Bush tax cuts turn 10; can we still afford them?

June 13, 2011

June 7 marked the 10th anniversary of the huge federal income tax cuts that President Barack Obama and Congress must soon decide whether to cancel or extend.

What a difference a decade makes: President George W. Bush proposed the tax cuts after he inherited a budget surplus. Three months after the cuts became law, the terrorist attacks of Sept. 11 led to the war in Afghanistan, followed in 2003 by the invasion of Iraq. Then the housing bubble burst, and the United States plunged into the worst economic slump since the Great Depression. With record deficits and serious national needs, can we still afford those tax cuts?

To mark the anniversary, Citizens for Tax Justice and Kentucky Youth Advocates released an analysis showing that if the tax cuts are made permanent, the richest 5 percent of Kentuckians will benefit 10 times more than the bottom 60 percent.

“In many ways, these tax cuts are little more than a stimulus package for the wealthiest of Kentuckians,” Terry Brooks, executive director of Kentucky Youth Advocates, said in a news release. “In these tough economic times, we need an approach where Kentucky’s hard-working families are given the same breaks as multimillionaires.”

To read the analysis, click here.


Farmer’s tax plan changes: sales tax up, not down

January 10, 2011

When researching my column today, I missed an important change in the state tax reform proposal that  Rep. Bill Farmer, a Lexington Republican, has made for each of the past several years.

Previously, Farmer said that by eliminating the state’s personal and corporate income taxes and extending the sales tax to most services, enough revenue could be generated to lower Kentucky’s 6 percent sales tax rate, perhaps to 5 percent or 5.5 percent.

Rep. Bill Farmer

But the version of the bill Farmer filed for this legislative session calls instead for raising the sales tax rate to 7 percent. Why the change?

“The economists missed badly last year” when estimating the tax revenues that would be produced by the changes he was proposing, Farmer said. How badly? About $1 billion.

Farmer said he still isn’t sure the changes would require an increase in the overall sales tax rate at a time when lawmakers would be taxing more services and removing exemptions in order to eliminate income taxes, but he is trying to be conservative. “It’s easier to start a little high and go low than to start low and have to raise it at some point,” he said.

Not that it is likely to matter. Farmer said he has little hope that any meaningful tax reform will happen this year — his plan or anyone else’s. And he is skeptical that Kentucky politicians will ever be willing to eliminate income taxes.

As I wrote in my column today, many business leaders and politicians like Tennessee’s tax system because they say that taxing consumption rather than income is more attractive to businesses and high-income workers.

But the tradeoff for Tennessee has been some of the nation’s highest sales taxes. That leaves poor and middle-class people paying a bigger share of their income in taxes than higher-income folks. The last commission Tennessee lawmakers appointed in 2002 to study that state’s tax system proposed fixing that problem by — you guessed it — creating a state income tax.


Tennessee tax system is hardly a perfect model

January 10, 2011

When discussing state tax reform, Kentucky executives and politicians often cite Tennessee as a model. But many people south of the state line would beg to differ.

What some tax reform advocates like about Tennessee is that it has no state income tax, which gives it a competitive advantage in attracting businesses and high-income workers. But Tennessee makes up for it with sky-high sales taxes.

While Kentuckians pay a 6 percent sales tax on most goods — and nothing on food — Tennesseans pay an average 9.35 percent in state and local sales tax on non-food items, the nation’s highest rate. Food is taxed at an average of 7.9 percent, the nation’s third-highest rate.

Taxing consumption more than income to spur economic growth makes sense philosophically. But things get complicated in the real world.

Tennessee’s tax system puts a greater share of the overall burden on poor and middle-class residents. High sales taxes also hurt small businesses and retailers, because Tennesseans often cross state lines or buy online.

Both Tennessee and Kentucky suffer from chronic budget shortfalls. They also spend less on health and social services than most other states do, which could help explain why both are in the bottom tier of state rankings of income, educational attainment and health.

The Tennessee General Assembly was concerned enough about the situation in 2002 to appoint the Tax Structure Study Commission. After two years of study, it recommended changing Tennessee’s tax system to be more like, well, Kentucky’s.

The commission recommended creating an income tax that would make it possible to lower Tennessee’s total sales tax rate to 6 percent, with food taxes falling to 4 percent. The income tax would have four tiers ranging from 3.5 percent to 6 percent, and families would not hit the top bracket until they made $100,000. (Kentucky’s income tax structure, a relic from the 1950s, tops out at 6 percent for people making more than $8,000 a year, which is virtually everyone.)

Like various tax reform plans in Kentucky, the Tennessee commission’s recommendations and similar proposals since then have gone nowhere politically. But they are worth keeping in mind, especially since Kentucky Senate President David Williams, who is running for governor against incumbent Steve Beshear, has Tennessee-style tax reform on his agenda.

Two state representatives — Democrat Jim Wayne of Louisville and Republican Bill Farmer of Lexington — have long proposed competing visions for Kentucky tax reform.

Wayne would recalibrate income tax brackets to reflect modern incomes. He also would tax some services used mostly by wealthy people. Farmer would eliminate most sales tax exemptions — except for food — and add taxes on most services.

He thinks that would generate enough revenue to lower the sales tax rate below 6 percent and eliminate the income tax. While in previous years Farmer estimated that could generate enough revenue to eliminate income taxes and lower the sales tax rate below 6 percent, the version of the bill he filed for this legislative session calls for raising the sales tax rate to 7 percent. (See followup blog post.)

The solution probably lies with some combination of those proposals, especially the ideas about taxing services, eliminating many exemptions and updating income tax brackets.

What Kentucky needs is an equitable, “business friendly” tax structure that promotes economic growth without shifting too much of the tax burden to poor and middle-income people; and one that provides enough tax revenue to meet Kentucky’s needs, even as the economy evolves. The devil, of course, is in the details.

As lawmakers consider tax reform, here are a few other things to think about:

■ Economists say Kentucky, compared to other states, under-taxes real estate. Low property taxes are a legacy of political pressure from property owners and 1979 legislation that capped annual property tax increases at 4 percent, despite the fact that property values have often risen much more than that.

■ Kentucky’s coal severance tax, which has been 4.5 percent for more than 30 years, is the lowest among major coal states. The tax is 5 percent in West Virginia and 7 percent in Wyoming. In addition, the citizens group Kentuckians For The Commonwealth estimates that Kentucky taxpayers provide more than $97 million in annual subsidies to the politically powerful coal industry.

■ Lawmakers have in recent years raised cigarette taxes from ridiculously low levels. But Kentucky’s 60-cent per pack tax is still less than half the national average of $1.45.

■ Kentucky’s tax code is riddled with exemptions, few of which have been analyzed to see if they provide any overall economic benefit to the state. A comprehensive analysis is long overdue.


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

February 3, 2009

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.”