each year when Kentucky lawmakers usually engage in their own version of insanity: doing the same things over and over and expecting different results.

The situation has gotten so crazy, though, that this year could be different.

Kentucky’s tax system has been out of sync with the economy for more than a decade, creating ever-larger deficits despite frequent budget-cutting and quick-fix tax increases.

The General Assembly is finally considering comprehensive tax reform, and lawmakers got some good advice Wednesday at a standing-room-only symposium organized by the University of Kentucky’s Martin School of Public Policy and State Treasurer Todd Hollenbach.

In presentations by six economists and other experts, it quickly became clear that the tax system’s inability to reliably provide enough revenue to meet Kentucky’s needs isn’t the only problem.

Compared with surrounding states, most of the economists agreed, Kentucky taxes property and the sales of goods and services too little and taxes income too much. That hurts economic growth because it puts Kentucky at a competitive disadvantage for attracting human capital and the businesses that employ it.

“We are discouraging younger, more-educated workers from moving to the state,” said UK economist Kenneth Troske.

Kentucky’s low property taxes are a legacy of rural heritage, political pressure from property owners and 1979 legislation that capped property tax increases at 4 percent a year, even though property values have often risen much more than that.

“We have a great tax code for a manufacturing economy and an agrarian economy and a poor tax code for a knowledge economy,” said Joseph Reagan, president of Greater Louisville Inc.

Kentucky’s 6 percent sales tax applies to goods but few services.

“The fastest growing part of the economy is services, and you’re not taxing them,” said William Fox, a University of Tennessee economist who first outlined the problem in a report to the General Assembly in 2002.

In addition, there are many special-interest tax breaks, but little analysis of whether they give Kentucky overall economic benefits.

Those factors create a narrower tax base and result in higher tax rates. A better system would be just the opposite: a broader base with lower rates.

Rep. Bill Farmer, R-Lexington, has proposed broadening the sales tax to cover services and closing loopholes so the 6 percent tax rate could be lowered and the individual and corporate income taxes could be eliminated.

Farmer said states without income taxes have shown more economic growth. But critics of consumption-based tax systems say they can be unfair to low-income people.

UK economist James Ziliak said that could be offset if Kentucky joined 23 other states in creating an earned-income tax credit. He recommended one modeled after the 35-year-old federal credit, which has been widely praised as a cheap and effective way to ease poverty.

Kentucky’s economy is actually a collection of at least six very different regional economies, many tied to cities in other states and all with their own special needs and issues, Troske said.

A highly centralized, one-size-fits-all state tax system doesn’t fit any region well.

A lot of tax revenues from cities go to support rural areas. But the rural-dominated General Assembly has given cities few ways besides payroll taxes to raise revenues to meet their special needs and compete for economic growth with similar-size cities in other states.

“This has hurt our local governments’ abilities to collect revenue and made us more reliant on the state,” said University of Louisville economist Paul Coomes.

Coomes said local-option sales taxes are common in neighboring states, and he noted that taxpayers are often more willing to pay taxes when they can see tangible local benefits from them.

David Adkisson, president of the Kentucky Chamber of Commerce, said that while the tax code needs improvement, the state also needs to spend money more wisely. In particular, he said, huge recent increases in state spending for employee benefits, prisons and Medicaid need to be curbed.

Kentucky needs tax and spending reform now, both to solve the potential $1.5 billion shortfall over the next two years and to create a brighter future for this historically poor state.

Ignoring the problems any longer would simply be insane.



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