Facing one of the worst-funded pension systems in the country and a bleak budget outlook, legislators in Kentucky overrode Governor Matt Bevin’s veto to pass HB 366, a 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. reform package, in the last few days of the session. Ultimately, HB 366 raises $395.8 million in revenue for the state and increases Kentucky’s ranking on the State Business Tax Climate Index from 33rd to 18th.
The final passage of HB 366 has been a multistep process that resulted in some unlikely political coalitions. The House and Senate passed the bill on April 2nd, but Governor Bevin (R) vetoed it and the budget bill a week later on April 9th, citing concerns that it does not make the state more financially stable and expressing a desire for more comprehensive reform. Budget Director John Chilton also expressed concerns that the revenue estimate for HB 366 was overestimated by approximately $87 million.
After a heated debate, however, the legislature voted to override the governor’s veto, with the Senate voting 20-18 and the House voting 57-40.
Here’s how HB 366 changes Kentucky’s tax code:
- Replacing the current six-bracket individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. , which has a top rate of 6.0 percent, with a 5 percent single rate individual income tax;
- Broadening the starting income 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. by removing most deductions and repealing the personal exemption credit ($10 per filer, $20 per dependent);
- Decreasing the amount of pension income excluded from income tax from $41,110 to $31,110;
- Replacing the current three-bracket corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , with its top rate of 6.0 percent, with a 5 percent flat rate;
- Phasing out the inventory tax using a tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. ;
- Adopting single-sales factor apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. and conforming to the federal Internal Revenue Code as of December 31, 2017;
- Suspending several business tax credits;
- Expanding the 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. base to include select services (landscaping; janitorial services; pet care and grooming, and small animal veterinary services; fitness and recreational sports; laundry, dry cleaning, and linen supply; nonmedical diet and weight loss centers; limousine services; bowling; overnight trailer campgrounds; extended warranties; and other personal services); and
- Raising the cigarette tax from 60 cents to $1.10 per pack.
The legislature then quickly shifted its focus to HB 487, the “revenue cleanup bill,” where several changes and minor drafting corrections were made to the original tax reform bill. The cleanup bill restores several tax credits, decouples from the federal pass-through deduction, and exempts manufacturing business inputs from the sales tax base expansion.
There is still work to be done. Kentucky imposes an antiquated local gross receipts-style tax called the Limited Liability Entity Tax (LLET), is one of only six states to levy an inheritance taxAn inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate. , and using a tax credit to phase out the inventory tax has proven to be a headache in some states.
However, the changes in this tax reform package dramatically improve the state’s tax climate. By broadening bases while lowering rates, starting to correct the inequities in the sales tax base, and taking steps to make the state more friendly to investment, policymakers in the state took a responsible approach to comprehensive tax reform.
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