Kentucky legislators are considering various sales and property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. changes this legislative session as part of H.B. 360, a bill that passed the House on March 8th with a committee substitute and the Senate on March 13th with a Senate committee substitute. The bill is likely to head to a conference committee that will resolve differences between the House- and Senate-passed versions, as has been done in past sessions. While some of the changes being considered—such as removing additional categories of tangible personal property from taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ation—are a step in the right direction, various proposed sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. changes could make Kentucky’s state tax landscape considerably more burdensome for manufacturers and other businesses.
Most notably, the Senate-passed version contains a concerning provision that would jeopardize Kentucky’s sales tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. for manufacturing supplies. For background, the Kentucky Supreme Court, in its December 2022 decision in Century Aluminum of Kentucky, GP v. Department of Revenue, held that industrial supplies consumed within the manufacturing or industrial process within a year are sales tax-exempt when they are purchased again in the future, not treated as taxable repair parts.
The Senate committee substitute to H.B. 360, however, contains a provision specifying that the Century Aluminum court ruling shall apply only to that company and only for dates between November 2010 and May 2015. This would effectively prevent the Court’s interpretation of the law related to the supplies exemption from applying to other companies or current purchases, opening the door for the Department of Revenue to enforce an overly broad definition of taxable repair parts that includes items consumed within the production process. Such an interpretation could sharply increase the cost of production for many Kentucky businesses, which could force them to raise their prices, reduce costs (such as by laying off employees or canceling planned investments), or leave Kentucky for states that maintain more appropriate sales tax exemptions for these and other business inputs.
Under a properly designed retail sales tax structure, the sales tax should apply to final personal consumption only, not to business inputs. Manufacturing and industrial supplies are quite obviously business inputs because they are directly consumed in the production process, but many economists would likewise consider repair parts—currently taxable in Kentucky—to be business inputs that ought to be exempt.
Taxing business inputs—especially those that are a direct component of the final product, as manufacturing and industrial supplies are—raises the costs of production and leads to economically harmful tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. , where taxes are embedded in the cost of goods sold multiple times over, leading to a tax on a tax when the final retail sales tax is collected from the consumer.
At a minimum, Kentucky legislators should allow the Kentucky Supreme Court’s Century Aluminum decision to stand. Beyond that, Kentucky legislators should reconsider the proposed treatment of various business inputs in H.B. 360 as well as the current treatment under existing law.
Both the House- and Senate-passed versions of H.B. 360 would remove marketing services from the sales tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , which is a step in the right direction, as marketing services are another form of business input. Both versions of the bill take a step in the wrong direction, however, by expanding the definition of taxable telemarketing services to an overly broad definition that includes some digital advertising, including text- and social media-based communications.
Since sales taxes—including Kentucky’s—tend to be destination-sourced, the tax is imposed on the company benefiting from the online marketing, meaning it falls on Kentucky businesses placing social media ads anywhere, not on businesses anywhere that advertise via social media in Kentucky. While this is already the case for telemarketing under current law, the proposal dramatically expands the definition of taxable telemarketing into areas likely to be more significant for Kentucky businesses in competition with out-of-state firms.
The best solution would be to remove marketing and telemarketing services from the sales tax base entirely, as the inclusion of these services in the sales tax base puts Kentucky businesses at a competitive disadvantage compared to out-of-state competitors. And Kentucky certainly should not expand its base to tax more advertising, which is almost invariably exempted in other states.
In fact, Kentucky should go beyond that by reversing the provisions within H.B. 8, enacted in 2022, that broadened the sales tax base to include additional business inputs. While H.B. 8’s income tax reductions and broadening of the sales tax base to additional consumer purchases are examples of good tax policy, the law’s broadening of the sales tax base to services purchased primarily by businesses was a less-than-ideal policy decision. Executive recruitment services, lobbying services, nonresidential security system monitoring services, janitorial services, linen supply services, social event planning services, and space rental services, to name a few, should not be taxable when purchased in a business-to-business context, as these too lead to sales taxes being passed along to final consumers in a nontransparent manner.
Notably, the House version of the bill (but not the Senate version) would exempt additional categories of tangible and intangible personal property from the property tax base, consistent with Tax Foundation recommendations. Farm implements and farm machinery, livestock, certain vehicles, and computer software are among the forms of tangible personal property that would no longer be subject to taxation. Ideally, property taxes should extend to real property—including land and structures—but not tangible or intangible property. Taxing non-real property penalizes capital investment in Kentucky, causes economic distortions, and creates a complex, nonneutral tax structure. It should be avoided.
As final negotiations occur between the House and Senate, legislators should avoid adopting new policies that would jeopardize Kentucky’s business tax competitiveness. Kentucky took great strides to improve tax competitiveness with the income tax-reducing provisions in H.B. 8, but some of that progress could be negated by the application of the sales tax to broad new categories of business inputs, including various types of manufacturing and industrial supplies, certain digital advertising services, and others.
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