Updated Kentucky Tax Reform Package Would Boost State from 33rd to 18th on the State Business Tax Climate Index (Updated)

With one of the worst-funded pension systems in the nation, among other pressing fiscal concerns, Kentucky lawmakers are searching for revenue. There have been several proposals for raising additional revenue, most of them straight-up 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. increases. The latest proposal, emerging from legislative conference committee this morning, is more intriguing: it raises an additional $487 million over the next biennium for a cash-strapped state government, but does so in the context of fundamental tax reform, trading additional revenue for measures which simplify the state’s tax code and improve its overall competitiveness.

In fact, while overall revenues would be higher, improvements in tax structure would propel the state on our State Business Tax Climate Index, which measures tax structure and rewards simple, neutral, stable, and transparent tax codes. If these changes were fully in effect today, Kentucky would rank 18th overall, an improvement from its current ranking of 33rd in the nation. The state would also experience marked improvement on most of the Index’s subcomponent ranks.

State Business Tax Climate Index Component Rank Projections for Kentucky

	Current	Proposed
Overall	33	18
Corporate	27	22
Individual	29	17
Sales	14	13
Property	36	36
UIT	47	47

Here’s what’s in the plan:

• Replacing Kentucky’s 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);
• Decrease 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; non-medical 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.

It’s true, of course, that the proposal constitutes a net tax increase, raises the cigarette tax, and taxes some intermediate transactions (with the potential for the sales tax getting embedded in the price of the final product multiple times over). Earlier rumored versions would have made great strides, eliminating the antiquated and uncompetitive gross receipts-style business alternative minimum tax (the LLET). But overall, the plan creates a more stable sales tax, with less effort devoted to picking winners and losers though the tax code. It implements low, single-rate individual and corporate income taxes, which matters at least in part because flat taxes are harder to raise in the future.

In sum, it eliminates costly and economically inefficient tax preferences in favor of broader bases and lower rates, which is exactly what tax reform is supposed to do.

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