A Response to Kentucky Gov. Steve Beshear’s State of the Commonwealth Address

January 8, 2014

Lyman Stone

Lyman Stone

Last night, Governor Steve Beshear (D) of my home state of Kentucky delivered his annual State of the Commonwealth address. In it, I was glad to hear him make a strong call for reforms of Kentucky’s “archaic” tax system, commenting on the “Blue Ribbon Commission,” whose disappointing recommendations we reviewed a year ago.

In his speech, Beshear said that Kentucky “generally gets good marks for our business tax climate” (we score the Bluegrass State as 27th in our State Business Tax Climate Index, two places worse than last year). He also called for some important reforms such as broadening the sales tax base (presumably to include services) and lowering the individual and corporate income tax rates. These are both important steps in making Kentucky’s code more modern and competitive.

However, the Governor also doubled down on some bad policies. He proposed to offer more tax incentives, not less (a strategy which has not always served Kentucky well in the past), and proposed the implementation of a local sales tax (a policy already present in 36 other states). Governor Beshear mentioned 12,000 jobs created through 217 incentive-receiving projects. Unfortunately, that statistic doesn’t address the majority of Kentuckians, who didn’t receive such incentives, and whose taxes ultimately pay for the public services those companies consume.

I’ve written previously that Kentucky’s tax climate is negatively affected by its high local income taxes and numerous tax incentives. Kentucky is one of just 12 states with local income taxes and, of those, just six (Alabama, Kansas, Missouri, New York, Ohio, and Pennsylvania) also have local sales taxes. Having both income and sales taxes at the local level (in addition to property taxes) can lead to increasingly burdensome local taxes, which is bad for businesses. Kentucky’s state-local combined top personal income tax rate is the 11th highest in the nation, and applies to many middle-income families. (To see average local income tax rates, see Table 12 of our 2014 State Business Tax Climate Index.)

Making the Governor’s proposed changes to incentive programs and local taxation would not improve Kentucky’s business tax climate. Kentucky already has relatively high tax rates, and, according to Governor Beshear’s speech and numerous commission reports, actually needs reforms to lower rates and make the tax base broader. A plan to have more incentives carving out the tax base and higher sales taxes is the exact opposite of real tax reform. Of course, if Kentucky policymakers believe a local sales tax is worthwhile, they could consider repealing the burdensome local income tax in exchange, which could make the state more competitive. But without some kind of real reform, Kentucky’s tax code will just continue to be an obstacle to the success of Kentucky businesses, and the state’s business tax climate will continue to deteriorate.

More on Kentucky.

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A 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.

The 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.

A 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.

A 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.